For many new products, price is a decision made shortly before launch. But pricing a software-as-a-service (SaaS) product presents unique challenges—and opportunities—for product and marketing teams. With SaaS products, pricing is such an essential part of the product, marketing and business model that you need to nail it early in the product development cycle.
Unlike traditional software, customers licensing SaaS products pay for your product on a recurring basis. This gives you more options for pricing models. And because the product is centrally hosted, you have additional flexibility for offering your product in unique packages.
Finding the right price is more art than science. However, if you get the pricing right for your SaaS product, you can delight customers, provide competitive differentiation and launch a more profitable product.
In the past few years I’ve had a hand in setting pricing for several successful SaaS products, including Citrix GoToMeeting, GoToMyPC, AppFolio and ProductPlan. Here are several key areas to consider when pricing a new SaaS product.
Price Based on Customer Value
Customer value is one of the most important elements for pricing SaaS products. It’s important for pricing all software products, but even more so with SaaS products.
It’s essential to have a deep understanding of the value your product provides for your buyers and users. This value should be the primary consideration for your price and pricing model—not features, not what competitors charge and not your costs.
The most common pricing model for SaaS products is a recurring subscription. Every month or year, your customers reevaluate whether they want to continue subscribing. This makes it even more critical to ensure pricing is in line with the value your customers receive.
Let’s define what I mean by “value.” Value can be quantitative, such as time saved or additional revenue earned. Value can also be qualitative, such as pain relieved or lifestyle benefits provided. By understanding and documenting this value, you can begin to narrow in on possible pricing models and a price range.
When we were determining pricing for GoToMeeting, we interviewed dozens of potential customers to gain a deep understanding of the value they might receive from conducting online meetings with our solution. We discovered:
- Lifestyle benefits from conducting meetings remotely
- Cost and time savings from reduced or eliminated travel
- Reduced frustration by not using complicated solutions
- Cost savings from switching to our solution versus expensive per-minute pricing of existing solutions
By understanding this customer value, we developed GoToMeeting’s unique $49 “All You Can Meet” flat-rate pricing (an industry-leading innovation at the time). Because the product was SaaS, we had the flexibility to price our product differently from the competition and create a unique product in the market. In a sense, we made pricing a part of the product. It became a differentiating feature that marketing promoted heavily.
Think Differently About Pricing Models
One of the exciting advantages of SaaS is that product managers can think differently about pricing models. Your product is no longer tied to a one-time purchase. With SaaS, you can consider models such as:
- Monthly and annual subscriptions based on seats or packages of seats
- Pricing based on a characteristic, such as storage
- Different pricing for packages of different features
- A free base product with paid subscriptions for enhanced features, functions or service
- Pricing for different market segments or user personas
With so many options, you now have the ability to discover a pricing model that aligns with your customers’ goals. For example, for AppFolio’s property-management software, we developed a unique pricing model based on the number of rental units managed by a property manager. Because we charged a flat $1 per rental unit per month, the pricing was simple and easy to understand. This pricing model resonated with customers because they paid more for our product only if they grew their business. If they were more successful, we were more successful.
When pricing a new product, there is a temptation to set your pricing relative to the competition. It’s common for new products to price using the same model as competitors, but slightly lower. Sure, you can price the same way as your competitors, and perhaps that’s what your customers expect. But with SaaS, there are so many ways to price the product that you have the ability to stand out in the market by thinking differently. Capitalize on the approaches that your competitors haven’t considered.
Understand Your Customer’s Lifetime Value
With SaaS, it’s important to understand what each additional new customer is worth to your product line. A customer’s lifetime value (LTV) is one of the most essential metrics because it influences the resources you allocate to the product, its sales model and what you can afford to spend to acquire customers.
While there are lots of ways to calculate LTV, I recommend keeping it as a simple back-of-the-envelope calculation:
For example, if you license your software at $25 per month, spend $5 a month delivering and supporting the service, and keep an average customer for 18 months, your rough LTV is: (25-5)*18 = $360.
The formula for success is simple in the SaaS world: LTV over time must be greater than the cost to acquire that customer. For example, mature SaaS companies with a recurring revenue stream like Salesforce.com have LTV multiples that are three to five times the cost to acquire that customer. However, your cost-to-revenue ratio may be higher in the early years until there is traction in the market.
Keep it Simple
Don’t overly complicate pricing. With so much flexibility in SaaS pricing options, there is a temptation to offer various flavors and packages. Sometimes there are legitimate reasons for doing so.
For example, it is common to have three packages of low, middle and high price (for example, bronze, silver and gold). Studies show that this approach anchors customers, and buyers consistently pick the middle package. That’s fine if this is your goal. However, creating an overly complicated pricing scheme has the potential to confuse customers and create a nightmare for your finance team. Keeping it simple reduces headaches and may even provide more revenue over the long term.
At ProductPlan (a product roadmap software), we saw that similar companies had complicated licensing options. Many required a paid license for every software user. We took a different approach to simplify the calculation. We charged only for editors of roadmap data and offered free licenses to other collaborators. Rather than offering complicated pricing tiers based on features, we offered unlimited use of all features for one price. Because the product managers want to widely distribute the product roadmap to stakeholders, this model benefits the customer. In addition, this model gives our product more exposure within the organization, so ultimately we sell more licenses when other departments ask to use the software.
Additional Considerations for SaaS Pricing
Here are a few additional areas to consider when pricing SaaS products:
- Your sales model influences your pricing. Conversely, pricing constrains the sales model options available to you. For example, if you have an expensive field sales force, you need to ensure that your customer LTV is high enough to support that model. Ultimately, your buyer persona determines your sales model, so make sure you understand the expected purchase process.
- Create upsell opportunities within your pricing model. One of the advantages of SaaS is the ability to offer upgrades and services that drive additional revenue. Consider these within your pricing model, as they can make a substantial difference in long-term product revenue.
- Use caution when offering annual prepurchase discounts. Many SaaS products that license on a monthly basis will offer a discount for annual prepurchasing. However, use this with discretion. Analysis shows that over the long term you leave significant revenue on the table.
- Build discounting options in enterprise licensing. Price transparently when you can, but remember that enterprise customers expect to negotiate. Whether you discount will depend on the buyer persona.
- Consider free trials. If your acquisition and activation model is simple enough, providing a limited free trial is a great way to increase your sales prospects. It’s common to offer 15- and 30-day trial options.
- Service is key. Because SaaS is typically licensed as a subscription, your customers are at risk of churning every renewal period. Service and support are even more critical than with traditional software. For this reason, many SaaS products build support and regular upgrades into the standard licensing fee. Consider whether your customers will be receptive to additional fees for support and maintenance.
- Customers don’t care about your costs. I’m not suggesting you ignore your costs, but don’t price your product working backward from cost. This is not how your customers will think about the pricing. Sure, cost of goods sold needs to be a factor for you to be viable, but this is not related to how customers value it.
- The demand curve is not linear. A customer’s perception of pricing is highly psychological and doesn’t always follow economic rules. A lower price doesn’t necessarily equate to more customers and revenue.
Test Pricing Early and Often
Pricing for SaaS products is such a core part of the product and business model that you need to validate it early in the product development cycle. A combination of qualitative customer interviews and quantitative price testing is needed to get enough data points to make good decisions.
With web-based SaaS products, it’s easier than ever to conduct A/B tests to gauge buyer behavior and optimize your pricing (both before and after launch). As you test the user interface, I encourage you to test your pricing with equal fervor. Get the pricing right, and you have a recurring revenue stream that places your product’s portfolio value well above traditional software products.