Key Points
Before you can determine pricing, you need to determine product positioning.
Pricing has to work for the business, the customer and be consistant with product positioning.
Pricing will evolve and need to be adjusted as you learn from your prospects and your business.
Developing a proper pricing structure for B2B SaaS software products is complicated. Pricing has many requirements, and figuring out how to get it right is not easy. It takes plenty of trial and errors. Getting pricing correct is extremely important because it will determines the length of your sales cycle, who the decision makers are, your position in the marketplace, sets customers expectations and has to keep you profitable.
SaaS solutions are attractive to customers because they reduce the upfront investment and avoid the ongoing costs of maintaining the hardware and the software. With a SaaS solution, those costs and risks are transferred to the software developer, so it’s important that the pricing structure accounts for this.
Pricing also has to work for all the stakeholders:
There is no simple formula or a 3-step process to help with pricing you product. I hope to show the different approaches and implications of various decisions to help you form a solid foundation for coming up with a pricing strategy for your products.
The one assumption I’m making is that you already know the product positioning for your offering.
Before we can talk pricing, there needs to be a clear product marketing position that pricing supports. If you haven’t figured out your product positioning, do it now, because a misalignment between pricing and position will quickly kill your sales.
If you don't take product positioning seriously, if will most likely kill your startup. Check out some startup post mortems here or here and look at the most common reason for failure. It's the "Lack of product to market fit". Which is generally the result product marketing failure.
Product positioning is an important part of a product marketing strategy. If you try to be everything to everyone, you may not succeed with anyone. A specific position helps buyers understand where the product fits in terms what it offers, and how it compares with the competition.
As an example, let’s look at the e-mail service space for an example of product positioning:
As you can see, all of the companies here are e-mail services providers and probably have a large overlap in their features. However, by positioning their product for a specific niche, and tweaking their specific features they are able to carve out a space to operate and generate profits from it.
If you haven’t thought about product positioning, now is the time to do it. There are many other wonderful resources on product positioning and marketing.
Let me give you two warning as you think about your product positioning. Do not let pricing be your differentiation. There will always be someone who will find a way to undercut you and offer a similar set of features cheaper than you can. Please try to find a different way to position yourself other than price.
Have a clear decision on if you’re going to be a premium product in the marketplace or not. A premium product may require a sales team, which means additional hiring, costs, commission, etc. A premium product also comes with certain assumptions about account managers, phone support, etc. This isn’t to discourage you from pricing at a premium, just be aware of the implications.
Pricing before the product is launched is more art than science. There are more unknown values in your equation than known numbers. The goal of here is to at least point you in the right direction and avoid a major mistake.
Key Points
You need to know the value propostion of your product
Switching costs and barriers are key part of determining correct pricing
Signs that your pricing is making sense
Once you know how your product is positioned in the market, and have identified your ideal customer, you need to understand the following information about your customers and your product.
What is the purpose of your product?
If your product promises to grow sales or cut costs, this is very easy for the customer to quantify and people are more willing spend money when they can quickly figure out if the results are there. As long as your price is less then the value to the customer, in theory, they would be willing to pay that. Don't be afraid to think about a higher price point since you’ll know exactly how much value you’re providing to the customer.
Example: There is an industry in helping shippers automatically get refunds for late or mishandled packages from UPS and FedEx. The pricing is always a percentage of the money recovered. It's the perfect: we charge you slightly less than the value to you.
Staff happiness and increasing efficiency is typically hard to quantify, and often prospects balk at buying a product that doesn’t offer a clear ROI they can put a number on. Imagine going to your boss for approval to purchase something and the boss asks "Great, if we spend this $500, how can we track the results?" If this is your value proposition, consider for your pricing to have low upfront cost or an easy way to get prospects comfortable trying the product - but not for free. We'll address the "Free" pricing later on.
Switching Costs and Barriers
If your product is extremely sticky, meaning once people start using it, it’s hard for them to move then the pricing needs to encourage people to get started. Consider a free trial, help onboarding, or anything else that encourage people to get started. This is especially true if the signup and launch process is completely automated and there is no customer configuration or onboarding process required.
I once had a number of conversations with an enterprise SaaS vendor that sold a product starting at $10,000 per year range and it probably saved their customers much more than that. They had the perfect SaaS setup, where onboarding was competly automated and their costs for a new account were negligible. They didn't offer a self-serve trial option at any cost (free, highlighy discounted, etc). They ended up going out of business. Now, this isn't the reason the company failed, but if it costs you $0 to offer a test drive, you should consider having the option. This will help you build your sales pipeline and potentially close more business.
If the product requires lots of upfront configuration, integration into other systems, etc consider having an implementation fee. This is something that businesses are used to because they require lots of handholding during the launch process to make sure it goes smoothly and doesn’t disrupt their operations. You also don’t want to lose money when launching clients. The implementation fee should cover your cost but should not be prohibitive. If you're going to spend time and resources to get a customer to launch, you want them to have skin in the game by committing some cash upfront.
If your product requires integrations and configuration, consider having a project plan you can present to the prospects. This will show them what they are getting as part of the onboarding and launch process and will help you justify the value. This will also help you clarify any assumptions the prospect had about the launch and minimize the "Wait, I thought I was getting an integration into my accounting system as part of this" difficult conversations.
As you begin the journey to come up with the pricing plan and ideas start to bubble up, here are the signs that you’re on the right path:
Key Points
You need to know the target customer well
Keep your pricing and your customers budget for your service in alignment
Now that you’ve identified your typical customer, build out a sample P&L for them. It’s easy to skip this step, but don’t. This will help you gage if your pricing makes sense and keep you on the right path. Using the average size business you are targeting, estimate’s their typical gross margins, other expenses to arrive to the first data point we need:
If I was a potential customer, given my business’s profitability and operations, how much can I possibly spend on this product?
As an example you decided to become an e-mail provider.
You’ve decided to target e-commerce merchants who are established, growing fast and doing between $10M and $20M in annual revenue.
Revenue $10M at 40% gross margin
| P&L Line | Ammount |
|---|---|
| Gross Revenue | $10M |
| Gross Profit | $4M |
| Net Margin | 20% |
| Profit | $2M |
| Warehouse costs, 7 FTEs, E-commerce software, accounting package, marketing, packaging supplies, etc. | |
Good news, you don’t need to be thinking about pennies as clearly a typical customer is operating with healthy margins and should be able to afford to pay for a service that will grow their business.
However, let’s say you you made the decision that you want to get the customers while they are small and have them grow with you. You’re now targeting retailers who are doing 500K in annual revenue as your ideal customer.
Revenue of $500,000 at 40% gross margin
| P&L Line | Ammount |
|---|---|
| Gross Revenue | $500,000 |
| Gross Profit | $200,000 |
| Net Margin | 5% |
| Profit | $25,000 |
| 2 FTEs, E-commerce software, accounting package, marketing, packaging supplies, etc. | |
In this case, you better believe that the owner is going to sweat the difference between $50 and $150 dollars a month, so you will have to price your solution significantly cheaper to get traction in this market and you’re going to be dealing with significantly more price conscious crowd.
This is just one example of why proper market positioning and pricing alignment is important. You can’t go after the entry level business at $500 a month or after growing businesses at $50 a month. In both cases you’ll find your self priced out of the sale because in one case you’re too expensive, in the other case, you seem so cheap that the prospect assumes you are probably lacking features or support.
Key Points
Learn how your competition is positioning their products. Often you can see their strategy from the pricing.
Look for gaps in their pricing and figure out why they are there.
The next step in the process will be evaluating the competitor pricings strategies and a framework for organizing them. It’s not enough just to find out what the competitor is charging, but it’s important to understand the drivers of their pricing and how they put together their pricing packages.
The most common pricing strategies include:
Freemium - Offer basic services or limited features for free and charges for more sophisticated components or more usage. Note at which size/feature the customers are forced to change to a paid plan.
Pay as You Go – Plans that grow based on use (transactions) or capacity (storage used) of the product. Generally, the more the client uses, the less they pay per unit. Note what the tiers are. This sends an important message to the prospects. If your top tier maxes out at 1000 widgets and I deal with 10,000 widgets, I may assume that I'm too big for your product.
User Based – Pricing based on number of users allowed to use the software at the same time.
License Fee - Pricing tiers based on access to certain features but not scaled based on actual usage of users in the system.
Additionally, note if your competition basing their pricing on:
Set license fee vs revenue share
Number of users / seats
Specific features locked / unlocked
Personal Anecdote: I was looking at a digital signature solution. I found one with a great entry level plan, which fit my projected use. The plans were based on the hybrid of transactions and additional features. One of my requirement was that it would sync to Salesforce. As soon as I added the Salesforce integration requirement, I got bumped into the Enterprise package, that cost 20x the entry level. They lost my business because they used "Salesforce" integration as way to split small business from Enterprise, without accounting for Salesforce being the most popular CRM.
Personal Anecdote: I was looking for a vendor to host some videos that had special player requirements. One looked promising so I sent over some questions. This is a quote from the response "We don’t actually have a team that supports Pro sales or account management currently." There is nothing wrong with a full self-service model, but if you're selling to other businesses some human to talk to customers is generally helpful.
Remember your pricing sends a very specific message to the prospect.
This is a quote from ChannelAdvisor's 2015 Q1 earnings report: "Fixed subscription fees were 78 percent of total revenue and variable subscription fees were 22 percent of total revenue for the first quarter of 2015. This compares to 73 percent and 27 percent, respectively, for the first quarter of 2014." Source
As you can see, their customers are forcing them into switching to license fee from revenue share.
This means that if I’m a smaller business, doing 200 – 800 transactions a month I may look and think that you’re too big for me since I fall to the smaller side of your smallest plan. On the other other hand, if I am a big customer, I see that your max plan is 10,000 and even if you have a note “for larger customers call us” I know that if I am doing 20,000 transactions, I’m twice your largest package and I can assume you may struggle to support me from a technology and other standpoint.
Key Points
- Make sure your price makes you money after all costs are factored in.
It maybe too early in the development of your product to properly calculate the cost of creating the product, lifetime value of a customer and cost of sale but you should at least try to keep in mind different costs that eventually the product revenue needs to cover.
So how many customers do you need at $10/month to cover all that?
As an example of the above list you can do back of the envelope math as following:
Key Points
Try to use all available inforation about your potential customers to come up with an acceptable pricing strategy
Pricing sends a message, be on the lookout for when the wrong messages
This is a collections of a few quick ideas to keep in mind before you get to the actual pricing considerations.
One of the key customer insights that many miss, is to find out what else the customer is paying for and see if you can back out some of their decisions based on that. As an example, let's say you are targeting e-commerce retailers. E-commerce shopping carts generally come in two options
Just by asking your potential customers what else they've bought or what platforms they have in place, you can make key decisions based on those insights. By asking what cart they are using, you just backed out the following information:
Be careful of pricing getting too complex. You can maximize revenue by segmenting your customer base, but the way you gate your product needs to be conveyed clearly in the prices. As you segment your pricing remember, price sensitive customers get limited plans, value sensitive customers get the VIP plan.
Too few tiers leaves cash on the table but too many tiers are just as bad at confusing customers.
You pricing point will determine wether you need a no-touch, low-touch or a high-touch sales operation. Are you interested in a business with fewer, high margin customers or a mass, lower margin offering?
Freemium is a marketing strategy, not a way to make money. This blog post is perfect read on the topic: Screw Freemium Use a Free Trial