Pricing and Planning: Strategic Alignment
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talio.
There are three steps to developing your pricing plan for 2024 and integrating it into the rest of your business planning.
The second step in planning pricing for 2024 is to align pricing with strategy. Pricing needs to support overall positioning, corporate values and key performance indicators (KPI). Pricing should also take into account the growth motion and packaging pattern that is used and the method used to set prices. Some companies are including the ability of pricing to influence Environment Society and Governance (ESG) goals in their goal alignment.
One way to organize the alignment step is with Roger Martin’s Strategic Choice Cascade, which Ibbaka has modified for use in pricing strategy.
Winning aspirations and pricing
Pricing is most often used to achieve revenue, cashflow and profitability goals. Another area where pricing is gaining traction is with Environmental, Social and Governance Goals (ESG) and Sustainability Goals, which are addressed at the end of this post.
The most common goals that pricing supports are …
Revenue
Revenue from new customers
Revenue from existing customers
Subscription revenue
Transactional revenue
Professional service revenue
Goals are often expressed as dollar values, as growth targets and as ratios.
One might have a goal to grow Annual Recurring Revenue by 40% to $100 million with 30% of the growth coming from New Customers, 10% from existing customers (NRR of 110% which is good but not unusual). One might further expect a breakdown of 50% of revenue coming from subscriptions, 20% from transactions and 30% from professional services (this balance is quite typical of sales led growth companies with an Average Contract Value (ACV) of more than $50,000).
Margin
Increasingly investors are looking for profitable growth and not just growth. Pricing is the key to margin management. Underprice and margins will fall below the target. Require exaggerated margin requirements and list prices will be set too high, leading to ad-hoc discounting or the failure to meet revenue goals.
Cashflow
Packaging and pricing design can also impact cashflow, which in some companies is even more important than profit. As long as cashflow is positive and operating capital requirements are kept low profitability is secondary.
Pricing can be designed to accelerate revenue collection or make sure that work in progress is minimized.
Unit economics
Many SaaS companies set have KPIs based on unit economics. This is a powerful approach as these metrics actually integrate different parts of the business. Investors regularly ask about unit economics and track performance.
Some of the unit economics used as KPIs are
Lifetime Value of Customer (LTV)
Customer Acquisition Costs (CAC)
Value to Customer (V2C)
Time to Recover CAC
Ratios are a critical part of this, the two most important of which are
LTV/CAC which tells you if your customers are profitable over time
V2C/LTV or the Value Ratio, which makes sure you are creating more
Have explicit goals for these ratios and use them in segmentation.
David Skok has provided the standard approach to this. See SaaS Metrics 2.0 – A Guide to Measuring and Improving what Matters.
Recently, Product Led Growth has led to a new set of key SaaS metrics. These metrics track progress in customer understanding of the value proposition, adoption of the solution, and scaling of use.
With the right package and pricing design one can impact these metrics as well, and it is important to have them front of mind.
See Kyle Poyar’s SaaS Metrics 2.0: The Case For Next Era Metrics Playbook
Where to play choices and pricing
Once you have alignment on goals and KPIs you need to consider your Where to Play choices. There are three main choices to make.
Growth motion
Packaging pattern
Ideal Customer Profile (ICP) and target segment
Pricing and growth motion
Most companies will have a primary growth motion and a supporting growth motion. Trying to support more than two growth motions will be a challenge for most growth stage and scale stage companies.
There are many ways to combine these growth motions and each combination influences pricing choices.
The most common growth motion is Sales Led Growth, and the most common supporting motion is Partner Led Growth followed by Product Led Growth. Companies with a well defined offer and value proposition that is easy to adopt are gravitating to Product Led Growth and its associated packaging pattern (generally Tiered or Good Better Best).
Pricing and packaging
Pricing and packaging are two sides of the same coin. It is critical to have agreement on the overall approach to packaging as part of your where to play choices. Each of these patterns leads to different approaches to pricing design.
Ideal Customer Profile (ICP) and Target Segments
The final Where to Play choice is the Ideal Customer Profile and Target segments. One does not provide value in the same way to everyone (at least most companies don’t)
How to win choices and pricing
The most important How to Win choice is not the price level, or even the price design, but how you set prices.
There are six common approaches and each has its role to play. As with growth motions, one often needs to combine two approaches in order to come up with a powerful pricing design. But one should have a lead approach. The six approaches to price setting commonly used in SaaS are …
Cost plus - generally used to set a floor price
Competition based - to price commoditized value
Willingness to pay (WTP) - to tune price levels to the market
Value based - to optimize pricing for long term revenue and customer lifetime value (LTV)
Behavioral - to set the frame within which price will be understood and to anchor prices are the desired level
Outcome based - the future of pricing as outcomes become more predictable and the assignment problem is solved (most outcomes have multiple causes and the contribution of each cause needs to be defined for outcome based pricing to work)
In general, SaaS companies will use some combination of Competition, Willingness-to-Pay and Value-Based pricing. Costs will provide a pricing floor. Behavioral pricing will be used to frame and anchor prices and as an input into market segmentation. Outcome based pricing, for most, is tomorrow’s story.
Once there is agreement on the pricing approach one goes on to pricing design. This does not need to be part of the annual planning work as it involves a lot of research and detailed investigation of value drivers, price elasticity, market dynamics and so on. It is part of the action plan for the coming year.
Pricing and ESG
An emergent theme for 2024 is the role that pricing and value can play in Environment Social and Governance (ESG) goals. In particular, there has been a lot of interest in sustainability. There is even a group Pricing for the Planet that offers courses and frameworks to help with this.
At Ibbaka this usually takes the form of having a Sustainability Model that works together with the other models in Valio to help understand and communicate the environmental impact of some of our solutions. This is how the different models fit together.
Some questions to ask about pricing and ESG in your planning process are …
Does use of our solution increase or decrease environmental impacts?
How can we price to encourage use that has positive environmental impacts?
How can we price to discourage use that has negative environmental impacts?
Should we provide some form of pricing incentive for our customers that encourages sustainable business practices?