Value-based Pricing for SaaS Technologies
Author: Stephen Newman, Founder Product Insight
Product Insight is a Product Consulting firm specializing in Product Management, Product Marketing and Pricing consulting services
We aren't going to sugar coat it... Pricing Is Hard. During the transition to SaaS-based solutions, software firms are experiencing significant challenges in their Go To Market strategies related to pricing. Buyers expect SaaS solution's to offer a value proposition that includes technology that is easier and faster to deploy with near-zero maintenance as well as pricing that is simple, predictable, and aligns to the value the software is providing. While software firms are getting a handle on adopting cloud-native technologies to streamline and provide better offerings they are still struggling with pricing. Many find it difficult to fully understand their COGS for their new cloud offerings while others are challenged to package their product portfolios to align to their buyers’ needs. Making things even more complex is a backlog of historical SKUs that were created to try to offer any possible option a customer may want to buy.
Over the years numerous pricing approaches have been used such as cost-plus, competitive, and performance-based pricing models. However, if you offer a differentiated product offering in the market you most-likely will seek a value-based packing and pricing model. Value-based pricing means the fee associated with your product aligns to the perceived value it is providing to your buyer. Your offerings align to specific buying segments where each package offers a different value proposition to the buyer, often referred to as Goldilocks Pricing. As most SaaS-based technologies are designed for recurring revenues, this pricing model supports a land and expand model, but also puts the responsibility on you to continue to innovate and extend your product's value to your customers.
While one fundamental concept is that value-based pricing is simple for the buyer to understand, the effort to create effective value-based pricing requires quite a bit of work and organizations are turning to Product Consultants / Pricing Consultants for help. Product Insight has been fortunate to help numerous enterprises develop their value-based pricing and has developed seven steps to develop winning packaging and pricing for SaaS-based technology offerings:
Establish Pricing Goals & Identify Challenges
Understand Your Buyer and Buyer Segments
Map Product Capabilities to Value-based Packages
Build Cost Model & Analysis
Set Target Price Points & Pricing Metric
Perform Gross Margin Analysis
Test Pricing in the Market
“Buyers expect SaaS solution's to offer a value proposition that includes technology that is easier and faster to deploy with near-zero maintenance as well as pricing that is simple, predictable, and aligns to the value the software is providing.”
Step 1: Establish Pricing Goals & Identify Challenges
Before developing pricing, it is key to meet with key stakeholders and capture what they identify as goals for your product’s pricing. Often this includes itemizing challenges stakeholders see in the current pricing. While the simplest step, it is the most important. Change is hard for most organizations, especially for something tied so closely to revenue such as pricing. By taking this inclusive step, it will both guide the pricing effort and increase the likelihood of the adoption of your pricing strategy. Sample questions you can ask key stakeholders:
What are your goals for the new pricing?
What’s not working with the current pricing?
Based on your organization, what are the key components your team contributes to Revenue or Costs?
What do you think makes the best pricing metric (the metric used to associate value)
Who do you see as the Buyer / Decision Maker of this offering?
What problems do the Buyers / Decision Makers care the most about?
Are there any market conditions / changes that should be considered in crafting the new pricing?
Who are the primary competitors and what differentiates the product offering from theirs?
Step 2: Understand Your Buyer and Buyer Segments
Value-based Pricing should be designed to align to your buyer / decision makers’ success criteria and packages should be designed to enable positioning to each of the segments of your buying population. In the same way knowing the persona of your buyers is critical to your product roadmap and messaging, it is fundamental to the development of your pricing strategy. When performing customer discovery to build out the buying persona:
Understand the key players in the buying / decision making process (not the users)
Identify their title, roles, and responsibilities
Identify traits in their career trajectory and experience
Understand how your offering aligns with the buyers’ corporate strategy and initiatives
Capture the buyer and decision maker’s motivations and goals
Focus on the buyer and decision maker’s challenges and pain points
Step 3: Map Product Capabilities to Value-based Packages
In Value-based Pricing, you want to align capabilities to packages which you can position to different Buyer’s needs. Typically, you want to identify the core / minimum capabilities that meet the needs of your Buyer and set those as the entry level package. Then you want to associate your differentiated capabilities into higher priced packages. This enables you to assign ‘value’ to these differentiated capabilities. You can then identify how to position each package to different segments of your buyers.
Step 4: Build Cost Models and Perform Analysis
For new products, product managers should identify requirements for the product that go beyond development. Requirements should be identified for Customer Success, Infrastructure, Marketing, Sales, Professional Services, Back Office Systems, and Enablement / Training. As the Product moves through the software development process, requirements for these other components of the offering should evolve and a clearer understanding of the total Cost of Goods Sold should be identified (as well as non-COGS costs). This effort is iterative and requires cross-functional cooperation. Of course, developing new pricing for existing products requires the same understanding of the cost involved in providing the offering to customers. This is often the most difficult step for organizations and where Product Consultants can offer the most help, working with finance and operations teams to extract out cost items, model the cost to different size customers, and perform analysis to identify risk.
Step 5: Setting Target Price Points & Pricing Metric
Setting the price points for each Value-based Package is dependent upon your products differentiation, market dynamics, competitive pricing, customer’s willingness to pay, and your product positioning. The Pricing Metric is how the fee is structured (e.g., number of seats, transactions, PMPM, target users) and typically should be chosen based on how the buyer associates value to price. Sometimes packages can have different flat fees based on the features/capabilities included and then use items such as number of seats or users as ‘Limiters’ that trigger a sign to the customer they should move up to the next package. Often, you can perform historical deal analysis and consider competitive pricing to establish target price point per package.
Step 6: Gross Margin Analysis
Once you have target price points for your packages, it’s time to validate the pricing will produce the margins necessary for your business. The cost models you created in step 4 will allow you to create a ‘deal margin analysis’ tool where you can run scenario testing to ensure your gross margins are acceptable. Scenario testing should cover different size customers as well as the added cost items for higher level packages. Be sure you have alignment with your finance department on which cost items count toward your COGS vs non-COGS so that you can appropriately identify your gross margins vs net margins for any given deal.
Step 7: Test Pricing in Market
It’s typically quicker to test your new pricing in the market by surveying potential buyers rather than just releasing your new pricing to your sales team and hope you got it right. By running market surveys, you can test prospective clients’ willingness to pay based on the value of each package. Based on the type of product, there are different price validation questions you can ask to identify the optimal price points with your buyers.
Value-based Pricing Benefits
While packaging and pricing efforts require a lot of work, the effort is critical to your Go To Market strategy. First and foremost, it allows you to highlight your product’s differentiation while protecting you from price erosion. Other benefits may include:
Driving adoption & revenue
Value-based Pricing that fits buyers’ needs now and allows for growth in the future
Pricing that establishes associated value to differentiated capabilities, increasing margins, and defending against price erosion
Product packaging that positions your offerings to different buying segments and their goals
Product packaging that increases retention through heightened value / price awareness
Streamlined product catalog that reduces back-office mgt. costs
Standardize offerings that enable simplified and consistent deployment
Product packaging that ensures features with higher support cost are aligned to higher priced offerings
Reduces costs for:
Data center maintenance
Optimizing your teams
Standardize support offerings tied to packages
Build the best products by incentivizing PMs to focus on adding capabilities that customers value
Eliminate development support for features that don’t align with customer needs
Transform your IT staff from cost center to building value into solutions
Challenges & Recommendations
Despite its criticality, organizations often fail to dedicate the time necessary to properly develop packaging and pricing strategies nor have the collective experience to drive through all seven steps. Therefore, many organizations turn to external Product Consultants or Pricing Consultants to aid them. If you do look for external help for pricing, make sure you pick a consultant that will also teach the process to your team so you can take over the responsibility after the project’s completion. This is important as it is good practice to review your pricing every 6 to 12 months.