How To Price A SaaS Product

 

If you are a budding entrepreneur, you must have struggled with pricing your product. 

You’ve created a groundbreaking product that is ready to disrupt the space it operates in. Your investors are happy with the end product, your target audience loves your marketing campaigns, and you’ve hit the market at the right time. But somehow, you cannot find the numbers you need to ensure profitability. If you cannot find faults with the product or your go-to-market strategy, have you thought of learning more about how to price a product effectively?

Most customers are inherently “price-sensitive”. Although this “sensitivity” to the price of a product may be at different levels, too high or even too low a price can put off potential customers. Let’s dive into the details.

How are software products estimated?

Software pricing is setting a final cost for your end product, the price usually consists of:

• Cost of product development;

• Cost of infrastructure;

• Revenue goals;

• Competitive product cost analysis. 

Businesses thrive if they are in profit, and getting your product pricing right ensures profitability. If the pricing of your software is not optimized, the fundamental economics of your business go off balance.

How the value of the product is determined

Did you know that software pricing is dependent on the concept of value? Highly-priced products are considered better than their lower-priced counterparts and seem to offer significantly more value. Additionally, inculcating a sense of scarcity-labeling products as a “limited edition” can expedite the time taken to purchase a product. 

However, the value of a product is perceived individually. This makes software pricing complicated and a sweet spot challenging to find, but it is the best software pricing approach.

A data-driven pricing process would follow these four steps:

• define the problems that are inhibiting company growth;

• use buyer persona data to find the source of these problems;

• find the best possible solution for these causes.

Unit economics and product pricing

Every business strives to enhance and improve its customer lifetime value and decrease its customer acquisition costs. This is the only way to achieve growth as a business. 

As your cost to acquire new customers reduces with an efficient pricing strategy, you generate more lifetime value from each customer acquisition, leading to a better bottom line. If you are constantly thinking about “how much should I charge for my product”, it is essential to understand a little about unit economics.

CAC or customer acquisition cost is the total cost of sales and marketing divided by the number of customers acquired. This is the cost of your marketing and sales efforts to get a new customer on board.

LTV or lifetime value is the average revenue per user (APRU) divided by your churn rate. This means that your LTV will be what you will earn from each customer as long as they use your offering.

It is essential for any company, including SaaS companies, to have an LTV/CAC ratio of >1. Note that your LTV must be substantially higher than your CAC for long-term growth, which is the fundamental tenet of your cost-plus pricing strategy.

SaaS pricing strategies

Most companies do not put enough thought into pricing their products. They also do not understand that pricing is a continuous process to attain maximum value per sale. 

Here are the most common strategies used by businesses to define their product pricing.

1. Competitor based pricing

This strategy is quite easy. It uses competitor pricing as a benchmark to set product prices. The problem with this strategy is that you have your competitor’s pricing strategy and not your own.

You are in the market to give your customers something better, which is the primary reason why they will shift their business to you. Additionally, the only way to earn more is to raise prices and become the “expensive alternative”.

In short, competitor analysis should guide you as a company and not influence your pricing decisions. 

2. Cost-plus pricing

This is the most straightforward pricing mechanism. You calculate the cost of providing your service, add a profit margin, and done!

The benefits of this strategy include its simplicity (which is only relevant if you know what your costs are) and the fact that it will cover your costs. It is a good starting point and has little overhead. Moreover, you know your profit percentage. 

However, there is an issue. For SaaS products, you won’t necessarily know all your costs upfront, and these known costs too might fluctuate over time. So, if your expenses increase by 20%, your 15% margin might not do you much good.

3. Value-based pricing

Value-based pricing is essentially customer-driven pricing. This means relying more on marketing research and looking for pricing inputs from the decision-makers, your customers. 

The only downside of value-based pricing is that it takes time to get it right. By understanding your customer’s willingness to pay, you can start at a higher price point and raise prices as you add more value. 

Common challenges to avoid

Here are some common pricing problems faced by software companies and the metrics you must analyze to price your software product effectively:

Poor unit economics and price sensitivity. Price sensitivity is the degree to which the price of a product affects the purchasing behavior of your customers. You must collate price sensitivity data according to each buyer persona. An excellent way to collect this data is through a price sensitivity study.

Poor user retention. The cause for this can be either pricing or packaging. You must run relative preference studies to gather price sensitivity data close to core features and value propositions.

Low acquisition volumes. The lack of a value proposition is the likely cause of low acquisition volumes. Knowing your customer’s relative preference for value propositions and brand promises through customer interviews is an excellent way to get this data.

Low conversion rates. Your existing pricing strategy is possibly the root cause of low conversion rates. To know more, run price sensitivity studies segregated by buyer personas. 

Using this strategy to price your product effectively across geographies will help your customers find price points that suit their preferences and needs and satisfy their value concept.

Final thoughts

It is vital for every company to know their customer base, understand software pricing strategies, and the importance of pricing software or SaaS products in a way that can help your business be successful in the long run. 

Keep in mind that pricing and product development go hand in hand. They are both iterative, consistent, and dynamic. So, a data-driven approach will tell you how to determine product pricing and reap the rewards of a scientific pricing strategy for years to come! 

Author’s Bio: 

Alex Kulitski is Founder and CEO of Smart IT and is the co-founder and executive CTO at MEDvidi. Being a serial entrepreneur, he is a keen investor in technology startups and runs several successful side projects besides Smart IT and MEDvidi.