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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