In this guide, Patrick Campbell, Co-Founder and CEO of ProfitWell, explains the basics of pricing your product, provides the key steps to help you develop a pricing strategy, and offers advice on implementing your pricing strategy too.
- The Basics Explained
- Why SaaS Pricing is Different
- Conducting a Pricing Audit
- Develop a Pricing Strategy
- Pricing Models Explained
- Implementing Your Pricing
- Further Resources
The Basics Explained
Pricing is oftentimes treated like an afterthought even though it’s 7.5x more powerful than other growth levers (like acquisition and monetization). Although pricing has the potential to unleash tremendous growth, ProfitWell research found that companies only spend 10 hours or less per year on pricing. We get it though, it’s overwhelming — this article is going to break down all the basics, starting with the key question, what is a pricing strategy?
It’s important to know the difference between a pricing strategy and a pricing structure. While they may seem interchangeable, a pricing structure and a pricing strategy are actually two very different things. The main focus of this article is to guide you through the pricing strategizing process; however, a pricing structure is complementary to your strategy, which is why we must talk about it.
What is Pricing Strategy?
A pricing strategy is a long or short-term plan of price-related decisions that a company commits to in order to maximize revenue. There is a wide variety of pricing strategies to choose from, including cost-plus pricing, competitor-based pricing, value-based pricing and demand-based pricing, all of which we’ll break down later in this article.
Pricing structure involves your whole approach to pricing across your company with a specific emphasis on how your pricing relates to the features of your product. A pricing structure defines your pricing setup for products or services, including your core price points, discounts, offers, and additional features. Simply put, a pricing structure is how you present your pricing strategy to customers.
Why SaaS Pricing is Different
SaaS pricing is different because most SaaS companies follow a subscription model. With a subscription, customers pay on a regular basis for continued access to a product or service. This recurring revenue requires building a long-term relationship with customers — and, since the relationship is long-term, product packages are more complex.
Having a strong pricing strategy, on top of an already great product, has numerous benefits. Strong pricing allows your company to gain a competitive advantage, provide true value to customers, unlock an untapped growth lever, and strengthen your SaaS unit economics.
Conducting a Pricing Audit
At this point hopefully, you understand why pricing is so important to get right, but you might be wondering — where in the world do I begin?
Step one: a pricing audit. A pricing audit assesses the pricing process of your subscription business to ensure consistency across similar accounts, maximize profitability, and benchmark against other companies. It will reveal what you’re doing well and what you’re not doing so well.
The main action items involved in a pricing audit are:
- Defining your organizational goals and objectives
- Reviewing current pricing strategies
- Identifying weaknesses and opportunities
You can do this on your own or enlist a professional service.
Develop Your Pricing Strategy
Once you have a strong grasp on the areas you’re doing well in and the ones you need to improve on, you can develop your pricing strategy based on that information.
Do keep in mind, though, that pricing is an ongoing process. It’s not something you set once and disregard for the next few years. You should constantly be thinking about pricing. We recommend following four main steps (to make it easy): problem, cause, solution, and implementation.
Step 1: Problem
Find the Main Obstacles Your Company Faces
Every SaaS company needs to ask this question: “What is stopping us from growing?” It seems like a simple question, but when you conduct research and get to the root of different problems, you’ll fill in your gaps with an understanding of why growth isn’t happening in certain areas.
SaaS companies tend to face five major problems when it comes to growth — poor unit economics, poor user retention, poor MRR retention, poor acquisition volume, and poor conversion. Almost all of these issues, with the exception of poor acquisition volume, can be solved by improving your pricing.
Step 2: Cause
Use Data to Discover the Root Cause of These Issues
Get to the source — your customers. Customers are the people paying money and using your product, making them the best source to tell you what they do or don’t value in your product. This step involves asking your customers the right questions and adding that data to your buyer personas. This requires hard work, but it’s necessary and helpful in understanding why your Saas business isn’t reaching its full potential.
Step 3: Solution
Use Data-Driven Experiments to Test Viable Solutions
Draft a few hypotheses and test them. Running tests and gathering data that will validate or invalidate your hypotheses will help you identify the best pricing strategy. To make optimizing pricing a continuous process, test small changes often, and get reliable data for each hypothesis you make.
Step 4: Implementation
Put the Best Solutions into Action
After running tests, conducting research, and experimenting with different hypotheses, you have to implement a pricing strategy that works best. This step requires making changes to your strategy and advertising those changes through your pricing structure.
Pricing Models Explained
Pricing methods are ways of calculating the price of goods and services by taking into account all the factors that can influence a pricing strategy. Influencers can be things like the actual product or service, its life cycle, market competition, and your target audience. There are dozens of pricing methods in existence across all industries, but we’ll break down the four most commonly seen methods.
1. Cost-Plus Pricing
Cost-plus pricing is one of the most commonly used pricing methods. If you’ve ever been to a grocery store or a gas station, then you’ve definitely experienced a cost-plus pricing strategy hard at play. Cost-plus pricing is extremely simple; it’s pricing based on the cost of product and desired profit margin. While this strategy is easy to calculate and doesn’t require any market research, it’s highly inefficient and generates an inexact picture of your costs.
2. Competitor-Based Pricing
Competitor-based pricing is pricing based on how direct competitors have set prices. It’s a more research-intensive approach and involves assessing the pricing of your direct competitors and averaging the results for a price point within a competitive ballpark. Competitor-based pricing can be effective as long as your goods are comparable to those of other competitors. However, competitor-based pricing can also be ineffective. If your competitors aren’t conducting proper market research, then their pricing may be way off, and if you’re duplicating their pricing, your pricing is off too.
3. Value-Based Pricing
If you have the time and resources, value-based pricing is the strategy we strongly recommend for subscription companies. Pricing is based on how much target consumers believe the product or service is worth.
With value-based pricing, you’re creating an entire strategy around your customer’s expectations, allowing you to build rapport with your customer base and obtain intel on how they might want you to improve your product.
Value-based pricing has many advantages, one of them being access to willingness-to-pay data. This strategy requires a lot of time and resources, so if time is limited, this might not be the best bet for you.
4. Demand-Based Pricing
This strategy uses levels of current general market demand, as opposed to customer-specific research, to determine pricing. This strategy is good for assessing the lay of the market, while also building revenue and customer knowledge. The cons involved with this strategy are due to the data being relatively less complete, so the monetary price must be adjusted to compensate for non-monetary costs that will be involved in setting customer willingness to pay.
Implementing Your Pricing
Now let’s dive into pricing structure, which is how you’ll implement your pricing. Pricing structures are vital because they complement your pricing strategy. How you present your product’s pricing and additional features could be the deciding factor when it comes to completing a sale or not.
With this structure, a company sets a single price and that’s it. There is one flat rate, despite what individual needs a customer may have. This can be effective in certain situations, like for companies with a narrow-focused product and only a one-buyer persona. It’s also good for a company in its early stages and is willing to set prices low to build customer volume. However, just because there is only one established price, it’s not a free pass to ignore your pricing. Even with a flat-rate price, you need to re-evaluate this structure just as frequently as you would the others.
Tiered pricing gives a prospective buyer multiple subscription options and distinguishes them by the features included. This is a very successful model for subscription services and products. Tiers can help you arrange features to appeal to a variety of buyer personas. Tiered pricing is an effective structure to use monetization to drive growth.
Companies with websites featuring this line: “Contact us for more information on pricing,” are using a variable pricing structure. This model seeks to negotiate a specific price for each customer. It’s an entirely customized plan for individual customers. This structure is best for specific software or software that comes at a financial premium.
This is a pay-as-you-go model that relates the cost of a SaaS product to usage. Usage-based pricing is effective for infrastructure and platform-related software — a good example being Amazon Web Services. For subscription companies, usage-based pricing is not the best model. It makes it difficult for companies using it to make concrete revenue forecasts.
Tiered and Variable
This is a hybrid structure using tiers as a basis for pricing with “regular-sized customers.” This allows you to retain the benefits of tiered-pricing, while the addition of a variable option gives the business room to negotiate rates and form customized deals. This is the most complex pricing structure, but can be effective when you have a consumer-facing product also used by specific business fields.
This is a simple and popular pricing strategy in which a single user pays a fixed monthly price, that can then add another user to the plan (and the baseline price increases accordingly). Per-user pricing’s main asset is being linear, making it best suited for simpler products with a smaller array of features. It’s easy for customers to understand what they’re paying for, while also allowing companies to manage and predict revenue.
Freemium is hugely popular among Saas companies like DropBox, Slack, Skype, et. al. With freemium, customers can receive entry-level access to product features for free, but can choose to pay for access to higher-level features. Freemium is a great acquisition strategy. You can introduce customers to your brand and product, without them sacrificing too much. Hopefully, they’ll find enough value in your product to pay for more features.
Pricing needs to be at the forefront of your mind at all times. You need to be adjusting your pricing and features at least once or twice a year. Since pricing is an undeniably strong growth lever, adapting your pricing as the market shifts will ensure you are optimizing that growth.
Here are the takeaways:
- Strong pricing allows your company to gain a competitive advantage, provide true value to customers, unlock an untapped growth lever, and strengthen your SaaS unit economics.
- Get started by conducting a pricing audit to see where your current pricing strategy is doing well, and where it’s not.
- Once you understand what needs to be improved, develop your strategy (remember this can be done in four steps).
- Decide which pricing model best fits your pricing strategy. We recommend value-based pricing for SaaS, but of course, do what works best for your business.
If you’re hungry for a deeper dive into these steps in this article, you can download ProfitWell’s ebook, The Anatomy of SaaS Pricing Strategy, free of charge. Plus, you can explore more blog posts on Mind the product:
- How to Price Your Product in a Startup by Fanni Fejes at Founders Factory
- Designing Pricing Strategies: Don’t Ask – Experiment! By Tom Whitwell
- Using Analytics to Raise Prices and win new Customers by Kieran Kilbride-Singh