What I Know about Pricing SaaS Products

Pricing software-as-a-service (SaaS) presents unique challenges — and opportunities — for product and marketing teams.

In the past few years I’ve had a hand in setting pricing for several successful SaaS products, including GoToMeeting, GoToMyPC, AppFolio and my current company ProductPlan (product roadmap software). In this article I’ll talk about the lessons I’ve learned along the way.

Let’s Start with Customer Value

Let’s start with what I consider to be the #1 most important element for pricing SaaS products: customer value.

Understanding customer value is essential for pricing all software products, but even more so with SaaS.

Because most SaaS products are priced with a recurring subscription, every month or year your customers reevaluate whether they want to continue subscribing. This makes it even more critical to ensure pricing is in line with the value your customers receive.

Let me define what I mean by “value.” First, value can be quantitative, such as time saved or additional revenue earned. Measuring this is straightforward, and is the basis of Return on Investment calculations. If your product is B2B SaaS, you are likely already factoring this in to your pricing decision.

But here is the tricky part: Value can also be qualitative, such as pain relieved or lifestyle benefits your product provides. By thoroughly understanding and documenting this sometimes nebulous qualitative value through customer interviews, you can begin to narrow in on possible pricing models and a price range.

It’s understanding this qualitative value that can help product managers set their product apart from the competition.

I believe that customer value should be the primary consideration for your price and pricing model. Not features. Not what competitors charge. And definitely not your costs.

An Example: How We Priced GoToMeeting

When we were determining pricing for GoToMeeting, I interviewed dozens of potential customers to gain a deep understanding of customer pain and the value they might receive from conducting online meetings with our concept. We discovered:

• Cost and time savings from reduced or eliminated travel (quantitative value)
• Cost savings from switching to our solution versus expensive per-minute pricing of existing solutions (quantitative value)
• Increased usage of online meeting technology because users were no longer tied to per-minute charges (quantitative value)
• Lifestyle benefits from conducting meetings remotely (high qualitative value)
• Reduced frustration by eliminating complicated online meeting solutions (high qualitative value)

By understanding these quantitative and qualitative values, we developed GoToMeeting’s unique $49 “All You Can Meet” flat-rate pricing (an industry-leading innovation at the time).

The pricing model directly relates to the pain and frustration we heard from prospective customers in our interviews — the current solutions were difficult to budget because the per-minute charges varied so widely. The buyer experienced sticker shock every month. Therefore, peace of mind was another qualitative value we could provide customers with our pricing model.

While it’s hard to assign a dollar amount to qualitative values, these are the benefits that ultimately made GoToMeeting a no-brainer for millions of customers.

Because the product was SaaS, we had the flexibility to price our product differently from the competition and create a unique product in the market. In a sense, we made pricing a part of the product. It became a differentiating feature that marketing promoted heavily.

Most product managers already know that finding the right price is more art than science. However, if you thoroughly understand the value for your SaaS product, you can delight customers, provide competitive differentiation and ultimately launch a more profitable product.

Which Model to Choose?

It’s a brave new world for pricing software-as-a-service products. Gone are the days of simply setting a per-seat fee and launching.

I now want to talk a bit about why SaaS gives product and marketing managers unprecedented flexibility to choose unique pricing models. Models that can differentiate your product in the marketplace. Models that ideally align with your customers’ goals.

One of the exciting advantages of SaaS is that you can think differently about pricing models. Unlike traditional software, customers licensing SaaS products pay for your product on a recurring basis. Your product is no longer tied to a one-time purchase. And because the product is centrally hosted, you have additional flexibility for offering your product in unique packages.

A Short List of Pricing Models

SaaS gives you the ability to consider revenue models that weren’t previously possible. Here’s a short (and by no means exhaustive) list of pricing models used today. Many products use a combination of these models:

• Per-user (many SaaS products)
• Per-user with free participants (GoToMeeting, ProductPlan)
• Storage (Dropbox)
• Features (plans based on feature tiers)
• Project (Basecamp)
• Freemium (LinkedIn)
• Per item/contact (AppFolio, Hubspot)
• Per Node/Server (Hadoop)
• Per Visitor/Traffic (AdRoll)
• Processor time/Data transferred (Amazon Web Services)
• Open Source (free with paid services)
• Advertising (Facebook)
• Broker fee (AirBnB)

Feel free to add to this list in comments. My point is that with so many options, you now have the ability to discover a pricing model that aligns with your customers’ goals.

Success-Based Pricing Example

For AppFolio’s property-management software, we developed a unique pricing model based on the number of rental units managed by a property manager. Because we charged a flat $1 per rental unit per month, the pricing was simple and easy to understand.

This pricing model resonated with customers because it aligned with their business goals. They paid more for our product only if they grew their business by adding rental units to their portfolio. If they were more successful, we were more successful.

Don’t be Tempted by Competitive Pricing

When pricing a new product, there is a temptation to set your pricing relative to the competition. It’s common for new products to price using the same model as competitors, but slightly lower. Sure, you can price the same way as your competitors, and perhaps that’s what your customers expect.

But with SaaS, there are so many ways to price the product that you have the ability to stand out in the market by thinking differently. Capitalize on the approaches that your competitors haven’t considered.

Keep it Simple

Don’t overly-complicate pricing. With so much flexibility in SaaS pricing options, there is a temptation to offer various flavors and packages.

Sometimes there are legitimate reasons for doing so. For example, it’s common to have three packages based on features. Studies show that this approach anchors customers, and can be an effective technique for driving customers to your best-performing package. That’s fine if this is your goal.

However, creating an overly complicated pricing scheme has the potential to confuse customers and create a nightmare for your finance team. Keeping it simple reduces headaches and may even provide more revenue over the long term.

For example, at ProductPlan (product roadmap software), we saw that products in our space had complicated licensing options. Many required a paid license for every software user. Several offered complicated pricing tiers based on packages.

We took a different approach to simplify pricing. We charged only for editors of roadmap data and offered free licenses to other collaborators. Rather than offering complicated pricing tiers based on features, we offered unlimited use of all features for one price.

Because the product managers want to widely distribute the product roadmap to stakeholders, this model benefits the customer. It’s aligned with their goals. In addition, this model gives our product more exposure within the organization, so ultimately we sell more licenses when other departments ask to use the software.

10 of My Top Pricing Tips

Here are 10 tips that you can use when pricing SaaS products. While many of these apply to SaaS products, the lessons overall apply to software products in general. Here we go:

1. Pricing must be a part of early validation. While you may not nail your final pricing until later, the earlier you can zone in on your pricing model the better off you will be. This gives you a greater chance of building your pricing model into the value proposition. At a minimum, during the product conceptualization stage actively interview potential decision-makers about their purchase process, how they purchased their current solution, and frustrations with the current solution’s pricing.
2. Ballpark LTV as early as possible. Customer Lifetime Value (LTV) is so critical to a SaaS business model that you need to estimate it as early as possible — well before you have customers and revenue. LTV influences the sales model and what you can afford to spend to acquire customers. While there are lots of ways to calculate LTV, I recommend keeping it as a simple back-of-the-envelope calculation with input from customer interviews and similar products.
3. LTV > CAC. The formula for success is simple in the SaaS world: LTV over time must be significantly greater than customer acquisition cost (CAC). SaaS companies with a recurring revenue stream like Salesforce.com have LTV multiples that are three to five times the cost to acquire that customer. Doing back-of-the-envelope calculations on CAC will help you avoid surprises down the road.
4. Your sales model influences your pricing. Conversely, pricing constrains the sales model options available to you. For example, if you have an expensive field sales force, you need to ensure that your customer LTV is high enough to support that model. You’ll struggle if your average customer purchases $50/month over a two year lifetime. Ultimately, your buyer persona determines your sales model, so make sure you understand the expected purchase process.
5. Create upsell opportunities within your pricing model. One of the advantages of SaaS is the ability to offer upgrades and services that drive additional revenue. Consider these within your pricing model, as they can make a substantial difference in long-term product revenue. This is the model we used with great success at AppFolio.
6. Use caution when offering annual prepurchase discounts. Many SaaS products that license on a monthly basis will offer a discount for annual prepurchasing. However, use this with discretion. Analysis shows that over the long term you leave significant revenue on the table.
7. Consider free trials. If your acquisition and activation model is simple enough, providing a limited free trial is a great way to increase your sales conversions. It’s common to offer 15- and 30-day trial options.
8. Service is key. Because SaaS is typically licensed as a subscription, your customers are at risk of churning every renewal period. Service and support are even more critical than with traditional software. For this reason, many SaaS products build support and regular upgrades into the standard licensing fee. Consider whether your customers will be receptive to additional fees for support and maintenance for a product that they expect to work flawlessly.
9. Customers don’t care about your costs. I’m not suggesting you ignore your costs, but don’t price your product working backward from cost. This is not how your customers will think about the pricing. Sure, cost of goods sold needs to be a factor for you to be viable, but this is not related to how customers value your product.
10. Pricing perception doesn’t follow economic rules. Customers often buy products for reasons that seem disconnected from the Return on Investment calculation. Pricing is highly psychological. For this reason the demand curve is not linear — a lower price doesn’t necessarily equate to more customers and revenue. Take this into account by thoroughly understanding the qualitative value that your product provides.

With web-based SaaS products, it’s easier than ever to conduct A/B tests to gauge buyer behavior, pricing, and acquisition costs (before and after launch). As you test the user interface, I encourage you to test your pricing with equal fervor.

Use qualitative customer interviews to get enough data points to make good decisions. Get the pricing right, and you have a recurring revenue stream that places your product’s portfolio value well above traditional software products.

Pricing is such a core part of a SaaS product’s business model that you need to get it right. These are a few of my lessons. Please add your own lessons in comments — I’d love to hear them!

Jim Semick is co-founder of ProductPlan, roadmap software for product teams. Jim has helped launch new products now generating hundreds of millions in revenue. He was part of the founding team at AppFolio, helping launch the company’s first products. Previously, Jim wrote the product requirements and helped launch GoToMyPC and GoToMeeting (acquired by Citrix). Jim is a frequent speaker on new product development. He lives in Santa Barbara California. @jimsemick