The thought of pricing came up again recently after a tech meetup held at the Advisory Board HQ, where I was able to catch up with the folks from Contactually (a SaaS based CRM platform). With more experience in tow, I think it’s an appropriate time to redeem myself for those early follies and provide some input into a high-level pricing guideline, specifically as it relates to subscription-based software.
While there are many different pricing strategies being taught in business schools, I’m only going to focus on value-based pricing. The model holds up especially well in software solutions, where unit costs are low and ability to scale is high. Consequently, vendors can fetch a premium price and differentiate their products with strong value propositions.
The Art and Science of Pricing
One also has to observe a key difference between selling to consumers and selling to business/enterprise (B2C vs B2B). Enterprise customers are going to be more rational and predictable. They need to know how your solution will decrease costs, increase revenues, or ideally do both. To hit the nail on the head, this concept must be clearly communicated in the value proposition. The amount that is being saved or created in this case can be reflected mathematically in the perceived value of the product. So while it may be easier to quantify value in the B2B space, discounts on your base rates are still expected (especially if the customer’s logo makes you look good).
Sequoia Capital put together some very valuable content related to value-based pricing and the ways to increase the perceived value of a product. Check it out here.
SaaS Solution Pricing is Different
In pure software-speak, SaaS is also unique in that it requires flexible and simple monthly/annual plans. Enterprise, small business, and individual customer segments will all have different price sensitivities, product usage, and customer service requirements. Understanding how buyers prioritize these elements will make a big impact on how a solution should be priced.
Steps in SaaS Pricing
1. Understand Psychology of Your Target Buyer Behind Purchasing Decision
The first key to establishing a price is to know who your alpha buyers are, and how they are driven to make purchases. Decisions motivated by fear may persuade a customer to pay a higher price for quality tax / legal services, compliance software, or disaster recovery platforms. A casual freelancer looking for a scheduling tool (decision driven by logic), on the other hand, will place more emphasis on a favorable price-to-value ratio. The enterprise customer will (usually) be less concerned with price and instead demand more customer service, system up-time, and functionality.
2. Establish Initial Value Perception Before Your Customers Do
There is a certain doubt to value-based pricing that makes it both exciting and unpredictable. If such a critical piece doesn’t follow ‘if-then statement’ logic, then some technically-oriented minds may find the whole process to be unsound. Those in charge of pricing should take that ambiguity and mold it with reality. A value proposition has to be based on some sort of metrics – with this solution a customer will reduce development time by X amount hours, increase average sales revenue by X amount of dollars, decrease employee turnover by X percent, etc. Such early measurements, combined with the behaviors of target buyers, should form the basis of the Initial Value Perception (in the eyes of customers). The value that your offering delivers should be reflected in the price that customers are prepared to pay for that value.
3. Hypothesize and Test Perceived Value, Then Repeat
A measurable value proposition has been established, and the Initial Value Perception is taking shape as customers get to learn about and use the solution. The process will likely result in more questions than answers, hypotheses that need to be explored, and factors that were previously overlooked. By now you have hopefully segmented your audience by certain traits, needs, or behaviors.
It is time to test the price sensitivity of your customers, and how each segment will potentially react to any given price. A great way to do this is through A/B testing, and personally I like to use Optimizely. For example, you can put two versions up on your website of a specific page. One would showcase a lower price while the other version will display a higher price. From there you will be able to see which price yielded a higher click-through rate for sign-ups. The possibilities for testing are endless, but try to see what works best.
You can also learn about price sensitivity and how your value is perceived by simply talking to your early customers via one-on-one discussions or sending surveys that cast a wider net. Ask them pricing-related questions which inquire about how much they’d be willing to pay for the solution given the perceived value.
Keep in mind that it is easier to initially charge more; customers would rather see prices drop than increase and most entrepreneurs under-price solutions in the beginning anyway. Furthermore, you may want to consider waiting until the last possible moment to announce pricing, and do so only after you’ve determined that testing has pinpointed accurate list prices.
4. Competitor Benchmarks for Market Fit
Attention should always be paid to competitors, but these external players shouldn’t affect your pricing strategy. Instead, this step should be utilized in a way that allows you to better understand substitutes and complementary products. Competitive benchmark pricing can be used as a guide to position your business in a crowded market. There is only one direction if a solution starts competing on price: down.
5. Developing Pricing Plans
Finally, it’s time to translate all the research of customers, value perceptions, and price sensitivity testing into formal price plans. Since potential buyers can be turned off by complexity, try to limit price packaging to three or four simple plans. You can always upsell additional features or support at a later time. Each price plan should map back to a specific segment of the customer base, and can be separated by a number of factors. These can include quantity differentiation (number of users, locations, or amount of storage), features available (basic vs. advanced use), or customer support (Tier 1, 2, etc). You can also include a ‘less attractive’ option to encourage potential buyers to choose a higher-priced plan.
If you look at the pricing plan page of Adobe Creative Cloud, segments and prices are broken down by Individual, Business, Students & Teachers, School & Universities, and further divided into solutions offered.