SaaS Pricing Decoded: Balancing Value, Growth, and Cost

Introduction

In any business, the interplay between cost, price, and value are critical variables in understanding pricing. A simple definition of price is the gap between your company’s cost structure and the value delivered to the customer. The difference between cost and price is the margin and your incentive to sell, and the difference between value and price is the incentive to buy. The larger the gap between value and price, the shorter the journey toward PMF (product-market fit).

“Most pricing challenges come from a lack of understanding of the relationship between these variables”

There are three avenues in a SaaS business to drive growth i.e., conversion (acquiring more customers), churn (retaining more customers), and monetization (getting more $ from existing customers). While pricing plays a role across all three avenues, it maximizes benefits around monetization driving growth and stability in a SaaS business.

Understanding SaaS Pricing

Pricing is one of the most important decisions that a SaaS company can make. A wrong pricing strategy can lead to lost revenue, market share, and even the failure of the business- this is also progressively difficult to correct as time passes and changes add strategic and operational risk to the SaaS business. There are several pricing strategies that SaaS companies can use. The best pricing strategy for a particular company will depend on a few important factors, including the product or service being offered, the target market, and the competitive landscape.

There is no one-size-fits-all SaaS pricing strategy, it requires some experimentation within your ICP (ideal customer profile) and must be understood in the context of your product and market. Below is a table with a non-exhaustive list of broad pricing strategies.

Pricing for Early Customers

In my own experience, the early customers and adopters are not mature customers and are driven by different motivations than mature and late-stage customers. A new, innovative, and category-creating product usually pressures customers to change their existing ways- this is more difficult with mature buyers requiring higher information and trust versus a leap of faith to solve an immediate pain using a new way. The early adopters have a higher risk appetite, looking for an edge, proving a point, and hence less price sensitive, it provides a new startup to charge for value.

“Going cheap early is like training the market to create a mental model around the product value. If optimized only for conversion rates and not value, it can permanently damage the value of the product”

A common issue is founders and CEOs equating pricing to only enhancing sales velocity (conversion rate) and not revenue, this is risky when creating a new product category or disrupting an existing market. The initial customers take a risk, but the startup risks training the market to a lower price point below its real value. Lower prices are irreversible and will also create reputational risk. Founders and CEOs must understand the product's value and educate the market to grasp its potential. There is a fine balance between charging for value and sales volume, sales velocity rarely changes if the product value is correctly articulated to the market.

Optimizing Pricing

Pricing requires constant testing and optimization with the end goal of maximizing revenue. Four key elements need to get in alignment i.e., price, conversion rate, sales volume, and revenue. The below table was mentioned in one session from Y-Combinator a few years ago. Looking at the examples in the below table, row #3 (in green) is the optimal path to fix pricing to maximize revenue. However, if your product and company have the cost structure and capitalization to afford the price in rows #1 and #2, they can be viewed as lost opportunities thus opening the room to tiered pricing structures and testing them for different customer segments.

An ideal pricing structure must stay focused on the outcomes of maximizing revenue, creating stickiness (low churn), and monetization potential.

“Do not let marketing and PR get too ahead of the product, it will hinder your ability to raise prices, articulate value, and eliminate degrees of freedom to pivot in the future”

Your pricing will drive your customer acquisition strategy and tactics, if the current state of your company has sub-optimal conversion rates driving low revenue, then rethink the customer acquisition strategy and/or price to make sure the margins can fund your CAC.

Common Pricing Pitfalls

• Don’t underestimate your costs, try your pricing to experiment in your early days and avoid undercharging. Your margins must fund your CAC (cost of acquisition), or else it will affect your capitalization.
• Young SaaS companies often discount too much because they don't understand the value of their product and fail to articulate it. This can lead to a downward spiral, as customers come to expect discounts and the company loses money.
• Focusing on the wrong customers (non-ICP) and trying to convince customers of a better product than competitors at a lower price never works. Pricing must preserve product value and protect the capitalization of a SaaS business.
• Do not let marketing get ahead of the product, it will hinder your ability to raise prices, articulate value, and eliminate degrees of freedom to pivot.
• Do not pick the wrong value metric for pricing, SaaS companies have a lot of options e.g., GB storage, compute, contacts, user seats, etc. Never assume that your competitors got this right either.

Key Pricing Considerations

• Pricing is neither static nor permanent, it must be executed in the context of the product, the market, and customer segments. Here are tactical considerations:
• Understand the variables and their relationships i.e., cost, value, and price, and impact on your SaaS business.
• Consider the product's context. Some products are more commoditized and priced on cost, while others have higher perceived value and can be priced based on value.
• Consider the market context. Enterprise customers will pay more, while individual users are more price sensitive. Get it wrong and you will lose customers and money.
• Consider competitor pricing, but don't blindly copy. Understand your cost structure, GTM efficiency, and value delivered. If prices are too high, lower costs or improve GTM. If prices are too low, you may not cover costs and need more funding.
• Be flexible, and pivot when it makes sense -customers, markets, and competitors change often and you need to be ready to adjust your prices as needed preserving your ability to operate and ability to compete.
• You must raise prices until you can hit an optimal zone of monetization e.g., lose 10-15% of deals. If you have never changed prices, then you are losing out on a lot of potential growth.

Concluding Thoughts

Pricing is a key lever for SaaS companies and by understanding different pricing strategies, SaaS companies can choose the best strategy for their value creation. Know your product, understand your market, and make sure you are aware of your cost structure and value delivered. One of the things that worked well for me in the past is - to initially charge 10% of the value delivered by your product and raise prices yearly by 3% until you start losing ~15% of your deals in the pipeline.

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