Table of Contents
- What is a SaaS Pricing Strategy?
- Why is a pricing strategy so important?
- What are the main factors that impact pricing strategy?
- Types of SaaS Pricing Strategies
- How to choose the right pricing strategy for your business?
- Implementing your pricing strategy
Choosing the right SaaS pricing strategy has a significant impact on growth and revenue. Even if your product or service is flawless, the wrong financing model can cause your business to stall in first gear. SaaS companies need to consider a range of pricing models and find the best path to monetization and revenue growth.
What is a SaaS Pricing Strategy?
A SaaS pricing strategy is a revenue generation model involving software that exists on the cloud. Instead of buying software outright and hosting it on-premises, companies lease the solutions via subscription or via a pay-per-use agreement.
SaaS companies can monetize their product in several ways.
The three most popular SaaS pricing models are:
a) Monthly or yearly subscriptions
b) Pay-as-you-go models
c) One-time use models
While there are several ways that a company can drive revenue, subscription models are the most popular because they are a great predictor of recurring revenue.
Why is a pricing strategy so important?
A solid SaaS pricing strategy can be the difference between success and failure. It's really that simple… and important. Pick a pricing plan that is too high, and you will put off potential customers. Charge too little, and you'll destroy your profit margin. It's a delicate balance.
Successful product pricing has two primary goals.
First, it should provide value to users. This function is vital for attracting new customers and retaining current users.
Second, it should offer your SaaS business a competitive advantage.
Get your SaaS pricing strategy right, and your customer base will feel like they're getting a bargain compared to alternate providers. This sentiment should reduce churn and increase your number of users.
What are the main factors that impact pricing strategy?
Several different things influence SaaS pricing strategies.
Company size: Is your SaaS business established, or are you trying to break into the market?
Competitors: Who are your competitors, and what benefits do they offer your potential customers?
Business goals: What are your business goals? Are you looking to grow revenue, establish yourself in the market or achieve market dominance?
Value proposition: What makes your SaaS stand out from the crowd? What features or functions do you provide that your competitors don't.
Buyer persona: Who are your buyers, and why do they need your product or service?
Types of SaaS Pricing Strategies
There are a few different SaaS pricing strategies. Each has its own merits based on how…
● established your business is
● your specific business goals
● the current state of play within your industry.
Let's look at each SaaS pricing strategy and see which works best for you.
Competitor based pricing
Many new SaaS companies use competitor-based pricing. Essentially, this involves using a similar SaaS product as the benchmark for your pricing.
This SaaS pricing strategy is a good option for new companies. If your solution hasn't been on the market all that long, you might not have enough data to know if you're actually providing value. By looking at your competitors, you can get a good idea about what customers are prepared to pay.
Once you have a firm understanding of what your competitors are offering — and the data on their price points — you can see where your product will fit.
There are three ways you can go here: above, below, or the same price.
Pricing above the market: If your SaaS business offers customers more features and functionality than other providers, charging more can be the right pricing strategy.
Pricing below the market: Going below the market is a good strategy when you need to win customers aggressively. Offering a similar solution but at a low price can help you win market share.
Pricing at the market rate: This strategy is commonly known as price matching. Here, the idea is that you offer a very similar price as your competitors but emphasize added value.
Pros & Cons
There are some pros and cons to using a competitor-based pricing strategy.
Less risk: By using competitors' pricing as a benchmark, you are adopting a model that already works for them. In a way, they've already done the research.
It's straightforward: It's a simple SaaS pricing strategy. Instead of running a lot of tests and research, you can test the waters by going in at a price relative to your competition.
Unsustainable: Pricing based on your competitors is a good SaaS pricing strategy for new SaaS companies. However, because it's not connected to your business fundamentals and development costs, it's not a sound long-term strategy for your specific business.
Incomplete information: You won't know why other providers have arrived at their price. There are lots of small details that go into setting a price, and if you're just blindly following your competitors, you're putting yourself in a vulnerable position.
For example, you risk repeating their mistakes if they've set their price way too high or too low.
Overall, pricing based on your competitors can be a good SaaS pricing strategy for new SaaS companies. However, it's not always a sound long-term strategy because it's not connected to your specific business fundamentals.
Hulu is a good example of a B2C SaaS company that uses competitor-based prices. Their price range and model have a lot of similarities to a competitive steaming service, Netflix. However, it's a slight bit cheaper to reflect their comparatively less original programming, a more limited roster of shows, and the inclusion of ads.
The main takeaway here is that Hulu looked at what the typical Netflix user is comfortable paying and priced their solution accordingly.
Penetration pricing strategy
A penetration pricing strategy is about moving into the market quickly. This is a strong SaaS pricing strategy for new companies.
The major factor here is that you offer your product or service at a low initial price. For example, you can employ this as an introductory offer for a limited time. Basically, by offering a reduced price, you are making your software attractive to potential customers.
There are a few different ways to gain market penetration through pricing. You can create demand by offering a discounted price to your first few customers. Or you can charge based on how quickly they sign up.
Pros & Cons
Quick market capture: You can stimulate market demand by offering artificially low pricing. This strategy can help you generate quick sales and revenue.
Brand loyalty: You can use this strategy to build brand loyalty. People love a bargain, and by saving them money, you can create positive feelings around your brand.
Establish market dominance: By offering your solution at a price that is way below your competitors, you can grab a large chunk of the market. Once subscribers are used to getting value from your product, and it's become indispensable to them, they might tolerate price hikes.
It hurts revenue: Offering low prices hurts revenue. To capture a market share, you might need to sacrifice profitability. Most SaaS companies can only afford to do this for a limited time.
Some customers might infer that your product is inferior: Some customers might look at your low price and assume that your solution is low quality when compared with your rivals.
User churn: When you do decide to raise your prices, some users might feel that it's too expensive. For example, they might consider your SaaS offering to provide value at the penetration point but not at the new higher price.
Disney Plus is a good example of a penetration SaaS pricing strategy. Their initial offering was $6.99, which was well below competitors like Netflix and other streaming services.
As Disney+ increased its value proposition, its prices have gone up to $7.99, with further raises hunted down the line.
Pricing below the value of your product is a good business model when your competitors are far more established. Once you've gained more familiarity (and a foothold in the market), you can slowly introduce a higher price.
Cost-plus pricing, also known as markup pricing, calculates your business costs and adds a percentage on top. This model is popular in production, but it's also used in the SaaS industry.
You can arrive at this number by adding up development, staff, and customer acquisition cost (CAC). For example, if it costs $100 to design and market your software, you can charge $150 to ensure you always make a profit.
Pros & Cons
Simplicity: It's a simple SaaS pricing strategy. You just need to calculate your business costs and add on an acceptable markup percentage.
Guarantees profitability: By calculating your costs and adding on a markup, you know that each sale will lead to profit.
Ignores your customers: A cost-plus model doesn't account for how your customers feel about prices. If it costs you a lot to develop and market your item, there's no guarantee your customers will feel comfortable paying the resulting end price.
Doesn't account for competitors: This inward-looking strategy doesn't consider various market factors, such as competitor pricing.
The best examples of cost-plus pricing are in manufacturing and other retail stores. Cost-plus isn't always easy to implement as a SaaS pricing strategy because costs can be unpredictable. If development and CAC rise, it's hard to keep adjusting your prices to ensure your desired percentage profit.
However, if you’re selling a physical product, you understand the costs of producing each unit. In addition, physical goods have a level of price elasticity that consumers will tolerate.
Value-based pricing strategies are customer-focused. They determine a price based on how much value a product will bring to the customer and how much they’re willing to pay for it.
This method doesn't strictly look at your production costs or at your competitors' pricing. Instead, it considers what your target audience wants or needs from your solution.
When you provide value, customers are willing to pay a premium. This model is often employed by companies that have a product with more features and functionality than their rivals.
Pros & Cons
Perception: If you price your product above your competitors, it can increase brand value and result in positive perceptions about your business.
Loyalty: The more money that a customer invests in an item, the more emotional attachment they have.
Bigger profits: If your customers are willing to pay a premium based on quality, you can grow your profits.
Smaller market: While value is essential to customers, not everyone has an unlimited budget. Big brands have a limited pool of potential customers.
More competition: Because your target audience is small, it's more vulnerable to competition.
Increased production costs: To justify an inflated price, you need to make sure what you are offering is the best on the market. As a result, development costs can rise.
Adobe's suite of products is a great example of a value-based SaaS pricing strategy. They're well established, trusted, and have unique products that are packed with functions and features.
Adobe's pricing page features a mix of different products with a range of prices for each different customer, like individuals, businesses, and schools.
This SaaS pricing strategy isn't the best pricing option for every business. Without having established goodwill and a strong reputation, customers might be unwilling to pay a premium. However, if you offer more value than your competitors, this pricing structure is a good option.
HootSuite also uses a value-based SaaS pricing strategy. They started in 2010 with a price of $4.99. Now, the price is $49.99. They have managed to increase this recurring revenue as they've added new tools and functionality in line with customer needs.
How to choose the right pricing strategy for your business?
There are a lot of factors that go into determining the best SaaS pricing strategy. Some of the things you need to consider are:
● Your competitors' prices and products
● Your buyer persona and their willingness to pay for your product or service
● How established you are
● How much value your product provides
Another factor to build into your pricing decision-making is the lifetime value (LTV) of each customer. If your SaaS business has been running for long enough, you'll have these metrics. But when you are starting out, they will be harder to estimate.
However, getting a rough benchmark from your competitors is a decent starting point. For example, if you know that the average customer keeps an account for one year, you can work out your development and marketing costs and average them against that to see what it would take to stay profitable while keeping the same level of retention.
Implementing your pricing strategy
Once you've decided on which SaaS pricing strategy works best for you, there are a few other things to consider. For starters, you need to know how you will bill your customers.
There are five main SaaS pricing models to choose from:
● Usage pricing
● User-based pricing
● Tiered pricing
● Flat-rate pricing
● Per-feature pricing
Usage-based pricing charges customers by how much they use the product. These models can be attractive to startups and small businesses because they only get charged for what they use.
Dropbox has a usage-based SaaS pricing strategy. Because they host files on their servers, customers are charged based on the amount of space they require.
Of course, we should note that Dropbox also offers a freemium model to attract light users. Similar to other file hosting platforms, they give a few gigabytes of storage for free.
Snowflake is a purer example of a usage SaaS pricing strategy. They charge based on how much data their users store and move around their cloud servers.
Usage-based metrics are a good way to optimize pricing: heavy users pay a bigger share than light users.
User-based pricing is another popular SaaS pricing strategy. It charges companies based on the number of team members that use the product. For example, there is one price for teams of 1-10, another for 11-50, a third level for 51-100, and so on.
Basically, it involves a flat fee for each user, with gradual discounts as more users are added. These models are attractive to companies because their monthly bills are predictable.
The popular messaging app, Slack, uses a user-based pricing model. They offer free accounts and a tiered system for individuals, businesses, and enterprises, but the costs are based on the number of active users.
The tiered pricing model is another familiar strategy. It splits potential customers into tiers based on features or resources. For example, you could offer a:
● free plan
● small business plan
● enterprise plan
Or you could price according to which features the user needs. This model is best for businesses that have a varied and comprehensive set of features that not everyone will use.
Flat rate pricing
Flat-rate pricing charges one price for all customers, regardless of size or usage. This SaaS pricing strategy is appealing to some customers because it's simple and predictable.
A flat rate is the preferred SaaS pricing strategy of many companies, including BaseCamp. The music hosting marketplace offers all users a flat rate of $99.99 for unlimited users and unlimited uploads. However, one downside is that it's not as dynamic as other pricing models and can even penalize light users.
Per-feature pricing has a lot of similarities to tiered pricing. However, instead of establishing tiers, SaaS companies charge customers based on the features they use. HubSpot is a good example here. They offer a free version of their CRM tool but charge separately for different Marketing, Sales, and Services add-ons.
This SaaS pricing strategy also shows the value of offering a free plan to entice your target market. Once they understand your solution, you can upsell them on your other packages.
What is the difference between a closed-loop and an open-loop pricing strategy?
Closed-loop and open-loop pricing strategies are both ways to estimate costs.
A closed-loop continuously feeds back things like customer data and historical pricing to produce data-driven price estimates and adjustments.
An open-loop system is more straightforward. It's built on things like development and marketing costs with desired profit margins built on top.
What are the five levels of strategic pricing?
There are five levels of strategic pricing. They’re best expressed through a pyramid where each level is the foundation for the next.
Value creation: What features and functions make your product stand out
Price structure: Which metrics should determine how you plan to bring in revenue
Value communication: How do you plan on marketing and advertising your product
Pricing policy: Can you negotiate with customers or offer different types of prices based on users, usage, or features.
Price level: When all that information is gathered, then you can set the final price.
Choosing the right SaaS pricing strategy is an important step for any business. Coming in below your competitors can be an excellent way to capture market share, but it's not always sustainable. Additionally, it can result in negative perceptions of your SaaS product if customers believe that low prices equal low value.
Mostly, the SaaS pricing strategy you choose should be based on your product's market fit. If you offer features and functionality that your competitors can only dream of, you should consider bumping your price accordingly. However, you need to be aware that this can limit your potential customer base to users who are prepared to pay premium prices.
We have so much data and metrics available to us that pricing doesn't need to be rigid. SaaS companies should be prepared to experiment and try a few different approaches. You can use introductory prices to build a customer base, while tiered, per-feature, or usage-based options are dynamic enough to respond to an ever-changing market.