Is your SaaS business making full use of its pricing power?
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talio.
Pricing is the most powerful way to improve SaaS business performance. Yet many companies hesitate to act. Why is this? Based on our conversations with SaaS CEOs we hear the following reasons.
“We are not sure how pricing will impact volume and revenue”
“Our competitors will respond taking away any advantage we might get from changing price”
“Our customers are not complaining about our pricing”
“We are not sure what action to take or how to take action”
“No one is responsible for pricing, there is no one to hold accountable”
“It is too hard to implement price changes”
“We have other priorities”
And one thing that we soledom here but is often the case
“We need to solve our discounting problem before we work on pricing”
One reason for the failure to act on pricing is that many people have a limited understanding of what pricing involves.
Some people think of pricing as simply sticking a number on a price tag. People that think that way will never be able to optimize price. In most cases the price tag is being put on the wrong thing. SaaS companies charge per user when allowing unlimited users and scaling through functionality or use would drive higher revenues. Or they use only one pricing metric when a hybrid approach would give them the flexibility they need to grow revenues and respond to market conditions.
Pricing execution relies on three steps
Align price with value
Target high value segments
Optimize price level
Align price with value
You align price with value by making sure your pricing metrics track your value metrics.
Value Metric: The unit of consumption by which a user gets value.
Pricing Metric: The unit of consumption for which a company pays.
In many SaaS companies the value metric and the pricing metric are not connected. When this happens it is impossible to price effectively.
Optimization efforts will end up optimizing the wrong things and will generally be counterproductive.
Sales will struggle to communicate value in pricing negotiations and will default to discounting.
Customer success will not be able to document value leading to lower net dollar retention.
Target high value segments
SaaS companies grow fastest when they focus on the customers where they create the most value. This is where they have the most pricing power, where sales go fastest and renewals are highest.
A meaningful segment is a group of potential customers that get value in the same way and that buy in the same way.
The target segments are those where one creates a lot of differentiated value and customer acquisition costs are manageable.
Optimize pricing
Optimizing pricing is where it all comes together. Price aligns with value; packages are designed for the segments where you deliver the most value; price levels are set to optimize revenue growth.
Align → Target → Optimize → Align …
By doing these three things over and over again you will see Customer Lifetime Value (LTV) grow steadily, Net Dollar Retention (NDR) go up over 115%, and Contract Value grow.
In many cases, Ibbaka has been able to help our customers grow contract value by more than 30%. In some cases, by providing a completely new pricing metric, we have seen average contract value go up 10X.
See What to price? What to optimize? How to optimize? Three key pricing questions
Let’s work through the common objections to taking action on pricing.
“We are not sure how pricing will impact volume and revenue”
The uncertainty here comes from a fear that price increases will lead to lower volume and revenues will go down after a price increase. The first thing to remember is that the volume optimizing price, the revenue optimizing price and the profit optimizing price are three different prices. The CEO needs to give clear guidance on the goal. Once there is goal clarity, market research, tests and modeling can answer this question.
“Our competitors will respond taking away any advantage we might get from changing price”
Yes, pricing is a game that plays out over time. Every significant pricing action will see a response from customers and competitors. The nature of this response will depend on the market dynamics: price elasticity of demand (the change in aggregate demand based on price) and cross price elasticity (the tendency of customers to change vendor in response to price changes).
Price elasticity is generally lower than many think for SaaS platforms. Companies with differentiated offers that create value for customers almost always have untapped pricing power. That pricing power should be used to grow volume, revenue or profit. Not using it is a big missed opportunity.
See Want to Nail Pricing? Understand Market Dynamics First
“Our customers are not complaining about our pricing”
Why not?
Are prices so low that they don’t matter?
Have you done such a great job communicating value that customers accept price?
Or is value so muddled that price is the least of your problems?
One should be having regular conversations with customers on value - value promised, value delivered, value documented, and how that value is shared.
“We are not sure what action to take or how to take action”
Many companies lack a pricing methodology. The three most common approaches to pricing are
Throw it at the wall and see what sticks
Copy our competitors
It’s a frozen accident (we priced somehow when we launched and not our pricing is baked into our systems)
None of these approaches leads to success.
A good pricing methodology follows the three steps outlined above.
Align price with value
Target high value segments
Optimize price level
There are now well tested ways to execute on each of these steps.
“No one is responsible for pricing, there is no one to hold accountable”
In that case the CEO is accountable. And boards and investors are getting better at holding the CEO accountable for pricing.
One reason companies struggle with pricing is that it requires coordination between all key functions.
CEO sets pricing goals, aspirations, metrics
CFO measures benchmarks and performance and models the impact of pricing actions
Product is responsible for creating value
Marketing communicates value
Sales crystalizes the value for a specific customer
Professional services deliver the value (using the platform)
Customer success makes sure that value continues to get delivered
Clarity on who is responsible for which part of the value cycle is critical for effective pricing action.
”It is too hard to implement price changes”
Once you have invested in a new pricing design and set up new price levels it can be hard to execute. The most common blocks are
Resistance by the sales team → arm them with value stories, incent them to act
Difficulty in configuring systems → CRM, CPQ, value management, billing, finance all need to reflect the new pricing. But are you going to let your business systems determine your pricing strategy?
Migrating the existing customer base → this can be a challenge, and it is important to have a plan. Not all customers can be migrated at the same time. Not migrating customers will become a long term drag on business efficiency.
See Customer segmentation for price increases
“We have other priorities”
More important that growing revenues, improving profitability and fixing net dollar retention? Well, OK.