Strategic Pricing for SaaS Startups
Pricing is a delicate balance, and it’s even tougher for small startups that don’t have much data to go on nor resources to execute.
Pricing for a SaaS business is hard. Really hard.
No matter what stage your company is at, pricing will always be a challenge. That’s because it’s part mental game, part math game, part trial and error. The key to growing revenue responsibly is to keep iterating. Think about a SaaS product you’ve used for years一it probably wouldn’t be around today if they hadn’t switched up their pricing from time to time (as annoying as it might’ve been as a customer). In each of those instances, that company came up with a new pricing strategy by weighing new features against COGS, against customer satisfaction and perception, against inflation, against their competition.
Despite the fact that pricing is a bit of a moving goalpost, we hope to provide a consistent, solid framework for how to think about pricing at an early-stage company.
Structural aspects of pricing to consider
Pricing is about a whole lot more than nailing down an amount someone will pay for something. You have to think about pricing holistically, from a product, value, timing, volume, and gross margins perspective. Here are a few questions you’ll need to ask yourself when you’re thinking about pricing for the first time or reassess your current structure:
- Will you have annual or monthly contracts? Monthly contracts might be more appealing for customers with tighter budgets that aren’t sure if they like your product yet. On the other hand, annual contracts give you more peace of mind with cash upfront and the security of a year-long commitment. Find out whether there are accounting or volume-related advantages to each. You might end up offering both annual and monthly contracts, giving people a price break if they pick the longer-term option. Whichever way you go, just make sure you have an auto-renew feature.
- Will you charge based on value or gross margins? Cost-plus pricing isn’t super advantageous to SaaS companies that don’t offer a physical product and may not yet have product-market fit. That said, it probably would end up making your product cheaper, helping you get an edge over the competition when you’re just starting out.
- Will your contracts be a flat fee, priced on consumption, or both? Right now, consumption-based pricing is on the up and up. According to OpenView Ventures, 45% of expansion stage SaaS companies have a usage-based pricing model. But remember, flat fees and consumption-based pricing don’t have to be mutually exclusive. For example, you might charge a flat fee to demonstrate the value of using your platform and then tack on extra fees for overages. A very common practice is turning this combo into a 3-part tiered structure. This strategy often leads to greater contract values but can be tricky to keep track of as you scale. If you go this route, make sure you have a plan in place for collecting overage data.
- Would dynamic pricing make sense for your product? Are there certain times of the year where the demand for your product skyrockets? Dynamic pricing may not be as applicable to SaaS companies, but it’s worth considering if it applies to you. You might as well capitalize on drastic shifts in demand.
- Can you get more customers in the door with a freemium strategy? If your company is in a crowded space, and you want to get a leg up on customer acquisition, freemium might be for you. Freemium is a smart choice if you have a low marketing budget and low COGS. Freemium allows users to try before buying, so if they have a fantastic experience and know that even more great features are behind a paywall, you’ll likely have yourself a loyal customer.
Five tenets of pricing
Leading VCs have published a lot of articles and ebooks on pricing. After reviewing several, we found several tenets come up over and over again. So let’s dive into what each of these five principles means before providing a real-life example of how each element works in practice. For this exercise, we asked how the founder of a growing SaaS startup in the HR space applied each of these doctrines to his pricing strategy.
1. Pricing will always be a WIP
It’s worth belaboring this point: pricing is never “done.” As Bessemer Ventures says, “too many companies treat pricing as a point-in-time exercise,” which seems foolish, given that the market is always changing, new competitors emerge, and customers’ budgets evolve. Not to mention, your company goals change, too. So revisiting pricing regularly一twice a year or more一is a practice you should adopt right away. It gets you in the iterative state of mind and makes you pay closer attention to the way customers’ needs and willingness to pay have transformed.
“I recently purchased another smaller SaaS company to merge with my current startup. Prior to the acquisition, the original founder modified pricing several hundred times. While he got some users in the door (60), he was bending over backward for it. And only 4 or 5 of those customers were on annual plans, so it was really hard for him to profit from the ridiculously low prices customers were favoring.
So the first thing I did was change it up. I instituted a freemium model because I wanted that steady stream of new prospects to demonstrate our value. And I elevated the base price slightly to show that we still provided the same quality as others in the space but were still 50% of the annualized cost per user of the next-best competitor. Based on the experience of the previous owner, I know that won’t be sustainable forever though. I don’t know how this new product will fit into our value prop and what customers’ willingness to pay for it is, so I’ve introduced a new policy of revisiting our pricing quarterly.”
2. Use the data you have
When you’re creating a pricing structure, the logical thing to do is to look at your competitors’. But what if you don’t have any competition yet? Startups are pioneering new industries, making it extremely difficult to know where to start. In fact, roughly 1 in 5 SaaS companies admit that they set their pricing by guessing what the right price might be. Often, this makes for a great excuse to put off pricing discussions.
Don’t fall into that trap. Even if no companies are doing exactly what you’re doing, there will definitely be benchmarks in other spheres. Study companies in a tangential space that serve a similar customer base. Or, if your product will be one of many in an enterprise’s tech stack, figure out how much the other products cost relative to yours. Take the time to do your research.
“There aren’t a ton of direct competitors, but that doesn’t mean I haven’t tried to find relevant data. I’ve looked at the pricing structures of employee recognition and rewards software, employee engagement platforms, recruiting AI companies, and even applicant tracking systems. They are all serving the same customer base we want to penetrate so looking at how they price was really helpful. Just like those companies, we wanted to offer a clean entry-level price, structured in a way so that teams could find an extreme amount of value without feeling like they were ripped off.”
3. Pay attention to feedback
When you’re small, everyone on your team is collecting feedback about pricing一from the customer-facing people to the product people. And customer feedback matters. After all, they’re the ones who are going to be refusing to buy your product or evangelizing it. If you’re the founder, people might feel more comfortable giving you their candid opinions, so use customer interviews to your advantage. Next, establish a way of collating and talking about all this input and how it can translate to changes in your pricing framework. This could be a monthly meeting, a working google doc, or part of your offsites. Designate a point person to organize the feedback and schedule time to keep pricing conversations going to prevent this dialogue from getting lost in the shuffle.
“Talking to customers and figuring out how they're using the product was huge for us. We realized there was an issue with per-user pricing: some users get way more value from our products than others. This is because recruiters use “aliasing” where they do their work on behalf of hiring managers. So, even if just a few recruiters were using our tool, they had to buy multiple seats. And the hiring managers who were being aliased really didn’t use the tool at all. So that’s when we decided to totally scrap per-user licensing.”
4. Packaging matters
Not all people are bargain buyers一they can be swayed by performance, packaging, and other perks. Think about what else you can offer, like a loyalty or referral program, outstanding customer service, specific product features, or access to a certain network of industry leaders. Also keep in mind that not all customers have the same objectives nor the same budgets. Segment your customers into personas to pinpoint their buying power, top use cases, and perceived value more accurately. Then, incorporate these differences into your pricing model to give customers more flexibility. A classic example of this is offering a software package with enterprise, small business, and personal editions. As you do more research, you might brainstorm ways to bundle your products in a way that encourages upsells or create more compelling offers and discounts.
“Because of the aliasing problem, we completely shifted our pricing strategy. Instead of a per-user pricing model, we came up with three unique tiers based on our customer segments. Our base plan has 3 seats at $99. This is an affordable price for some of the mid-market companies we’ve been targeting. The next level up has unlimited seats, but has a cap on the messages recruiters can send. It’s a flat $399 platform fee plus volume buckets starting at $5 per month. The enterprise model (the highest tier) also has unlimited seats but has to talk to sales to negotiate a deal for the volume piece of the puzzle. Based on how this goes, we’ll also be thinking about the integrations we offer (custom vs. basic) and other ways to switch up our pricing based on features coming down the pike.”
5. Measure your success
You won’t know if the pricing and packaging you’ve decided on are working unless you measure it. But like everything in pricing, measurement is a bit nebulous. Try setting KPIs based on customer pushback and the number of inquiries, leads, and conversions you get from different versions of your pricing page, email campaigns, and sales scripts. Use A/B tests to gauge customer behavior and continue refining until you see patterns in each customer segment. Of course, keep the bigger picture in mind. One pricing strategy might get really good reception and seem like a wonderful idea until you realize you’re actually losing money.
“My rule of thumb is that if you generate 50 inbound leads and 45 of them convert on the pricing published on your website一no questions asked一your pricing is too low. If people are inputting their credit card information with no hesitation at all, you’ve way undershot. It’s time to increase your prices. Keep track of what people are responding to and what they’re not and continue trial and error-ing until you get the response you want. At the same time, keep your unit economics in mind. I once read that your Annual Contract Value (ACV) divided by your Customer Acquisition Cost (CAC) should be greater than 1 (ACV/CAC > 1).”
Pricing is a delicate balance with so many variables. And it’s even tougher for small startups that don’t have much data to go on nor resources to execute. But, of course, that doesn’t mean you should just give up. Instead, you should think about pricing as an ever-evolving project bearing these five tenets in mind.