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If you are running a SaaS business with a SaaS pricing model, you are probably very focused on customer retention and product adoption to drive up your annual recurring revenue (ARR), right? Of course you are. But many companies don’t invest nearly as much time on the SaaS pricing strategy as they should.
Why should businesses dedicate focused energy on how best to price their SaaS software? Because pricing is the fastest and most effective way for businesses to increase profits to the bottom line or at a minimum make the additional funds available for other investments.
As far back as 1992, Harvard Business Review research revealed that a 1% improvement in pricing leads to an 11.1% hike in operating profit! More recently, McKinsey reported that on the average income statement of an S&P 1500 company, a price rise of 1% would generate an 8% increase in operating profits, if volumes remained stable. That pricing impact of nearly 50% greater than a 1% drop in costs, and more than 3X the impact of a 1% sales volume increase.
Why does SaaS pricing make such a difference to the bottom line? Unlike new customer acquisition and customer retention, there’s little to no ongoing operational cost associated with pricing changes. The price point lever can therefore have an outsized influence on gross and operating margin of the business.
What are the different pricing models and which ones should you consider for an effective SaaS pricing strategy? Below are the various pricing models available. For a detailed description of each type, please refer to my report "Price Design".
Determining the value line is the basis for XaaS value-based pricing. That is, establishing the tangible and measurable ROI of the offer and confidently determining a fair exchange rate for that value.
Let’s review a few common “as-a-service” pricing pitfalls I routinely see happening at technology companies. Whether you’re SaaS, DaaS, IaaS, etc., as long as you offer anything “as-a-service”, you’ll want to check to see if you’re currently making any of these mistakes and start developing a plan to fix them.
Today, almost half of all SaaS offers have engaged in market-based pricing, tagged to the competitive environment. While it feels like a winning approach to pay close attention to competitors’ SaaS pricing strategy, it does eject suppliers out of the control seat and hitches its profitability prospects to its competitors, who may or may not be investing in SaaS price intelligence. While this works for companies like Apple with highly sought-after solutions with market leading pricing, it is more often associated with downward pricing pressure of market followers responding to competitive forces to feature functionality by volume.
SaaS pricing model practices.
Source: XaaS Offer and Pricing design study, 2019.
The remedy? Suppliers that believe they have a strong relative value proposition should confidently unhitch themselves from their competition’s price and design a value-based pricing model, starting with an assessment of their pricing power and creating a tangible value framework.
The data shows that 68% of companies with vertically segmented offers also price the value delivered in those offers uniquely. What about the remaining 32%?
Prevalence of segment specific pricing for vertical segmented offers.
Source: 2019 TSIA Offer Design & Pricing Survey.
Assuming suppliers deliver unique and tailored value to each of their market segments, not pricing for that unique value may leave margin points on the table.
What can be done? TSIA's research shows that offers delivering a vertical segment specific value proposition are more likely to have a high offer-market fit and therefore higher pricing power. As such, it’s recommended that businesses who lack vertical segment specific pricing for their vertical offers, reassess their vertical pricing design starting with a review of their tangible value and an assessment of the customer price sensitivity and willingness to pay.
Monetizing value is the reason SaaS technology suppliers are in business. SaaS pricing is the process of arriving at a fair exchange rate for the supplier’s value.
An effective SaaS monetization strategy for a solution portfolio and the related pricing process is a function of the supplier’s pricing power and the strength of their economic moat. Going to market using a defined pricing model, an attractive pricing anchor and specific price point makes the strategy a reality.
If you’re a TSIA XaaS Product Management member, you can read my full report “The Pillars of Pricing Power” here.
There are many more ways to leverage TSIA’s research and advisory in defining an effective SaaS pricing strategy. These include:
Post Date: August 6, 2019
Laura Fay is the vice president and managing director of offers research and advisory for TSIA. She also serves as TSIA’s vice president of XaaS product management research. Laura is a technology industry veteran with over 30 years' experience driving business growth in the enterprise technology industry via leadership roles in product management, general management, product development, and customer success.
The Technology Services Industry Association (TSIA) is dedicated to helping technology and services organizations large and small grow and advance in the technology industry. Find out how you can achieve success, too. Call us at (858) 674-5491 or we can call you.