Pricing Strategies for SaaS Products

The Pricing Decision

Your SaaS product is finally ready for market! Hooray! You’ve spent your nights and weekends coding, and have deployed what you think is the production ready version. And now comes one of the hardest decisions you have to make – how do you price the damn thing. Its obviously worth millions (billions?) to you, but how much are your potential customers willing to pay?

For most of your target customers, software is productivity not pleasure. There is no joy in software installation, integration or instruction. Companies undergo the trouble because they have to: the inertia against change is substantial. A lower introductory price might help to work down that resistance, and help keep you on the short list during a long sales cycle. Free beta installations are also part of minimizing the initial implementation resistance.

But once the customer is yours, the situation switches in your favor. The customer is still reluctant to switch to something new, only now they’re afraid to switch from you, and not to you. They would much prefer to add the functionality of your upgrades without having to learn how to use new software. From your perspective, price sensitivity is much lower as comfort and ease factors increase. So we might raise our upgrade price accordingly.

While acquiring new customers is great, you also need to realize that once a price expectation is set it is very difficult to move away from that. So if you price too low to penetrate the market you may end up losing money when you are unable to raise prices later. We will now discuss some of the common strategies adopted by companies in making the right decision.

Pricing Strategies

Pricing strategies fall into one of several categories. While most companies with multiple products will use multiple pricing strategies, each product has a dominant pricing strategy. The common strategies are described below:

Cost-Based

Vendors price their products based on the variable cost of goods. They may use rules of thumb like $10 over cost or 3X manufacturing cost. Many hardware manufacturers used to do this. Software distributors often use this method. However, this strategy does not consider the value to the customer. Also, you must be a low cost producer to win.

Value-Based

This strategy is based on the performance/price ratio of a product. Vendors using this strategy offer a performance premium at a given price point (e.g. optimized workflows and document storage at lower prices). They can also offer a choice of performance options at different prices (e.g. good, better, best products at three different price points). They do not cut price to raise the value ratio.

Meet the Competition

This is often a promotional ploy and not a long-term strategy. However, many companies will have products that are directly comparable to a competitor’s offering. Competitors or customers will force these companies to play this game. Competitive upgrade and “suite” prices are two examples.

Market Skimming

Market skimming (as in “skimming the cream off the top”) strategy involves a new product in an emerging market setting a high price point to maximize revenues before the competition catches up.This was a common strategy for some engineering software companies and super-minicomputer vendors. Companies that are “first with the most” may be able to do this until a competitor catches up – or catches on.

Market Penetration

This strategy is the opposite of a skim strategy. In this case a vendor offers unheard-of-value at a price point. In the early 80’s, workstation vendors offered $50,000 products that outperformed $250,000 minicomputers. At a time when IBM’s Rational Suite was being sold for thousands of dollars a seat, Atlassian began offering JIRA and related products at tens of dollars or lower. At launch Atlassian’s functionality and performance was significantly lower than the competitions’, but their penetration strategy enabled them to overcome that hurdle. This strategy expands a market by opening new, price sensitive segments. If the price is so low another entrant cannot make money, this is also called pre-emptive pricing.

Follow the Leader

Many companies have a commanding lead in their product category like Oracle in databases, Microsoft in PC operating systems. In any product segment, any direct competitor will be compared with the leader. Many times, direct competitors have to follow what the leader does in pricing. IBM used to be a price leader in mainframes. Other mainframe companies followed their pricing lead and would price somewhat below IBM’s price points. When IBM lost their leadership position in the PC industry, prices collapsed.

What is the Best Pricing Strategy for Your SaaS Product?

In the case of your specific SaaS products, ask yourself the following questions:

• Is there a dominant player in your market, and therefore does the Follow the Leader strategy apply?
• Is the product or the concept new or radical enough to justify a market skimming strategy?
• Are customers price sensitive and therefore is pricing a key factor in market penetration?
• Can you quantify the value that your SaaS product is adding to the business processes of your customers?
• Has the established competition already set the price range? This is especially true for relatively mature markets where you have little price flexibility and have to compete primarily on functionality.
• Are your costs directly correlated to your revenues? Will increasing your base costs (and therefore quality/throughput) increase penetration?

The best pricing strategy for the product will usually to be a combination of diferent strategies based on answers to the questions above. For most products surveyed as part of this study, the strategy was a combination ot Cost Based, Value Based, and Competitive Pricing.

Costs and Value – Considerations for Pricing

Relevant Costs

Strategic pricing is a means of making a profit today, not of recovering costs spent a year ago. Therefore you should not use the cost of developing Version 1 as the basis of the price of Version 1. Instead, you will have to use the cost of developing Version 2 as the basis of the price of Version 1. In other words, the price of your SaaS product should be based on the cost of developing the improvements and enhancements that you can foresee for the next significant upgrade.

The other costs that need to be covered are the manpower costs incurred for actual implementation (customization, development of templates, etc.), training of users and administrators; and the marketing and administrative costs incurred.

Elements of Value

The initial step in establishing a value for the product is to determine whether a software product should be considered as a “tool” or as an “asset” that should be managed according to a dynamic usage metric.

Software products that that fit the “tool” category are usually relatively low cost and/or the product’s value is driven by the ability to solve potential problems at any time rather than actual use. Typical metrics are either node based or named user based.

As value increases, products are viewed more as assets. In order to manage these assets well, dynamic licensing metrics need to be chosen that closely approximate use or “work accomplished”. These software products can be segmented into categories according to functional characteristics and usage characteristics; different licensing metrics may fit each of these segments. The dynamic license metric most commonly chosen is the number of transactions, as this precisely measures the “work accomplished”.

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For more interesting strategic discussions about SaaS product development and marketing, contact us at Quantilus.