There are three factors to increasing revenue: acquisition, retention, and monetization. In my experience working with over 8,000 companies, I’ve found most companies ignore the third: monetization. At ProfitWell, both pricing and monetization is our calling.
Most companies use a weak method of pricing their products early on, and that method, in turn, sticks around 5 years (or even worse, longer). So let’s take a look at the proper way to price products. But first, you must understand pricing in general.
In this guide for SaaS pricing, I’ll review:
- Why using value metrics is pivotal to pricing your product
- How to find a proxy for your value
- Four steps to revamping product pricing
- How to think about pricing at three different startup stages
Value metrics: the secret to successful pricing
There are several common pricing strategies, but we’ve built ProfitWell around the most effective: value-based pricing. And at the heart of this model: Our value metrics.
Simply put, a value metric is how a customer pays you, and what they pay for. It could be a dollar amount priced per:
- Goods sold
- Thousand contacts
- Number of help-desk tickets
… the list goes on.
The perfect value metric for every product (B2B or B2C) should align with one of these three customer priorities:
- Revenue you’re bringing them
- Costs you’re saving them
- Efficiency you’re adding for their business
Find a proxy for your value
Attaching a dollar amount to your value-added — and then pricing just below that point — is economically the best way to capture the most value.
But getting that magic number is easier said than done. That’s why the next best thing is finding a proxy for your value. Salesforce, for instance, charges per user per month, while video hosting site Wistia charges by bandwidth use and number of videos.
Whatever proxy you use, you want your value metric to be as close to the amount of value you’re bringing the customer as possible. So what are the traits of a good value metric? The metrics should pass four key tests:
1. Be aligned with your customer’s perceived value
If your value metric isn’t near where a customer sees value, raising or lowering your price won’t have a desirable effect on profits. The closer your value metric is to where the customer sees value, the more you’ll be able to extract value.
Customers using Amazon Web Services (AWS) benefit from storage, time, and redundancies, so that’s how AWS charges. For a marketing product, the ideal place of value is the number of leads or contacts. Depending on your industry, you’ll want to choose an appropriate area for a value metric.
2. Be easily digestible
Customers will only buy if they understand your pricing. Especially for touchless sales, customers need to understand your pricing well enough to buy without speaking to a person.
“Easily digestible” can be dependent on your customers. You might be able to use a complicated pricing system to sell AWS to a developer, but need a simpler, more user-friendly pricing schedule to sell a CRM to a marketer at a small business.
3. Grow with value
Too many startups find themselves in a position where they’re selling to big international conglomerates and tiny startups, with both paying the same amount. If a customer sees more value, you should see more value. After finding product/market fit, many startups identify this issue and then need a way to roll out price increases without causing a customer uprising.
4. Pass the gut-check
Those three elements are the key fundamentals: they get you most of the way there, but don’t account for everything. I’d also consider whether the value metric would cause any unpredictability or undesirable behavior.
Typically, to see whether a value metric would cause this, I ask two questions:
- Can the customer control the value metric?
- Will they want the value metric to increase, even if that means they will have to pay more?
Take help desk software, for instance. One of the most accurate metrics for value added is the number of support tickets. But charging by support tickets can cause problems since the metric isn’t controlled by the software company’s customers.
What if they get more support tickets in December than January? They then aren’t able to predict how much their help desk will cost each month, which would drive their finance team crazy, in turn potentially preventing them from using your solution. Instead, what if you priced by their number of seats? While it’s one more level removed from your actual value, this proxy for your proxy (proxy for your proxy?) is much more palatable.
Common pitfall: Using “per-user” as a value metric
For most companies, “per-user” is a terrible value metric. Some companies still use it because it’s a hold-over from how software companies used to sell perpetual licenses. The problem: tracking users. On a marketing product, for instance, a company may have ten people on the marketing team, so they’re paying for ten users, but they also have a hundred-person sales team that benefits without paying a dime.
If someone can use the same login to get the same experience, never charge per user. If the experience is different — like Salesforce, where logins are lead-specific, per-user could work. In general, though, still be less precise than an ideal value metric.
How to understand your customers and capture value
The best pricing pinpoints the exact amount a customer is willing to pay. A lot of factors could drive that, including product, brand value, and competitors. At the end of the day, pricing is a question of customers. How much are they willing to pay? To answer that, you have to understand them.
1. Who is your customer?
Start by asking questions about your customers. Who are you selling to? What are they trying to accomplish? Answer these questions as specifically as possible. When I ask a CEO, “Who are your customers?” they typically lean more vaguely with something like “developers.”
But at a minimum, you should know your customers to this level of granularity: “Python developers at companies of 5 to 50 people based out of San Francisco.”
You might also have multiple customers, each with different traits. That’s an important realization; be sure to keep those groups separate.
2. What do they need?
Once you understand your customers, you can pinpoint their needs and how much they’ll pay for those needs. At this point, I recommend data.
Start by choosing a data-gathering framework. Then, ask your customers questions as scientifically shaped as possible, to pinpoint how much they’d pay for a solution to their problem. The more data you have on their problem and propensity to pay, the more accurately you’ll be able to capture value.
Four steps to revamping your pricing
To amp up pricing, startups can follow these four steps:
1. Admitting there’s a problem
The most important step to pricing properly is admitting that most pricing methods are wrong. Many companies price by guessing. But choosing a price arbitrarily—or leaving it up to chance—is just dangerous. Instead, recognize you need a formal method and get your team on board.
2. Getting aligned
When we surveyed 270 SaaS businesses, we found that only 17 percent defined their pricing strategy with input from their whole team. This is a huge opportunity loss. Pricing touches on all parts of your business, so all parts of your business should touch on pricing. At a minimum, get input and alignment from these four key departments:
Your product team builds features based on a deep knowledge of what users need. This deep knowledge can contribute crucial insights into your product’s packaging and pricing.
Your marketing department understands your customers and their behavior; use them. They also need to be kept in the loop in identifying the right messaging and communicating price changes.
Pricing needs to drive profits, which means it must allow your team to close sales. Familiarity with your pricing can help your sales team develop a more defined pitch and more accurate forecasts, which ultimately impact your revenue and profit.
Your company’s executives, from the CEO down, tie it all together. Management should take control of coordinating the pricing strategy, bringing in knowledge from all other departments when arriving at a decision.
3. Executing a Method
Now that your team is on board, it’s time to execute an answer. Pricing should be a scientific process, so use the scientific method: do research, develop hypotheses, and test.
Start by talking to your target customers. Ask a dozen people about their problems. Without leading the witness, ask what they think about pricing. Then run that data through a technical method like MaxDiff or Price Sensitivity Meter. These are incredibly efficient models for determining a person’s willingness to pay; use them.
That process will spit out a recommendation for your company leaders. At this point, it’s important that one person has the final say and a deadline to pull the trigger. Otherwise, you may end up pricing by committee, which can thwart the effectiveness of this whole process.
4. Staying Updated
Pricing is not “set it and forget it.” You should be changing something about pricing, packaging, or positioning every six months – ideally even more quickly. Whenever you put out a new product or feature, consider how it affects your overall pricing.You should be changing something about pricing, packaging, or positioning every six months - ideally even more quickly. Click To Tweet
Common pitfall: Beginning too big
This process can seem daunting. Starting small is the best way to avoid analysis paralysis and prevent a huge, multi-year pricing plan, which doesn’t adjust quickly enough. Starting with one piece of the puzzle helps get the ball rolling. Identify your value metric or price a new feature properly by getting input from multiple teams and deeming a final decision maker with a deadline. You’ll see the benefit to your bottom line and it’ll encourage the whole company to improve pricing across the board.
SaaS pricing at three different startup stages
You can apply these tactical tips to a startup of any size. Different stage companies do, however, have specific difficulties. For each size, here’s what to keep in mind:
Early-stage companies have so much to focus on, which can pose a challenge for pricing changes every six months. The most important element is your value metric. Figure it out as soon as possible. A well-chosen value metric can give you a lot of leeway. I’ve seen plenty of companies mess up several other elements but still survive because they chose the right value metric.
Growth-stage companies — especially venture-backed ones — are expected to grow incredibly aggressively. Once you have your first batch of customers, you can start witnessing market share problems: The easy customers are already acquired, so where does your new growth come from? That’s why growth-stage companies should make sure their value metric drives revenue as their customers grow.
If your value metric grows along with your customers’ growth, you can grow from retaining users, even if you’re not acquiring new ones. Stripe, for instance, is paid a portion of customer revenue per transaction. As long as their churn stays low, they can grow rapidly alongside customer success.
Series A and B pricing
Seed-stage companies often have to make their own mistakes before realizing the importance of good pricing. Once a startup hits Series A and B, however, things get more serious. These companies have already learned the value of thinking deeply about pricing.
When I work with Series A and B companies, I ask these questions:
- Have we pinpointed the best value metric possible?
- Can we align price to customer value more precisely?
- Can your customer personas be broken down more granularly?
Understanding different personas allows a company to eliminate harmful customers and capitalize more extensively on the beneficial ones.
An e-commerce platform, for example, might find some customers are profiting greatly from the platform, costing lots of resources, but only paying the entry-level price. Once you realize that, you can change the price (I’ve seen $30/month become $3,000/month).
Money is a measure of perceived value. When you’re charging a customer, set your price where they perceive your value.
Forgetting to raise prices can be costly, too. If your customers are growing, reaping more and more value from you, you’ll, in turn, reap value from that relationship.
Pricing effectively isn’t easy, but it’s worth it. Your marketing team is probably already invested in some simpler pricing questions, like the color of your “buy now” CTA button, or whether your more expensive option should be on the left or right side of the screen. If you can channel that interest into bigger questions like, “what’s our value metric?” or “how should we be positioned?” you’ll capitalize exponentially on the most important issues — and those are the issues that drive real profits.