SaaS startups are bad at pricing. On second thought, I take that back. They actually know how to determine prices for SaaS software. What they don’t know is how to figure out how much customers want to pay. And the difference between the two is quite profound when it comes to effective monetization.
We at Eleken have helped dozens of SaaS companies with design and noticed one paradoxical pattern. Startups put acquisition and retention higher than the work on the monetization of their services. They put tons of effort into their home page. The price page they often set once at the beginning and then forget forever.
This is despite the fact that monetization has the most significant impact on the bottom line, leaving retention and acquisition far behind. According to the study published by Price Intelligently, a 1% improvement in pricing results in a 12.7% profit increase. Acquisition and retention affect the bottom line not nearly as much.
It looks like working on how to price your saas product is the most important thing you can do for success. But in fact, for an average SaaS startup, it takes only six(!) hours to decide on pricing. That is not per week or per month — six hours, overall, to set, test and sharpen everything.
The anatomy of SaaS pricing strategy
Pricing a product is much easier than pricing a service. Pricing innovative service is a hundred times harder than pricing any everyday stuff. No wonder that the SaaS pricing process often reminds of picking numbers out of the air. Guesswork doesn’t count as a SaaS product pricing strategy.
Whatever price you guess, it will fall somewhere between one that is too high to generate any demand and one that is too low to cover expenses. You’ll hardly know if your customers appreciate your service more and you are leaving money on the table. You’ll figure out that you were overpriced only after you scare away a bunch of potential customers.
SaaS companies need some tools to narrow down the pricing search. In this article, we’re providing three SaaS software pricing strategies for you to come to the rescue. Each of them has its place in business, but (spoiler alert) SaaS companies need to pay particular attention to the latter one.
Cost-plus pricing strategy
This strategy embodies what people basically mean by business — selling items for more than the cost of production. It is the most widespread strategy for manufacturing and retailing companies.
Cost-plus pricing's advantages are its simplicity and predictability. It requires no formulas, it doesn't need a deep understanding of your market or your customer. You spend $2 to brew some coffee and want a 50% markup that makes $1. Slap the numbers together and voila, you get $3 and put it on a price tag. You're guaranteed to make that $1 with every sale.
The cost-plus pricing model lacks the flexibility to fit SaaS companies. What if you need to intensify marketing or hire a new employee? The cost may change swiftly. Subscription prices can't be modified all the time to absorb every cost fluctuation, which means the margin will take a hit.
And by the way, why do many startups put so much emphasis on internal cost when determining price? Customers are not interested in your costs. Just like they don’t think about the price of components when buying a bottle of cola, they don’t care about how much you spend on development. Cost-plus pricing may be convenient for a company, but it has nothing to do with customers’ expectations.
If you sell software as a service, the value your products deliver is probably
much greater than the cost to produce them. Start looking beyond your product to stop missing out on money.
Competitor-based pricing strategy
When you enter a new market, you don't usually know how to price SaaS. You don't want your price to look ridiculous when compared to similar offers. You look left to find the lowest price, then you look right at the highest price and take a safe place somewhere in between. Your monetization is competitor-based.
The main advantage of the strategy is, again, simplicity. It takes half an hour to browse the competitors' websites and a bit of math in your head (or a spreadsheet for advanced users) to have the price ready. “So, my competitor’s price is $3, and I will charge the same because they probably did their homework and know that $3 is what the market used to sustain, right?”
Yes and no. On the one hand, it’s a good idea to bear in mind what your competitors charge. Businesses that compete in a highly aggressive space may depend on this strategy completely since a slight price difference defines the users’ choice. Consider you decided to open a coffee-to-go shop. You won’t attract many customers with the price twice as high as the coffee shop next door.
On the other hand, no one ever made a major breakthrough by copying someone else's (not necessarily correct) decisions. You’re probably offering a service that differs from others somehow and has more value than your competitors’ service. Otherwise, why would you stay in business? Putting a price tag based exclusively on matching your competitor, you’re losing an opportunity to stand out, to separate yourself from the others. You’re losing your chances for rapid growth.
Value-based pricing strategy
It's the process of systematically identifying the best opportunities to deliver your audience what matters most. The truth is that the journey has no endpoint. You can never have a good enough understanding of your prospects.
Therein lay the biggest downside of value pricing — its сomplexity. You don’t have all the needed information ready, as in the case of cost-plus. You also have no opportunity to gather all the data in 30 minutes of going through competitors’ sites, as we’ve done with the previous strategy.
Yet, the value-based option is highly recommended for SaaS.
This SaaS model pricing strategy gives you two significant advantages. Firstly, you can charge more than your competitors, given that the audience is ready to pay for the value you’ve prepared for them. While healthy SaaS businesses have a lifetime-value to a customer-acquisition-cost ratio (“LTV:CAC”) of at least 3:1, value-based pricing can kick that ratio far beyond, skyrocketing their growth rate and profitability.
Let's take an example of a social media marketing tool HootSuite. Its cheapest plan was $4.99/month in 2010. Since then, they've updated their pricing year after year to reach the price of $19/month for a starting package, it's almost four times costlier.
Secondly, you can raise prices as you develop new features and add more value to your services. Development costs may stay the same, but as customers appreciate your services more, they will be ready to pay more. Who really cares that Dropbox went from $9.99 to $11.99 per month if the shift was followed by four times more storage offered?
This strategy assumes that you’ve learned your audience and can split it into buying personas to offer every persona a feature mix of its dream. Let’s see how it works for a real-life B2B SaaS pricing strategy.
Slack is one of the most successful SaaS businesses in the world, that hits 12.5 million users, including ourselves. Slack offers a basic set of features for free plus three more upgrade plans. The company splits its offer into packages to fit a wide range of customers: for small and medium, large and very large businesses. Slack knows what features each group cares most (and least) about and includes the list of killing features to each package.
- The Free plan exists to convert interested users. Here you pay $0 but get limited by up to 10 app integrations and only 10,000 last messages available.
- In the Standard plan, you pay $6.67 per person per month to get app integrations and message searches unlimited.
- In the Plus plan, you pay $12,50 per month per person to get enterprise-level services in terms of security, compliance, and administration on top.
- The Enterprise Grid is for companies too big to work in a single workspace. It allows the creation of multiple interconnected workspaces. Pricing for Enterprise Grid is open-ended to fit any company too big for a pay-per-person approach.
We at Eleken do something similar with pricing for our design services. We also have three pricing packages, but in our case, the criteria for differentiating is not the size, but the challenge customers come with.
The essence of the value-based strategy is the continuous work on your target persons' profiles. The results you get are useful not only for pricing but also for product, design, and marketing. A deep dive into the values of your audience will help your team stay focused and make consistent decisions. It will help you prioritize product updates. It will help you avoid feature creep.
To sum up
Your pricing is not a task you can cross off the list when done, it’s a process — a long hike to the top of the mountain. Don't be afraid to start from a “minimum valuable” pricing when you roll out your minimum valuable product. The price is part of your product, so you can develop it together with your service and your knowledge.
Few, if any, big shiny SaaS brands launched with perfect pricing. The best pricing strategies for SaaS are dynamic ones. Mailchimp, Slack, and Hootsuite have all modified their SaaS pricing as they've perfected their core product, with ups and downs, learning what their customers' value and trying to maximize those values in their products.