Jason Knight is a stand-out Product thought leader at DueDil, a London-based RegTech startup, and his Twitter game is second to none. I recently had the chance to chat with Jason on the One Knight In Product podcast about the nuances of SaaS pricing and positioning.
We covered a lot of ground, including:
- SaaS pricing orientations
- Why herding is not an option in SaaS
- Three signs of lousy pricing
- A 4-step plan to perfect your pricing
- The problem with freemium
You can listen to the full episode embedded below or keep reading for a recap of the interview.
What are the Different SaaS Pricing Orientations?
One of the first decisions you need to make about pricing your SaaS is your company’s existing pricing orientation. You have three options to choose from:
1. Cost-based pricing
Cost-based pricing means covering the cost of your product and selling it for a profit. This model calculates your cost of goods sold (COGS) and adds your desired gross target margin to achieve a final price.
Its execution is straightforward. The main problem: customers don’t care about your costs. They only care about the value they get. Cost-based pricing doesn’t take customers’ perceived value of your product or competitors into account.
2. Competitor-based pricing
For competitor-based pricing, you look at what your competitors are charging, determine where you stand, and set a price based on your perceived premium or discount to the relative value you provide.
Many high-volume SaaS businesses have transparent, public pricing, which means you can quickly figure out what your competition is charging with a bit of research, but this is not the case for more enterprise-focused SaaS companies.
However, competitor-based pricing doesn’t factor in consumer willingness to pay, which means you can’t be sure the price you decide on will resonate with your target audience. It can also put your Sales team in a position where they can’t defend your price, which isn’t a great place for any business. You don’t want to be in an unintentional race to the bottom.
3. Value-based pricing
Value-based pricing is the North Star that every SaaS business should strive for, although like the North Star, it’s a destination you can never fully reach. The orientation is customer-focused, backed by deep research, and gives you (and not your competitors) 100% control.
In this model, customers pay for the value your product provides and the benefits they get from using it. Your buyers will gladly pay the price, as the product’s inherent value has a strong ROI. You need to align all marketing and sales team members to effectively communicate that value with prospective buyers to do this well.
This approach does take time to achieve but is worth the time and effort long-term.
‘Herding’ in Competitor-based Pricing
It turns out that herding is not only for sheep. It’s also a term used to describe when companies in a market blindly follow one another because no one has done their pricing homework.
This situation leads to the market suffering from unreliable prices; everyone’s just copying each other, and no one can justify their prices. As a result, the market price can quickly diverge from underlying customer value. This situation leaves profit on the table, cedes pricing control to your competitors, and results in unhappy customers.
This cycle continues until a disruptor enters the market that has done the proper research based on value, profitability, competition, and customers’ willingness to pay. That disruptor then takes over as the leader in the space, leaving the rest of the herd behind.
Three Signs of Poorly Executed SaaS Pricing
So how do you know if your SaaS pricing is off-base or poorly executed? Here are a few signs to watch for:
1. Heavy focus on spreadsheets and quantitative data. If the people in charge of your SaaS pricing only talk about spreadsheets and quantitative data, they’re likely leaning heavily on a cost-based approach. There’s a massive opportunity to re-orient the company to customer value.
2. No pushback from prospects. If your SaaS product’s pricing isn’t getting any pushback from prospects, that’s a problem. It’s a signal to charge more. If your prospects tell you that your prices are too high, take it with a grain of salt. It may be accurate, but it can also be a negotiation tactic your prospect employs to get a better deal. If you’ve done your homework, you’re more likely to recognize fact from fiction.
3. The lonely bundle. If a SaaS offers features in tiered bundles, but only one of those tiers sells, it’s time to reassess your offerings. There should be fair distribution among the tiers, even if it’s not entirely equal. Many SaaS companies use multiple bundles, or offer configurations, because multiple bundles:
- Streamlines your go-to-market motion
- Reduces customer acquisition cost (CAC) by allowing customers to self-select a suitable option based on their needs
- It makes it easier for sales representatives to assist prospects without explaining hundreds of different features.
Freemium Isn’t the Nirvana you Think
Many companies think freemium is the key to Product-Led Growth success.
The reality is: It isn’t easy to move customers from a free model to a paid one. This situation is known as the Penny Gap—moving customers from $0 to $0.01 is an infinite percent change in price. It’s nearly as difficult as selling to a net-new user of a product.
Even best-in-class companies convert 1-3% of freemium users into paying customers. For this to happen profitably, you’ll need to play in a market of millions of potential customers.
Most problems SaaS companies experience are better answered with a 14-30 day free trial than a freemium model.Dan Balcauski
The Four-Step Model to Establish a Pricing Strategy for Your SaaS Business
If you need help figuring out how to establish a pricing strategy for your SaaS, here are the four steps you need to take.
1. Understand your customer segments
You’re not selling to everyone; you’re selling to your ideal customer. In a market like SaaS, you can’t build a product for everyone. Start with a deep understanding of the different customer segments in your market and document their needs, wants, pain points, and concerns.
2. Articulate your unique value
Articulate the value of your product as it relates to your target customer. What makes your offering unique, innovative, and helpful? Customers attach different levels of importance to different value drivers, so it’s essential to articulate your unique positioning and nail down the value you provide to your customers.
3. Identify competitive alternatives
Contrary to the default narrative, most B2B SaaS companies aren’t competing with the startups down the street. The question to answer is: “If your product didn’t exist, what would your customers do?” Answering this simple question may lead you to realize that, like many SaaS companies, you’re competing with homegrown solutions (e.g., email+spreadsheets+an intern) to the problem you’re solving. From there, you can define the clear differences that give you a compelling edge and work that into your pricing conversations.
4. Choose a strategy
Once you’ve collected and aligned on these inputs, you can nail down your strategy. This includes aligning on your ideal customer segments, determining your positioning, packaging, and pricing strategy.
SaaS Pricing: Final Thoughts
SaaS pricing is nuanced because there are a lot of moving parts. It would be best to explore it beyond gross margins or competitor analysis. You can’t just put together data and add a target markup to arrive at your final pricing.
A deep understanding of your market and customers, the differentiated value of your product, and a bird’s eye view of the overall market will help you position your SaaS product in a way that makes sense both for the company and the customer.