I recently sat down to chat with T.A. Monroe’s Alex Gluz on his podcast Revenue Engine. We covered several pricing and packaging topics, one of the most critical but overlooked growth levers for a SaaS business.
We touched on the importance of segmentation in determining pricing and packaging, the three primary pricing orientations for SaaS companies, and why my suggested pricing orientation always centers on the customer.
SaaS companies across the board struggle with how to price and package their products. In addition to not investing enough time figuring out pricing and packaging, there isn’t usually a centralized team dedicated to it, so it often slips through the cracks.
Listen to our conversation in its entirety below, or read on for an overview of the topics we covered.
Segmentation: The Foundation of Modern Marketing
Segmentation is the foundation of modern marketing, helping to determine who you will serve with your product.
The first thing to keep in mind is that your market is not homogenous. On the contrary, it’s filled with people who have varied interests and contexts. Your customers have different needs and will derive benefits and value from your product depending on those needs. So how do you organize and understand all the varying interests of your customers? The answer is segmentation.
SaaS Pricing and Segmentation: How They Fit Together
Segmentation entails grouping customers based upon have they value your product. Understanding your customers’ different interests through segmentation helps you hone in on which customers it makes sense to focus on serving.
You have to identify your customers’ varying interests, contexts, and motivations because all of those factors will lead to them assigning a specific value to your product. That’s important because the value ascribed to a product directly relates to the price people are willing to pay for it.
As I mentioned, customers operate in different contexts within the segments. Because of this, their motivations and desired outcomes will differ, and the value they place on your product will be based on those interests and goals.
On top of that, each customer segment will be comparing your product against different competitive alternatives that offer solutions to the same problem.
Phew. That’s a lot. Let’s break down the steps of pricing and segmentation a little more.
- Understand your customer’s particular context.
- Determine how your product provides value.
- Figure out how your product is differentiated from other competitive alternatives
- Capture that differentiated value in the pricing and packaging of your product.
Essentially, every discussion about price will center on who you serve and what value you provide because the price is merely how a buyer and seller divide the value in a transaction.
Public SaaS Pricing and Packaging: The Three Models
One of the questions Alex had for me was whether SaaS companies should make their pricing public or private. It depends on market size, the similarity in willingness to pay among market segments, and competition.
There are three main models, and each is best in a different situation. Let’s jump in.
- Full pricing and packaging are publicly available.
This approach is best for companies with horizontal products and a large, homogenous market. The project management tool space (think Trello) is an excellent example of this. This is a highly competitive “red ocean” type market. Most of the major players in the Project Management tool space are transparent about their pricing and packaging, so not publishing would put you at a disadvantage.
2. No pricing or packaging is publicly available.
This approach is best for companies with complex packaging that require a salesperson to explain or companies with colossal willingness to pay differences between customer segments. For example, a financial services client might be willing to spend 4x more than a retail client. In this case, making pricing public would put a limit on profit potential.
- Packaging is publicly available, but no public pricing is available.
A hybrid option, this approach is a good one if you have high differences within customer segments, but you have simplified packaging that does not require interpretation assistance from a salesperson.
SaaS Pricing Orientations: The Basics
In general, there are three main orientations to SaaS pricing. Let’s break them down.
- Cost-based pricing
COGS + desired gross margin = charge x amount.
This orientation is based on simply attaining targeted gross margins and is the most common approach to product pricing.
- Competitor-based pricing
This orientation is pretty self-explanatory. Given your company goals, competitor-based pricing requires you to look at what everyone else is charging and then set prices at either a discount or premium to the market.
- Value-based pricing
This orientation demands an in-depth understanding of what your product is worth to your customers. Your customers’ perceived value of your product will primarily determine your pricing.
Note that these three orientations are not mutually exclusive. Of course, you need to understand your costs and competition. If you don’t consider your expenses, you run the risk of being unprofitable. If you don’t understand your competition, you’ll disconnect yourself from the reality that your customers occupy. This argument is really about the order of operations vs. exclusivity. Your focus should primarily be on the value your product provides to your customers, and then consider costs and competition as secondary factors to influence your pricing further.
Value-based SaaS Pricing: A Customer-Centered Approach
Since I’m all for putting the customer at the center of pricing and packaging decisions, this is the approach I find most interesting to discuss. Unlike the other two options, value-based pricing focuses on the customers’ needs and perception of value.
Say my company is selling a widget. You put it on your manufacturing line and find that it reduces downtime of that line by 50%. That means you not only can produce more goods, but you also don’t have to pay technicians as often for repairs. This benefit adds value to my product, which has nothing to do with my incremental COGS or my competitions’ prices.
Through value-based pricing, you end up aligning the company’s profitability directly with the customers’ value. It’s the only model that allows the company to control its pricing rather than ceding control to competitors or basing pricing on COGS.
It’s clear that when you do product pricing and packaging right, it takes a long time and requires a strategic approach and lots of research. However, done right, pricing and packaging help every aspect of the business.
For those interested in learning more about how to price and package a product effectively, here are two final pieces of advice.
- Represent the customer.
Take the time to do the research. Segment your market and understand how your customers perceive value in your product. Making your customer successful will make your company successful. Representing customers’ perspectives in your decision-making is vital.
- Market research is critical.
Rather than A/B testing your SaaS pricing, which overcomplicates and confuses everyone in a B2B context, do your research to determine what works best. This research process means identifying your business objective, conducting internal analysis with internal stakeholders and customer-facing teams, identifying the main pain points you want to solve, and coming up with a hypothesis you can test with prospective and existing clients.