Successful pricing techniques for SaaS start–ups
Pricing is one of the most important and complex issues faced by any business, especially start-ups. In the words of Warren Buffet: “the single most important decision in evaluating a business is pricing power”. However, too many teams still find it hard to get pricing right. A recent study in the Harvard business review found that “72% of all new products don’t meet their revenue targets. And a quarter of companies, according to the same survey, confess that not one of their new offerings met its profitability goals.”[1]
In this article, we share some insights and best practices, on how a SaaS start-up can set itself for success.
We first cover how the pricing process starts in the product design phase with the choice of product features, and the understanding of user profiles. Then we discuss how to create effective price plans, and how to choose the right monetization model, before closing with how pricing strategy can support revenue maximisation and market share.
A few pre-requisites for a sound pricing strategy
Pricing and product configuration are intimately intertwined. Most successful companies will try to design product features with already a price point in mind. This best practice stems from obsessing over customer needs and designing customer centric products. When start-ups are able to design their product in this manner, they are in the best position to capture a customer’s willingness to pay. This approach allows them to use the full benefits of value-based pricing, especially if the product is disruptive. Value based pricing charges customers a fraction of the incremental value created by the product. This value could originate from enabling the customer to do something new that was until now impossible, or from creating direct savings in costs and time, or even from increasing convenience for users.
The other crucial pre-requisite for successful pricing is a good segmentation. Every start-up will have one, because they realise that they can’t have a “one size fits all” approach. However, in most instances, start-ups don’t use segmentation enough to influence product development[2]. They use it to customise sales and marketing messages, and it is often based on observable characteristics such as geographic location, size or industry, to name a few. What I found to be a better approach in many instances, is to focus on specific use cases of the product. Consider for example a simple classic segmentation based on company size: Small, Medium and Enterprise. What if in this case, the medium and Enterprise customers use a product in two similar ways, solving two similar problems, and deriving comparable benefits? Would it not make sense to do a segmentation based on those use cases that run across the “Small, Medium, Enterprise” categorisation? If customer willingness to pay is driven by the use cases, then yes this would be the right approach.
Creating the right number of price plans or tiers
The next stage of the pricing process is to list all product features available then bundle, or package them to create different offerings that meet the needs of the different segments.
Generally, for a SaaS start-up that has a simple offering, three tiers or pricing plans are sufficient. An internal terminology often used to describe these tiers is: Good/ Better/ Best. The “Good” plan will offer the core feature of the product, while the “Best” plan will have all the bells and whistles, as well as appropriate services and SLA expected from enterprise customers. The bundling of features and services for each of these categories will reflect an increasing and deepening usage of the product capabilities, and also more complex business requirements on behalf of the buyer.
As a rule of thumb, and from case studies encountered, no more than 20% of customers should opt for the first option, while 80% should opt for the other two. It is also common to strip the “Good” offering of some desirable features to incentivise customers with strong willingness to pay to move up to the next tier or package. Otherwise a start-up might end up with too many customers in the entry plan and will be foregoing substantial revenue.
Monetizing models for the SaaS start-ups
Choosing a monetization model means determining how a customer is going to be charged or billed, which is as important today as the price itself. This approach integrates an understanding of affordability, and how users derive benefits from features and packages. An effective monetizing model for SaaS will enable new customers to easily get on-board the platform, and progressively deepen their use of the new product or service.
Here are some common examples of SaaS metrics reflecting usage.They have the merit of being clear and transparent to users.
- Flat rate subscription for use of all product features
- Rate per user
- Rate per tiered user – SMB, Enterprise etc…
- Rate per storage unit
- Rate per product feature or group of features
- Rate per active user
- Pay as you go
- Freemium
Let’s look specifically at two interesting cases, the two-part pricing model and the freemium model.
A very common and successful monetizing model for SaaS involves the combination of a subscription fee to access the platform with a variable cost associated with the use of specific features. This two-part tariff or pricing can increase revenue and profitability if executed correctly.
In general, the per-unit price for the product or service will be lower under a two-part tariff. This encourages consumers to consume more under the two-part tariff than they would otherwise. The profit from the per-unit price, however, will be lower, but the flat fee is set high enough to at least make up for the difference but low enough that consumers are still willing to participate.
With the freemium model, a company offers a price tier for free, provided that the cost of serving these users is very low or nearly nil. The goal of a freemium model is to attract a very large customer base to the free version and later convert a part of it to paid subscriptions. A freemium plan also develops a community of evangelists within an organization which drives demand to a higher level. This free offering becomes in effect, a marketing tool for the premium offering.
Prioritising revenue, profits or market share
The final important consideration we will cover here, is whether a start-up will use its pricing policy to maximise revenue and profit or market share. Pricing will be very different depending on the goal chosen.
In the first strategy, the goal is to maximise revenue and profit for the new product. The optimal price in this case is the point on the price elasticity curve at which the profit or revenue curve reaches its maximum. This strategy is valid when, as described by Ramaujam & Tacke, “there are no early adopters with disproportionately more willingness to pay, or when gaining a huge market share rapidly is not worth the expense of lower revenue, or profit”[3].
In the second option, the start-up will intentionally price its product lower than in the previous strategy to rapidly gain market share and penetrate the market. This approach is very common for SaaS companies, and serves a similar purpose as the freemium models. This is all the more effective in markets with network effects. As a result, the start-up is in a better position to maximise customers’ lifetime value from future sales and upsells3.
Iterate and perfect
Pricing a new product right often follows an iterative process and requires some time to stabilise. For example, if the sales funnel is moving too fast and there are very few price escalations, it is probably a sign that the packages are under-priced and need to be changed, the converse is also true. A common advice I have often heard in the field is the following: “If 10-15% of the well qualified customers for which the new product is a good fit, are lost because of price, this is a sign that the price is about right.”
On the long term, a significant sign of customer satisfaction in SaaS companies, is whether customers are happy to renew their subscriptions and continue paying the price of their package. In this case churning is low and requests for price renegotiations are rare.
In conclusion, effective pricing is a difficult exercise that starts during the product design phase and continues way after the go-to-market phase has executed. It hinges upon a multitude of factors such the choice of features, the segmentation, the bundling and the tiering plans, the monetisation model and finally the strategic decision of whether to go for profit maximisation or market share acquisition. Getting all those parameters right is an exploration process involving multiple cycles of trials and adjustments.
[1] https://hbr.org/2014/09/the-silent-killer-of-new-products-lazy-pricing
[2] M. Ramaujam and G. Tacke, describe this very well in Monetizing Innovation
[3] M. Ramaujam and G. Tacke, in Monetizing Innovation
