SaaS Pricing Strategies for Short- and Long-term Success
Pricing is always a tough subject. It’s one of the most daunting things to tackle because there are so many ways to approach it and no one right solution. Weeding through all the options to find the best pricing strategy for a particular product can be especially challenging for startups whose leadership teams are taking on the task for the first time.
In my first year as CEO of Lola.com—a super-simple platform for booking, managing, and reporting on corporate travel—we’ve already made some critical pricing changes that have had substantial impact on our bottom line. Pricing was also a major component of our overall growth strategies when I was CMO at HubSpot and later at Cybereason. As a founding member at HubSpot, I can attest to the fact that we spent countless hours debating pricing. It was easily the most contentious topic our management team grappled with in the eight years I spent with the company.
While I don’t consider myself an expert on pricing, I definitely think of myself as a dedicated student of pricing practices. So far, what I’ve learned is that at the end of the day, getting to a viable and profitable pricing strategy requires three things.
- First, you have to find a pricing structure that works with your business model.
- Then, you have to bring in a multi-dimensional element to help maximize revenue around specific use cases and buyer scenarios.
- Finally, you have to continuously assess what’s working and what’s not to ensure that you’re not selling yourself short and leaving money on the table.
Let’s dive into each of those in a little more detail.
Starting with the Right Pricing Structure
The first hurdle you have to clear is figuring out which pricing model makes the most sense for your product. At first glance, this might seem pretty straightforward, but it actually takes some in-depth thinking and experimentation. Not only is there no one-size-fits-all solution, you can’t even always base your pricing structure on that of a similar product because even a single variable can throw the whole model out of whack.
For instance, Salesforce, which does a phenomenal job with pricing, establishes its cost tiers via a user-based model. This makes a lot of sense for them because both salespeople and service people use their product, and both of those groups tend to scale along with a company. In other words, as a company’s revenue grows, so will the head counts in those departments. And as head count goes up, so does Salesforce’s user-based fee.
This approach completely falls apart for a marketing product like HubSpot. While a marketing team might expand a little as a company grows, the total number of people in the department will stay relatively small. A $100 million company might only have two or three times the marketing staff of a $10 million company. The number of users on the marketing side just doesn’t scale enough to correspond accurately to the increased value a growing company gets out of HubSpot’s product.
After figuring out that the user-based model wasn’t a good fit, we briefly considered an email-centric model like the one ExactTarget was using at the time. Again, on the surface, this seemed like it might make sense because a growing company will send a growing number of emails. However, there were two major flaws. First, we didn’t advocate for sending out tons and tons of emails as a solid marketing strategy; and second, we didn’t want people to think of HubSpot as an email system when it was really so much more.
We struggled for a long time, and in the end came up with a twist on the usage-based model that was based not on the number of actual users within your company, but on the size of your marketing database. This ensured that as a company found success and grew their database, HubSpot would share in that success. The structure made sense for HubSpot, and it also made sense to customers who understood the increased value. After all, HubSpot was both managing more data—providing more capabilities based on the larger database—and helping drive success by generating more context.
It’s not a perfect solution, but it works. And it may evolve at some point to adapt to changing market conditions. With pricing, ongoing assessment and change is part of the process.
Adding Sophistication with Multi-Dimensional Pricing
One of the most common missed opportunities I see companies make is settling for what I call “flat” or “one-dimensional” pricing. It’s a big mistake to create a basic, tiered pricing structure and think you’re all set. That might work for the early-stage company, but as a company grows and gets more advanced, you need to take a more sophisticated and strategic approach. The best-in-breed SaaS companies typically have two or more dimensions to their pricing. For instance, a company might combine a tiered pricing structure based on certain feature sets with a usage-driven pricing component.
Salesforce provides what is probably the earliest example of this more sophisticated approach to pricing. They really nailed the multi-dimensional aspect because the market they’re in provides a lot of natural opportunities that lend themselves to this approach. In the simplest terms, they have multiple prices that they charge per user for their core platform and functionality—their sales cloud CRM product—and then, based on the number of seats on an account, they apply usage-based upcharges.
The beauty of multi-dimensional pricing is that it creates a real multiplier effect that can drive substantial uplift in revenue. And there are a lot of different ways to bring it into play: usage, features, number of users, metered usage, add-on products, and so forth. The key is to think about the best ways to extract value from your customers, but to make sure you’re doing it in such a way that you’re also delivering value back to them.
It’s also important to remember that the customer must be at the heart of any pricing strategy. Case in point—at HubSpot, a single insight about our customers completely flipped the way we were looking at churn and ultimately drove a transformative uplift on our churn rating. Initially, we were trying to minimize churn by looking at the bottom 30% of our customer base, the least active users who weren’t getting value out of the product. We banged our heads against the wall trying to figure out how to make them happier and keep them from cancelling. What we eventually realized was that we were paying attention to the wrong group of customers. We should have been looking at the top 20 – 30% of our base—the happiest group of users who already loved our product.
Once we figured this out, all we had to do was give these customers opportunities to give us more money; and that’s exactly what we did. During the time frame a few years before and after our IPO, all of the uplift we got on our churn rating—going into negative churn—and a lot of the uplift we saw on things like average contract value was driven by pricing and our strategy to give our most active customer segment opportunities to pay more.
Making Sure You’re Not Selling Yourself Short
On the topic of giving users ways to pay you more money, there have been some really interesting experiments done on the ways pricing interacts with marketing and branding. One of the best-known examples is research around how consumers judge various bottles of wine based on their perception of how expensive it is. In short, when told a particular bottle is ten times more expensive than another bottle, they perceive the more expensive wine as a superior product (regardless of actual quality).
A similar phenomenon often applies to SaaS products. At HubSpot, for example, we found that larger companies would look at our $250 per month fee and assume our product either wasn’t very good or wasn’t designed to support their complex needs. At the same time, very small companies looked at the same price tag and thought it was really high. It’s the whole “eye of the beholder” concept, and it presents a real challenge for SaaS companies marketing to multiple audiences.
At Lola, we faced a slightly different issue in that our pricing was originally completely based on transactions. In this model, we made money when people booked flights and hotel stays through us, and often the customer didn’t even pay the transaction fee because it was more of an industry commission. The unanticipated fallout from this pricing structure was that customers’ uncertainty about how we made our money made them doubt the quality of our product. This doubt, in turn, held them back from implementing our product aggressively. Instead they might test it out slowly with only two or three employees.
When I joined the company as CEO, I layered subscription-based pricing on top of the transactional fees. We started out at a monthly fee of $100, which is fairly nominal if, for instance, a company is spending half a million on annual travel expenses, but it is much higher than $0. The result was pretty instant. Customers immediately had a much better perception of our product as a high-quality solution; and the rollouts went much faster—getting all of a company’s employees onboarded within a day.
As a bonus, when you are charging more, customers tend to give you more and better quality feedback on things like bugs and UX problems. As soon as we started charging Lola’s customers $1,200 per year, they were reporting all kinds of things that were really helpful to our developers.
Another common trap that inexperienced companies fall into is getting sucked into a race to the bottom with the competition. It can be very tempting to follow when competitors slash prices, but the only situation in which you want to have the lowest price is when your entire business is based on being the lowest-cost provider. (Think Walmart or Costco.)
If low cost isn’t your differentiator, you want to avoid undercutting yourself and instead focus on emphasizing your true points of differentiation. Price is rarely the best way to differentiate anyway. Usually, you can establish a much stronger and more stable market position if you differentiate your company based on features, service, credibility, or community. And within each of these categories there are nuances of how to set your brand apart. You can differentiate via which services you deliver or the method by which you deliver them. You can build credibility and inspire trust by amassing a lot of 5-star reviews or having a huge number of customers. A large community of customers can also give you the edge that comes with ubiquity. If, for instance, you were going to launch a new sales or marketing platform, you’d face an uphill battle against companies like Salesforce and HubSpot that have achieved such massive market penetration that almost everyone in the industry is familiar with and trusts their products.
Having warned against selling yourself short with too-low pricing and getting into pricing battles with competitors, I do have to acknowledge that sometimes it’s actually wise to leave a little money on the table. In fact, in the short term you almost always want to set things up to create what economists call “consumer surplus,” which refers to the difference between what someone is willing to pay for your product and what you’re actually charging for it. In the first few years of business, you want to avoid trying to squeeze every single dollar out of the customer. Instead, focus on making them really happy by making them feel like they are getting a ton of value.
In the long term, while you still want to steer clear of making pricing and packaging your competitive differentiator, there can be great competitive advantage in developing pricing that drives better unit economics. If you have better unit economics or higher LTV or CAC compared to everyone else in the market, you’ll be more profitable and you’ll have more cash to reinvest in your business.
Creating a Competitive Advantage to Withstand Any Market
Pricing is hard. It can make or break your company. It’s also an unavoidable part of the business, so your best bet is to arm yourself with as much information as possible so you can make informed decisions. The best pricing strategy is one that considers things from your customer’s perspective. When you lose a sale, don’t immediately assume it’s because your prices are too high. Instead, ask yourself if the customer was able to see and experience the value that justifies the pricing. That’s a very different conversation that will lead you in a very different direction strategically.
You want to look at your customer’s experience and be able to define clearly how they can be more successful with and because of your product. Being able to convey that potential effectively and help your customer experience it first hand will give you all the conviction you need to charge a premium in even the most competitive market.
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