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Jul 23, 2019

How to Build a Pricing Strategy for SaaS 

If pricing is the foundation for the growth of a SaaS company, why is it so underestimated? Companies fight to create the perfect product and spend countless hours with limited resources to acquire new customers. Nevertheless, most SaaS do not know what is the real value for their clients and how to communicate it.

If a company does not have a pricing strategy, it probably does not fully understand who its clients are. It has no idea that it may discourage its customers by bad price positioning or inappropriate package content. The effect of that may be the loss of the possibility of obtaining an exponential increase in revenues at higher, but better-matched prices.

How does pricing work in practice?

The average company operating in the SaaS model spends about 6 hours in the whole life cycle of the company to build a pricing strategy. Less than one workday of thinking whether prices and the way they are calculated to reflect the value of the product in the same way as customers see it.

The best companies regularly make adjustments to their pricing strategies, which translates into optimal growth. Effective monetization of a product means iterative changes in the areas of price positioning (for whom the product plan is – a startup, SMEs or large corpo), list of features offered in a particular package and the price itself. Together these elements constitute a pricing strategy, which translates into good economics of the business.

Despite the fact that the pricing strategy is the heart of SaaS business, it is often ignored. This is partly because it is the aspect that affects all parts of the company – it is located at the crossroads of marketing, sales, and product, which means there is no natural owner of it in the organization. Often young companies become price takers especially when they deal with enterprise clients.

According to an analysis by PriceIntelligently, for every 10 blogs on the topic of growth in SaaS, 7 focus on acquiring new customers, 2 relate to maintaining them, and only 1 is concerned with the pricing strategy. You have to realize that growth is more revenue, not more customers. The key is how customers are monetized.

Why is pricing so important?

Pricing affects individual economics – in particular, LTV (lifetime value) and CAC (customer acquisition cost).


Lifetime Value of the Client (LTV)

LTV is the averaged value of all revenues that will be generated by one client while he is your customer.

LTV can be calculated as the quotient of ARPU / Churn Rate. 

 


Average Revenue from the Customer (ARPU)

ARPU is how much the customer pays you on average in a given period of time. It directly depends on the pricing strategy. With a good pricing strategy, you can increase your ARPU and reduce the churn rate. Raising an ARPU can be a consequence of, for example, clients switching to higher plans that meet their expectations to a greater extent.

ARPU can be calculated as MRR / Number of Customers


Churn Rate

Churn rate shows you how many customers your company lose each month. The reduction in the number of cancellations results from providing customers with real value, which is possible when you precisely position your plans.

Lost # Customers (this month)  / Total # Customers (this month)


Average Cost of Obtaining a User (CAC)

CAC is the sum of marketing and sales costs in all channels divided by the number of new users acquired.

CAC = cost of marketing and sales/number of users acquired).


Thus, pricing has an effect on ARPU, churn, CAC and, as a result, on a key LTV / CAC indicator.

Getting to LTV / CAC more than 1 is necessary, but not sufficient. The experience of successful SaaS companies indicates that the LTV / CAC ratio of at least 3: 1 is needed to successfully develop business. With continuous optimization of your pricing, you can move this indicator to much higher levels.

 

How to do it?


How to make the right decision about the price of your product? 

  • Based on competition

The competition-based approach uses competition prices as a benchmark. The advantage of this method is speed – after a short analysis of competitors’ websites and with enough information about prices and packages, you can quickly create a “pricing strategy”. In addition, it is unlikely that your prices will be overshoot if we set them in the middle of the observation.

You should rather avoid that your product can be directly comparable to the other solutions as for your customer it will be just pricing driver to switch to another provider and this lead to a constant price decrease. There are many ways for differentiation such as; additional features, customer support, add-on services such as consulting etc.

  • Based on the value for the customer (value-based pricing).

Pricing strategy based on the value for the customer is the best option for your business. It assumes that the price list should reflect the value that is perceived by the target customer.

One of the main advantages of this approach is its reliance on the client’s willingness to pay. This means that you have stay in a constant feedback loop with your customers and find out what value do they see in your product and which functionality do they value the most alternatively what is still missing in our offering.

Minus: this process is time-consuming. It is based on the quantified buyer persona.

The pricing strategy is not just the price visible on the site. It is about how a package is composed for a given client group, i.e. what functions it has and how it is offered (what are the pricing variables?). This approach will help you understand the desires of the customers and inform what features to map in the product development.


How to create a buyer persona?

Most companies think that they know their client. However, there is a big difference between thinking that you know your client and being absolutely certain that the person you are communicating with would like to buy your solution.

A quantified buyer persona (Persona)

Persona should be the most accurate reflection of the client possible. The persona has the following parameters:

  • Demographic data
    • age, gender, position and role, etc.
  • Challenges
    • which they encounter in day to day work (in which software can help).
  • Goals
    • what they want to achieve and what is important to them in relation to their industry and product.
  • Communication
    • how they usually communicate, preferred communication channel (e-mail, telephone, social media, livechat, etc.).
  • Offer
    • how our company and software can help improve their work and provide a tool to solve daily challenges.

It is important that all functional areas of the company take part in the creation process because in the end, the whole organization will benefit. It should also be noted that the buyer is not always the end-user. In many cases, SaaS users have nothing to do with purchasing a product. Often, the management of the company’s expenditures lies in the hands of managers.


Below you find some methods can be used to collect information required to define your persona:

 

  • Interviews
    • personal or online – asking questions about what is important to them and what is the reason for the purchase.
  • Surveys
    • email or social media – questions about shopping habits, challenges, goals and software usage.
  • Analytics
    • demographics and reports can give a good overview of people who visit the website.
  • Competition analysis
    • the competition is trying to attract similar clients. Who are they communicating to, who are their recipients, how are they sourced?
  • Market analysis
    • analysis of market data from the industry.

However, the easiest way to create a persona is to clone our most active clients. You have to answer the question – who gets the most value from our product? How do they use the product to meet challenges and achieve goals? For the most active clients, you need to look for similarities in what they do and use the information in order to create a persona description. Then, for each persona, it is necessary to get answers

for such questions:

  • How much is persona willing to pay for the product?

  • What is the LTV?

  • What is the CAC?

  • What features are important? And which are less engaging?

  • What are the marketing channels via which you are able to reach a given persona?


The answers should be quantified. Data should result from numbers/statistics, i.e. you need to have a certain sample of observations in each area and based on that you can draw conclusions for each type of persona.

The approaches to the pricing strategy described above are the basics and just the tip of the iceberg (but you have to start with something!). A pricing strategy based on the value for the client is a process in which you have to pay attention to several elements and it is not a one-off task. The price list should be regularly analyzed and, if necessary, updated so that the company can fully exploit its potential.

Leszek Orłowski

Investment Director @ bValue VC

Leszek Orłowski has many years of experience both as an advisor and investor. He advised multiple startups, as well as the largest companies in Poland. He has hands-on experience in crafting market entry strategies, search for strategic investors and commercialization. He is also an expert within corporate finance, M&A, financial restructuring.