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Pricing Metrics: Your Secret Weapon in the Quest for Value-based Pricing

By April 1, 2022May 5th, 2022Featured, Pricing, Pricing Strategy
Old Scale

Most SaaS leaders have no clue what packaging is. It’s nothing to do with boxes, that’s for sure. But packaging in SaaS is more impactful to a company’s bottom line than the price level, so it’s a concept well-worth understanding. And one of the critical concepts in packaging is your choice of pricing metric.

It’s one of the most crucial decisions a company can make. But most businesses aren’t putting enough emphasis on it. They’re only thinking about price level—instead of who, how, and what they’re charging.

In this article, we’re going to dive into:

  • Why focusing on pricing metrics should be an essential part of your business strategy
  • Why picking the right price metric is all about research
  • How to tell if you’ve chosen the right pricing metric for your business and your customers

Let’s get started.

What Is Packaging For SaaS?

Let’s begin by unpacking, well, packaging. SaaS packaging is all about how you monetize your product. There are four main aspects to SaaS packaging:

  1. Pricing Metrics. Price metrics are the units to which the price is applied. They define the terms of exchange—what the buyer will receive per unit of the price paid. Your SaaS price metric could be any number of things: total users, transactions processed, number of contacts in a marketing database, etc.
  1. Pricing model.  Also known as a monetization or business model, this component is about how a customer pays for your product. Think subscriptions, pay-as-you-go, freemium—the list goes on.
  1. Offer configurations/bundles. A typical example of this in SaaS is the “Good-Better-Best” approach. Here you offer various groupings of features targeting different customer segments. With its various offer configurations (Premium, Recruiter, Sales Navigator), LinkedIn is a fantastic example of targeting different customer segments with its offerings.
  1. Pricing fences. Different customers pay different prices for the same service. We do it in theaters (think matinee performance pricing), and it’s the same in SaaS—Companies can base these on volume, time, or identity differences. Think about the different prices per seat if you buy one vs. 100. Or end of quarter sales discounts.

Learn More: Profitable Products Come in Well-defined SaaS Packaging

Pricing Metrics go Hand-in-Hand with Your Pricing Orientation

What inputs do you consider when you’re setting pricing? If you’re only considering costs, then you’re not going to be able to make a pricing metric that aligns with your customers’ needs.

Value-based pricing should consider costs, competitors, and customer value—the most important one being customer value. Let’s take a closer look at these pricing orientations:

  1. Cost-based pricing. How much does it cost to make, sell, and maintain the product you’re offering? That, plus whatever your desired margin, is cost-based pricing. 

Caveat: Customers don’t care about your costs. They only care about their problems.

  1. Competition-based pricing. This is when companies base their pricing in relation to competitors—either at a discount or a premium, depending on where you see your product fitting in. 

Caveat: Your competitors’ pricing research and strategy might be full of hot air.

  1. Customer-value-based pricing. This orientation is most likely to optimize your profit. It involves extensive customer research to gauge the actual value of a transaction between buyers and sellers.

Caveat: It’s not easy and requires an investment in time and expertise.

Whatever pricing orientation you choose, price metrics have to:

  • Align with your customer’s business requirements and perceived value of the product.
  • Allows the company to capture fair value predictably
  • Minimizes operational friction of both buyer and seller – both sides can exert reasonable control over the metric

But here’s the problem: there are as many possible pricing metrics as they are ways to perceive value. And you need to understand that your customers have different ways in which they value your product.

Most companies choose pricing metrics by tradition. While there is nothing inherently wrong with ‘per seat’ pricing, a pricing metric that genuinely aligns with customer value makes your product so much easier to sell. 

Dan Balcauski

When deciding on which pricing metric you’re going to use, a fundamental choice is whether you’re choosing a capacity or a capability metric. Capacity metrics scale with the size of an organization or usage (e.g., seats, events, API calls).  But with capability, you’re paying a flat fee for capabilities such as per module or per product. Capability metrics are straightforward, although not usually optimal. Capacity metrics are more powerful (especially for your bottom line) but require a more complex series of decisions to determine the best fit. 

We’ve covered packaging, pricing orientations, and how different customer segments derive value. But with so many different ways of deriving value, how’s a business supposed to figure out which one is right.

Well—it is complicated but bear with me. We’ll find our way through it together.

Learn more: The 4 Hidden Fears of Value-based Pricing – Product Tranquility 

Nagle And The Great Pricing Metric Filters

Finding the right pricing metric may be complicated, but it’s also highly profitable. First, you have to follow a rigorous process that assesses the needs of the buyer and the seller. Any SaaS company serious about improving its pricing needs to go down this road.

Thomas Nagle’s book, The Strategy And Tactics Of Pricing, has had an enormous influence on the pricing world. Nagle described the process of finding the right pricing metric through a series of tests as a pricing metric filter.

Nagle narrowed it down to five filters through which your pricing metric should pass:

1) Tracks with differences in value across segments

2) Tracks with differences in the cost to serve

3) It is easy to measure and enforce

4) Facilitates favorable positioning versus competition

5) Aligns with how buyers experience value in use

Companies should run all their options through these filters. They will narrow down the viable candidates. And the next stage is testing them against the market—seeing what resonates and doesn’t with your market.

This step is where a lot of companies stumble. Internal analysis requires them to put on a customer perspective, which many companies struggle with, especially if they only adopt a cost-based pricing orientation.

Nagle did a fantastic job, but his book and approach were general-purpose–meant for all industries and products. I built on and updated Nagle’s pricing metric filters for the B2B SaaS world. Let’s break them down.

The B2B SaaS Pricing Metric Filter

B2B SaaS Pricing Metric Filter
B2B SaaS Pricing Metric Filter

1. Does your pricing metric track customer value by segment?

This filter ties your pricing metric to customer business outcomes. You only do well if your customer does well, which makes your marketing and sales teams’ lives easier because they can quickly tell your product’s value story in a way that’s relatable to customers. And that means value and price are in alignment.

Within this component of the pricing metric filter, you need to consider a few other points.

Does the unit of offer match the customer’s unit of benefit?

Can your sales team easily convince customers that it tracks to value? Whether it aligns with the actual value doesn’t matter one iota if your customers won’t accept that. They need to see a clear connection between value and price.

How does your pricing metric align with how buyers experience value in use?

If the expense’s timing and magnitude align with the benefit’s timing and magnitude, then customers will feel less anxious about making the purchase.

This type of pricing is easily scalable—the customers experience more value, and you charge higher prices for your product or service.

This metric acts as a kind of risk mitigation for your customers. They pay for the service as they experience value, lowering the adoption risk. Plus, it avoids the dreaded taximeter effect, which can stifle product usage.

The taximeter effect: Say you’re getting a Lyft. You open the app and say where you’re going. Lyft returns you a price before you even finish booking the ride. But if you get into any old cab and the driver makes a wrong turn? The meter is still going up. You don’t know what the final bill is going to be.

My value hasn’t changed. It’s still getting me from A to B. But my anxiety has increased because I feel like the driver is charging me for every minute we’re stuck in traffic. Versus  “they said it would be $8, And it’s $8. If the guy takes a wrong turn, it’s still $8.”

Dan Balcauski

There’s a tension between monetizing for fair use and aligning that to perceived value. Incorrectly setting your pricing metric can disincentivize product usage, even though, in theory, the customer would get more value by doing that action. So, tread lightly here.

Is your pricing metric consistent and easily applicable?

Different customer segments can have wildly different operations, accounting for the significant price to value ratio differences.

Example 1: You’re running an accounting software business—you might think that the price per invoice is relatively consistent and easy to apply. Plus, your enterprise-level customers who have invoices in the $10,000 range probably wouldn’t blink. But small businesses with many invoices in the $100 range? They’d be clear losers in that situation. Simple as it is, the problem with this metric is that a unit isn’t just a unit. 

Example 2: You’re selling a product to cargo shipping companies. You’re considering a per container pricing metric. Now, imagine your customer has a cargo ship full of containers. If they’ve loaded that ship with Lamborghinis, and it sinks? Then they’ve lost a whole lot more value than if they had stocked those containers with plastic utensils. 

A single metric might make sense for the customers shipping Lamborghinis, but not for your other customers. And that’s where you have to do the research and make a strategic choice as a company: either we use a single metric that is inconsistently applicable, use a different metric per segment, or another option. There’s a lot of tension between optimizing every penny and being understandable to your customers.

It just goes to show that whatever pricing metric you choose, there will be winners and losers amongst your various customer segments.

Assess how close to value your product is

Value-based pricing works best when your product has a clear link to the economic benefit of your customers (e.g., increasing revenue or decreasing costs)—you can then attach a clear business result to your product.

For example, infrastructure-type products, like AWS, are relatively far from value creation. It’s a challenge to translate CPU cycles into cost savings or increased revenue so that customers can easily understand.

Therefore, the usage costs for infrastructure are far removed from derived business value. Infrastructure-like products are horizontal plays—which means customers can use them for a wide variety of value-creating activities, which leads infrastructure vendors to adopt a cost-based, not value-based, approach to pricing.

Value-based pricing tends to be much easier for vertically-focused companies vs. horizontally-focused firms. Horizontally focused companies make up for their usually smaller margins by the sheer volume of customers and customer use cases they address.

Dan Balcauski

But for Marketing Automation products like Hubspot, you’re closer to value and revenue-generating activities, making the line to value clearer for both customers and vendors.

2. Does your pricing metric track with the company’s differences in the cost to serve?

Tracking differences in the cost to serve aligns financial incentives of the company to serve the customers better that value that benefit. Proper execution requires understanding how your company’s costs scale with usage. A proper metric will discourage excessive use of products or services that impact your costs.

An excellent example of this is Amazon Prime’s free shipping. Everyone loves free shipping, but it’s a costly thing for any e-commerce company to offer. When Amazon was thinking about offering free shipping, they considered the potential problems.

When you offer a free all-you-can-eat buffet, who shows up first? The heavy eaters. It’s scary. It’s, like, oh, my God, did I really say as many prawns as you can eat? And so that’s what happened. But we could see the trendlines, we could see that all kinds of customers were coming, and they appreciated that service. So that’s what led to Prime.

Jeff Bezos

Amazon had to consider whether they were losing out by some customers taking advantage of that or not—it’s a delicate balancing act. Ideally, this metric should discourage excessive usage unless you clearly understand the potential upside.

Most Amazon Prime members don’t shop around anymore—they just go straight to Amazon because they know that it will show up on their doorstep the next or even the same day. That drives incredible value and customer loyalty for Amazon, despite the rising costs of providing said service.

3. Is your pricing metric easy for the company to measure and enforce? 

You don’t want to be in a complex situation where customers have to voluntarily report information that would lead to a higher price (i.e., pay-for-performance on profits). Complicated pricing models like this will just frustrate your customers.

You can’t charge what you can’t measure. If you’re selling software, you’ll need a license management system tied into your revenue tracking systems and product to enforce license usage, invoice, track, and demonstrate usage statistics to customers.

But beware—the more complex it gets, the more likely you are to annoy your customers. Sometimes it’s better to keep things simple, even if you might be slightly off the mark from your product’s actual value.

4. Is your pricing metric aligned with internal business goals, and does it facilitate favorable positioning vs. the competition?

The following pricing metric filter considers alignment with your internal business goals. Every SaaS executive wants to capture fair value for your service. Otherwise, you won’t be able to keep offering it.

You need to ask yourself the following questions:

  1. Does it facilitate favorable positioning vs. your competition?
  2. Is it in financial alignment with your company’s needs? 
  3. Does the new pricing metric decrease sales friction?

How does your product compare to companies with more substantial market positions or innovative products? Companies with better offerings can enable favorable competitive positioning by intelligent use of pricing metrics. And that’s something your competition can’t match.

If your company’s architecture is more scalable and cost-efficient than that of your rivals, then guess what? You won’t incur anywhere near as much in overhead costs as usage scales. That means you’re able to maintain similar profit margins to your larger competitors at a significantly lower price point.

5. Is your pricing metric relatable?

Is the metric easily understood in a 30-second elevator pitch? Is it something your customer already tracks? The perfect metric may be too complex for customers that are not technically savvy. 

Case in point: Databricks, a data and AI company, adopted a credit system-based metric. It’s a complicated scheme based on server type, usage, storage, and about half-a-dozen mechanics that will make your head spin.

Look, I’m sure it’s reasonably close to the cost drivers of their product, but it isn’t something your average customer can understand in 30 seconds or less. It’s an almost perfect example of how not to do pricing.

You also want to make sure it’s fair. If your customers don’t have a sense of control over the product, they’re more likely to feel like you’re ripping them off, which is something to avoid.

6. Is your pricing metric predictable?

Can customers predict in advance how much they’ll need? A good pricing metric makes life easier for your sales team, as they can quickly help customers with the right-sized initial purchases. Nobody likes financial surprises—unpredictable invoices can lead to disputes and headaches further down the line. 

You also need to consider the nature of the product or service that you’re providing. If it’s highly variable or seasonal, that can make things difficult for internal finance forecasting and your customers.

Those were my six filters that any decent pricing metric should pass. You should be starting to get an idea of which metrics might suit your company and which ones won’t.

Why Optimized Pricing is all About Research

A structured research process for choosing the right pricing metric leads to better outcomes and unearths problems before implementation. The method below can be applied to any part of evaluating your pricing and packaging, not only for pricing metrics. 

You might get lucky, but there’s usually not one perfect pricing metric.

Dan Balcauski

If you have a portfolio of products, you may have to do this product-by-product. There may be advantages to keeping consistency across the portfolio of products, even though a given metric may not be optimal for a particular product.

I break down the research process into four distinct stages:

  1. Prioritization and discovery. Evaluate relative urgency and priority compared to other projects. Outline what is working well and areas for improvement. Then brainstorm a set of pricing and packaging options to evaluate for further research. Find a set of metrics that you would charge and validate preferences with your target market by applying the pricing metric filter discussed above. 
  1. Research. Dive deep into how customers perceive value. What are customers’ value metrics that you can align with your pricing metric? There are several ways you can about this:
    • Customer interviews and surveys
    • Competitive studies
    • Customer activity and usage data

Learn more: Why Listening to Your Customers Sabotages Your B2B SaaS Pricing – Product Tranquility 

  1. Testing and iteration. As I mentioned, there’s probably not one clear winner here. A single metric probably won’t meet every criterion—you might need to apply multiple metrics simultaneously to solve this (e.g., a company might use a two-part tariff structure).

    Now is also the time to build out your What-If models and see what effect these changes would have on existing customers. Who will be the winners and losers under the proposed model changes? How will it affect signups, new business sales revenue and cycle duration, feature adoption and stickiness, and net revenue retention? Don’t forget about organizational implications to Finance, RevOps, and Product implementation.

Get feedback from internal and external (e.g., customers and partners) to validate your assumptions. Consider these implications carefully.

  1. Decide and implement. How will you communicate these changes internally to your Sales and Customer Success teams? And how will you share it with existing customers?

Honesty is a great option. Mixpanel is one company that knows how to do it. Rather than drown customers in marketing babble, they clearly communicated what they were doing, why it wasn’t working, and the research they undertook. Check out their post below.

Read more: Why And How We Updated Our 2019 Pricing – Mixpanel 

The goal of understanding and researching pricing metrics is to allow better your business to capture the value you’re creating for customers. It requires a lot of work—the more specific you can get, the more you know your customer segments, the better you can accurately package and position your product. 

Most companies aren’t putting enough emphasis on the packaging aspect of pricing. But taking the time to do the research will pay dividends down the line.