In 2003, Porsche launched the Cayenne — its first ever sports SUV. 10 years later the car accounted for 50% of Porsche’s annual profit. At the time, SUVs were alien to Porsche. It was known for sports cars, like the flagship Porsche 911.
The Cayenne wasn’t successful because of engineering. It was successful because Porsche focussed on what customer’s wanted, valued and were willing to pay for. It was priced perfectly.
Today, we’re going to talk about principles you can use to price your SaaS startup like Porsche did. We’ll focus exclusively on startups who have little to no data for their pricing strategy.
The SaaS business model
SaaS is amazing because you build once, and sell forever.
There are 3 components to the demand side of every SaaS company: acquiring customers, retaining them and monetising them.
According to YC partner Kevin Hale, monetising offers the most leverage but is least discussed:
if you increase just your efforts or resources by 1%, your work on acquisition, usually get a return of about 3.32%. In retention, it's about 6.7%. And when you're optimising pricing, that gives you your biggest bang for your buck in terms of impact on your business, yet it's the one that is most neglected and I think it's the one that everyone is so afraid to touch because they're so scared that if they get the pricing wrong, that they will lose all their customers.
Every business’ viability depends on the following and SaaS is no different: can your margin cover the costs of your product? The only two variable costs in SaaS are marketing and infrastructure. People costs are your main fixed costs.
I realise I’m stating the obvious, but here’s what I believe is not obvious:
Your price determines your business model, GTM and sales strategy.
Here’s a quick example to illustrate. A company prices its product at $10 per user. The target customer is an employee of the payroll department at companies with less than 100 employees. Let’s assume there are 3 employees on average. This means you’ll make 3 x $10 x 12 = $360 per customer per year.
At $360 per customer per year, you’re very limited in terms of sales and marketing. This is neither a bad or good thing. I’m just calling out that you need to think about price in the context of how you plan to sell your product.
Principles for pricing
Before we dive into the details, here are a few principles for pricing that we’ll draw on:
- Price your product based on the value you provide and the buyer’s willingness to pay.
- Nobody gets pricing right the first time.
- A price is better than no price.
Your decision on how to price your SaaS startup can be broken down into two parts.
First, what pricing model should I choose? And second, what price(s) should I choose?
Choosing your pricing model
The first step to pricing your startup is to think about your value metric.
Your value metric is the variable that determines the amount of value a buyer of your product is receiving.
Practically, choosing your value metric shouldn’t be a long, arduous journey. Think about what benefit your product adds and ask yourself what your product solves for your customer. Choose a metric that is easy to understand for you, and for the buyer.
Consider Zapier, the no-code automation tool. Users derive value from automation, this means every time Zapier helps move data from one application to another (called “tasks”). Zapier’s value metric is the number of tasks a user completes, and pricing is based on it.
Now that you’ve found your value metric, here are the pricing models you can choose from:
You offer a single price for all customers and for all features.
The advantage here is simplicity. The disadvantage is that you are unlikely to take away the optimal amount of money from the table. Going back to our principles, it’s likely that different sets of customers receive different amounts of value from your product — meaning you should charge them different prices (which flat pricing does not allow).
Flat pricing is unlikely to be the right option for your SaaS product.
You offer different tiers of pricing, with different features under each tier.
Typefully, a Twitter publishing tool, offers 4 different tiers. Each subsequent tier offers additional features. If you plan to use Typefully for multiple Twitter accounts, the Creator or Team plans make the most sense.
Feature gating is nice because customers can upgrade. You can earn more revenue without actually increasing your customer base. In many cases, you will find feature gating tied to a value metric (e.g. number of Twitter accounts in the Typefully example above).
Usage based pricing
The price of your product is defined by usage. Your value metric is used to determine “usage”.
Snowflake uses usage based pricing. A customer’s bill is determined by the amount of data storage, computing resources and cloud services they use. Snowflake offers multiple products and therefore has 3 different ways to compute your bill (depending on what you use).
The biggest consideration with usage based pricing is volatility. Customers will not be able to accurately predict how much your tool is going to cost them. Consider this carefully because it makes the buying decision harder.
In addition, you might be able to bill your customer only after your product has been used. Incidentally, Snowflake solves this by charging customers in advance (they pay an additional amount if their bill is over, or receive a credit if their bill is under).
Usage based pricing is an excellent option when your costs can vary a lot. If you offer a fixed price, and your costs increase, you might find yourself in a negative margin territory.
Per seat pricing
Your price is determined by the number of users who you use the product.
This is the most common SaaS pricing model. However, it only makes sense if your value metric is the number of users. If not, you will run into issues — for example, users might share logins in order to save costs.
An interesting way to check if this is the right model is to ask: does every use see something different within my product? If not, you should assume people will share logins.
Examples of products where per seat pricing makes sense: HR tools (Workday, Lattice), messaging tools (Slack) and productivity tools (Notion).
It’s common for SaaS companies to mix feature gating and per seat pricing. This usually happens when companies mature. If you do decide to mix these two, make sure it’s easy enough for the customer to decide.
Choosing the price(s)
Now that you’ve chosen a model, you need to choose a price or set of prices to go with it.
There’s no magic answer here. It gets easier once you have paying customers and can experiment with different price points. But that isn’t relevant to someone who is just starting up.
Set your price using the following processes:
Study your competitors
Figure out who your competitors are and study their pricing model. This does NOT mean you need to be cheaper than your competitor. If you believe you offer more value than your competitor, you should price yourself higher.
Studying competitors’ pricing is important because your buyer will use it as a reference point. You should be able to articulate why your product is priced where it is relative to your competitor.
Talk to prospective customers
When you talk to prospective customers, you can ask them questions to help you determine what you should charge. Do not ask them what price you should set. This is your job, and you need to figure it out by asking the right questions:
Option 1: Make it relative to an existing product
Relative to Salesforce, how much value does this product give you? Use the answer and Salesforce’s pricing to set your price.
Option 2: Ask a set of questions to determine price
What do you think is an acceptable price for this benefit?
What do you think is an expensive price for this benefit?
What do you think is a prohibitively expensive for this benefit?
Products usually end up being priced close to the expensive price option.
Measure the value provide
If you can quantify the value you provide, you can use this to determine price.
For example, a company that focusses on vendor management might be able to calculate the amount of money they saved.
If you can do this, Madhavan Ramanujan - an expert on pricing - recommends that you capture between 20% and 50% of the value generated. Anything below this leaves money on the table, and anything above it leaves room for a disruptor.
Here are the most important factors to consider when thinking about pricing:
- The goal of pricing is to ensure that you can make sufficient margin. Choose wisely because it determines your sales and marketing strategy.
- Price your product according to the value you provide to the customer.
- Start by figuring out your value metric, and using it to determine the pricing model that works best.
- After choosing your pricing model, set your price by looking at competitors, talking to users and estimating the value you provide.
- Pricing is a dynamic, analytical exercise. Remember to review and update it as required.