A Pricing Strategy for Your SaaS Offering
Pricing strategy is a major component of any business, whether brick-and-mortar or bits-and-bytes. In addition to being an important strategy to hash out, it is also generally quite tricky to do correctly. Should pricing be value based or cost based? Should it focus on maximizing income per unit or volume? For all of the things our beloved SaaS delivery model does for us, it does not ease pricing strategy pains. I’d even venture to say that it makes pricing strategy even more complicated. After all, SaaS providers pride themselves in allowing tenants to pay a periodic base cost and tack on optional (and potentially intricately priced) bells and whistles. So how should a SaaS offering be priced? Clearly, this is something that should be considered on a case-by-case basis, however, I do feel there is a good framework to work from that focuses on boosting adoption rate and deferring creation of income and healthy margins to a path of least resistance.
From the provider’s standpoint, one of the beauties of SaaS is its predictability. Generally, this is discussed from the standpoint of revenue, but in reality, many things are measurable and predictable – including cost of service per user. Over time, it should be relatively easy for a provider to determine how much must be charged per some time period to recuperate this cost. From my point of view, a good framework is to build pricing with distinct cost based and value based components and focus this pricing strategy on supporting a sales strategy that relies on harvesting additional, high margin revenue from existing customers.
In business, you have two choices when it comes to generating revenue and income: sell to new customers and/or sell to existing customers. Selling to existing customers is generally easier than selling to new customers. Clearly, selling to new customers is the only way to grow revenue when existing customer sales have reached saturation (all those who would buy the finite set of additional existing products/services have bought them). In perpetual license models, high prices generally posed significant barriers to new customers whether it was directly because of the expense or indirectly because of things like requiring approval from purchasing, etc. SaaS has significantly reduced this barrier but brought its own problems: one single perpetual license sale generally equated to significant revenue while one single SaaS customer does not. Given the aforementioned, many providers strive to rapidly boost adoption to reach a pleasurable cash-flow position, and rightfully so.
The Framework
The above brief discussion defines certain requirements of a SaaS pricing strategy: boost adoption, cover costs, and generate an appropriate margin. Let’s tackle these one at a time:
- Boost Adoption: Adoption is generally boosted by lowering the barrier to acquire your SaaS offerings functionality. In the Web 2.0/consumer space, we’ve seen the freemium model work well. Freemium may or may not work in the enterprise space, but I’d recommend staying away from it. Instead, offer a free trial. Next, price the base plan(s) for your product (the product without additional, for-charge bells and whistles) at cost or only slightly above. This reduces adoption resistance (assuming all other things are equal, like your offering is actually good and people see a need for it) and should optimize your ability to bring on new customers. If you price too high (which may happen if you focused on value based pricing), you may create a significant adoption barrier. If pricing is too low, adoption would be boosted but at a loss.
- Cover Costs: Generally, you may not be interested in selling at a loss. As described in the ‘Boost Adoption’ point, price at cost to recoup. It would even be logical to price slightly above cost to absorb any sudden fluctuations. This is where predictability matters. You shouldn’t have too many operating surprises and given a good amount of time, your cost estimates should be quite accurate.
- Generate Healthy Margins and Profit: This is the bread and butter of the bottom line. My suggestion is generate profit by selling the bells and whistle components of your SaaS offering to existing customers. If you can use cost oriented pricing to boost adoption through a low base cost, you should have a healthy market of existing customers that pose significantly lower resistance to spending more money. This is particularly true if your bells and whistles are actually valuable, giving you good justification to charge a value oriented price.
This seems obvious at first, but I see companies charging high prices for base use of their applications. This may be severely limiting in nature. Instead, hook new customers to your base product and then offer high margin value once they’re using it. Focus on getting as many paying customers on your base product, since this validates that they’re willing to pay and that they value your product. Figure out how to profit from that base afterwards. As I mentioned, this may not apply in all cases, but it seems to be a good starting point. The goal is to exploit the ease at which people can sign-up for SaaS offerings and get as many tenants into your easier to harvest tenant corral as possible.
Do you agree with this type of pricing strategy, or do you feel that something like a strict value based price is wiser? We’d love to know what has worked for you or where you are feeling the worst pains.
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Although many providers strive to rapidly boost adoption to reach a pleasurable cash-flow position; the Selling General & Administrative Expense (SG&A) of getting there is sometimes missed, so I agree that pricing should be a major analytical point for any Start-up SAAS or transitional SAAS Player.
SAAS Pricing Strategy can be achieved through estimation of your demand curve, cost calculation and understanding your environmental factors such as legal constraints or competitor actions.
Once these factors are in place the next steps is to choose a pricing methodology such as Cost + pricing (Self Explanatory) ,Target return pricing (deduced from an ROI expectant model) or Value-based pricing (Most profitable but difficult to achieve).
Having a SAAS business strategy partner is key to any SAAS success.
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Uri Lederman
SAAS Catalyst Program
There are a couple of factors that we discuss with our SaaS companies that I think are worth mentioning:
1) Set-up Fees – this speaks to the market adoption section in Sinclair’s post. How much will implementation slow down the sales process. What is reasonable and how does this influence the monthly recurring prices?
2) Minimums – in many SaaS models there is a function of usage based pricing similar to usage tiers on cell phones. In these cases the vendor may choose to lower implementation fees to get higher minimums.
3) Contract Length – There are differing views on contract length and how that should influence pricing depending on the service offered. In some cases signing a three year deal will provide reasons to look at “investing in the customer” by lowering the starting prices.
Uri,
Good point relating to environmental constrains (legal or otherwise). Clearly, that makes a significant difference in what is feasible.
Lars,
If you’re at liberty to answer this, I think it would shed some light on one of your points: In your experience with Hummer Winblad’s portfolio companies, do contract lengths have a drastic dampening effect on demand curves and/or sales pipeline close rates? I imagine that many customers are turned off by contracts of any sort when the SaaS medium promotes a low implementation cost and relatively low coupling.
I think creating a customer base for your main SaaS product is important, even if you created in a “low-cost” type situation, i agree in lowering the cost of the main product you can get a lot of customers from that strategy.
I would be interested to hear why you are recommending to stay away from Freemium. I personally think the strategy you are suggested is a bit web 1.0. You mentioned demand curves in one of your follow-on comments…..I think the idea of a trial is a great way to reduce adoption. Especially if the trial is only 1 month. If it was a 1 year trial then it may work.
Generally I like the freemium model much better and if you believe Chris Anderson free is the wave of the future. We aren’t there yet in the enterprise world but are we going there? Probably.
Mark
Mark,
I’m not a believer that freemium is the model for enterprise focused apps. SaaS usage by medium to large enterprises ($50mm a year in revenue or greater) will continue to grow. The notion of companies that size relying on freemium offerings won’t work because of reasons like SLA needs, perceived reliability, etc.
Additionally, as we move forward in the world of SaaS, I anticipate that application complexity will grow significantly. We’ll be seeing 3D rendering engines, photo editing software, etc. make their way into this medium to large enterprises. The incremental cost per user may make freemium prohibitive, which relies on low incremental cost increase per user (for the free users) making it recoverable as a marketing expense by paying users.
Trials seem to fit complex B2B offerings much better.
Good Thought process. There should also be a way to divide the company by segments and have a pricing scheme for each segment. Also, I think, the margin curve will be wavy, when adopting the SaaS model. By the time we reach the maximum utilization of the infrastructure and start getting the max margins from the infrastructure, it will be time to upgrade/buy more to accomodate new customers. Virtualization can be of a great help here but still more investment will be required after sometime.
Nice post, Sinclair, I think that the freemium model is a unique aspect of SaaS that I wish I could use more in my shrinkwrap software world. I’m linking to your post here: http://techprodo.com/wordpress/?p=292
Thank you for this article.
I agree that creating a low barrier to entry by keeping the base product/service price low is effective.
How can we get an idea of how much SaaS companies charge for enterprise? Everyone knows it’s cheaper than proprietary but can you give some examples of SaaS pricing models that have been successful? They usually don’t tell you the information on their website and require you to speak with their sales team before they divulge their pricing