Thursday, June 21, 2012

The Price is Right (or not)

One of the most important questions which every SaaS company has to solve is to find the right pricing – the right pricing model as well as the right price levels. It’s obvious that getting pricing right is extremely important: If you’re too cheap you will leave money on the table and reduce your ability to invest in customer acquisition. You may also hinder adoption especially from bigger customers who think that your product can’t be good because it’s so cheap. If you’re too expensive you might be scaring away the majority of your potential customers.

It is of course impossible to find the optimal price point in a way academic textbooks would define it. Finding that would require you to do more tests than you can possibly do. What you should do is try to get to that point as close as possible, and when I talk about the “right” pricing I mean a reasonably right pricing.

Unless your target customers are all very similar (which is unlikely), the most important thing that your pricing model has to accomplish is to capture different amounts of money from different customers based on their willingness and ability to pay, which correlates with the value that they’re getting from your product. In the old enterprise software world this used to be the job of the sales people – talk to the customer, find out about his needs, get a sense for what he can pay, offer him a solution and negotiate a price. In the world of SaaS, customers (rightly) expect more transparency and will look for a price list on your website before they start a trial.

In many cases a per-user pricing (often also referred to as “per seat”) is an obvious choice, and some of the most successful SaaS companies including are using that. Other successful examples include pricing based on:
  • number of clients managed with the software (e.g. Freshbooks)
  • number of newsletter emails sent (e.g. MailChimp)
  • number of email recipients in the system (e.g. ConstantContact)
  • amount of storage that is used (e.g. Dropbox)
  • number of events tracked (e.g. KISSmetrics)
What these companies have in common is that they've found an "axis" that highly correlates with their customers' willingness to pay, which allows them to keep their service affordable for small customers while asking bigger customers for much more. It also allows them to benefit from the growth of their customers, since a growing company needs more seats/emails/MBs/events/etc over time. Ideally this can lead to what is known as "negative churn" – the wonderful situation when the MRR growth of some customers of a customer cohort more than offset the effect of terminations from that cohort.

Importantly, most successful SaaS companies differentiate their prices along more than one axis (David Skok wrote about this here). Secondary axes include the level of support, additional features or other usage parameters. For example, Freshbook's pricing is based on a combination of the number of clients that you can manage and the number of seats, plus two additional factors:

So what's the right pricing model for your SaaS startup? For obvious reasons it depends and I have no general answer to that question, but here are a few practical tips:

  • Try to find one or more axes which correspond with the value that your customers are getting from your product and which correlate with your customers' willingness to pay. Talk to your customers and analyze how your early users are using the system to find out the ways in which larger customers are using your product differently from smaller customers.
  • In the beginning, err on the side of being too cheap rather than being too expensive. In the beginning the most important thing is to get customers. You can optimize your margins later.
  • Later on, make sure you're not leaving too much money on the table. If not a single customer ever complains that you're too expensive that's a strong sign that you're too cheap.
  • Accept the fact that it's very unlikely that you will get your pricing right at the first shot. Go out with something that you think makes sense, get feedback from the market and be prepared to make changes quickly.
  • If you increase prices, try to do it along with new value-add features that help justify the price increase. And offer your existing customers extremely generous grandfathering terms.
  • If your pricing is differentiated based on features, consider giving all users the high-end plan with all features during their trial so that they can play around with the full product.
  • Maybe not necessary to mention since these are all known best practices, but just in case: Give users a self-service free trial. Offer monthly pay-as-you-go subscriptions that users can cancel at any time. Provide an option to pay in advance for a year (with a discount). Create a clean, beautiful pricing page. 
Do you know any examples of pricing models that worked or didn't work, or would you like to get my feedback on your pricing model? Get in touch!