Pricing is such a core part of a SaaS product’s business model that you need to get it right. In this series I’m writing about SaaS pricing lessons I’ve learned from launching several SaaS products including GoToMeeting, AppFolio, and ProductPlan.
In the first part of our series, we reviewed why pricing based on customer value is key to a great product strategy. In the second part, I described how SaaS gives product managers flexibility to be creative with pricing models.
Here we go:
- Pricing must be a part of early validation. While you may not nail your final pricing until later, the earlier you can zone in on your SaaS pricing model the better off you will be. This gives you a greater chance of building your pricing model into the value proposition. At a minimum, during the product conceptualization stage actively interview potential decision-makers about their purchase process, how they purchased their current solution, and frustrations with the current solution’s pricing.
- Ballpark LTV as early as possible. Customer Lifetime Value (LTV) is so critical to a SaaS business model that you need to estimate it as early as possible – well before you have customers and revenue. LTV influences the 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 with input from customer interviews and similar products.
- LTV > CAC. The formula for success is simple in the SaaS world: LTV over time must be significantly greater than customer acquisition cost (CAC). 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. Doing back-of-the-envelope calculations on CAC will help you avoid surprises down the road.
- Your sales model influences your pricing. Conversely, SaaS 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. You’ll struggle if your average customer purchases $50/month over a two year lifetime. 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 SaaS pricing model, as they can make a substantial difference in long-term product revenue. This is the model we used with great success at AppFolio.
- Use caution when offering annual prepurchase discounts. Many SaaS products that license on a monthly basis will offer a discount for annual prepurchasing. However, with SaaS pricing, use this with discretion. Analysis shows that over the long term you leave significant revenue on the table.
- 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 conversions. 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 for a product that they expect to work flawlessly.
- 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 your product.
- Pricing perception doesn’t follow economic rules. Customers often buy products for reasons that seem disconnected from the Return on Investment calculation. Pricing, specifically SaaS pricing, is highly psychological. For this reason the demand curve is not linear – a lower price doesn’t necessarily equate to more customers and revenue. Take this into account by thoroughly understanding the qualitative value that your product provides.
With web-based SaaS products, it’s easier than ever to conduct A/B tests to gauge buyer behavior, pricing, and acquisition costs (before and after launch). As you test the user interface, I encourage you to test your pricing with equal fervor.
Use qualitative customer interviews to get enough data points to make good decisions. Get it right for SaaS pricing, and you have a recurring revenue stream that places your product’s portfolio value well above traditional software products.
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