“Nowadays people know the price of everything and the value of nothing.”
Lord Henry, The Picture of Dorian Gray by Oscar Wilde
This piece was written in collaboration with Chris Bruno.
As we discussed in our first piece on pricing published 10 days ago, pricing and pricing strategy is an important decision for all businesses as it is critical to profitability. Sadly, it often gets far too little focus.
This piece dives deeper into the importance of pricing as a lever in driving profitability. It also steps through the different variables involved in devising a pricing strategy for a B2B SaaS offering.
I tell entrepreneurs and CEOs that a key value-add of a “strategic financial leader” is their ability to leverage financial thinking in influencing important operational decisions. One of those I always mention is pricing and pricing strategy. Yes, the CEO is the eventual owner of pricing decisions. And the CEO should reach out beyond Marketing and Finance to get input from Product and critically Finance before reaching a pricing strategy decision.
When most business leaders talk about growth, the primary focus is on new customer acquisition. A secondary focus, which garners more importance in subscription business models, is customer retention and upsell/cross-sell. The third leg of total revenue growth, monetization is talked about much less frequently than the other two.
And yet studies of multiple businesses have found that pricing (monetization) is the most important contributor to improvements in profitability.
Pricing Philosophy
Some B2B businesses price their product using the value/price/cost framework. I find it the most compelling way to justify the price. However, calculating the value received by a user of the product is tricky. Instead a number of companies set their price to provide them a “margin” or profit over their cost and then sense check that against competitor pricing.
The equation governing pricing strategy is that the value provided to the buyer is substantially greater than the price charged by the seller. In turn the price (adjusted for how long a paying customer remains) needs to be greater than the cost incurred to acquire a customer, deliver the goods and provide them ongoing service.
Many software sales people strive to make a case that the value provided to the buyer is at least 5x the price paid and often 10x+. Value is usually measured as including both hard dollars (increased contribution margin or reduced costs) and soft dollars (value of time savings and/or fewer errors). Providing a compelling explanation of both the hard and soft dollar savings is where there is “art” involved in pricing and sales.
Pricing Structure
Businesses know that different customers will ascribe different values to a product. The greater the benefits provided by your solution to a particular business the more they will be willing to pay.
The Editions Framework
To help divide potential customers into segments (groups with different needs), most B2B companies adopt an “editions” approach to pricing copying what the train/airline industry has done with “classes of service” - economy, premium economy and business class. Higher priced editions offer some combination of (a) additional functionality, (b) more throughput / usage, and (c) a higher level of service.
Salesforce, the first SaaS business, has followed editions pricing for years and sets examples that many other companies have chosen to emulate.
Pricing Structure
Within each edition, most companies increase pricing based on number of users (a per seat pricing model - as with Salesforce above) or unit of consumption (some throughput metric or number or value of transactions). Both these metrics are meant to be proxies for value generated by the buyer. In the last several years, SaaS pricing has been slowly moving away from a per seat model towards a usage model. Usage (# or value of transactions) tends to track more tightly against value created.
Types of Tariffs
Companies that price using a consumption metric tend to prefer what is called a 3-part tariff. Part one is the base platform fee. Part two (included in the base platform fee) is some level of usage. This is often set uniquely for each customer. And, Part three is an overage fee to be charged for usage over the base included level (within a month or year). Three part tariffs allow individual sellers more flexibility in customizing offers. And, customers benefit from being able to initially buy a lower level of usage and then pay for extra as they use it.
Reducing Friction
Most B2B SaaS vendors require buyers to have a conversation with a sales rep to get insight into pricing. Chorus.ai (the sales conversation intelligence platform) says that pricing comes up 4-5x in the first conversation between a prospect and a sales person. Pricing can often be the biggest barrier to having a serious sales conversation.
Ways to reduce friction in the sales process include:
(a) Disclosing as much as you are comfortable with around your pricing on your web-site (a B2C analogy on software pricing would be if the price of the clothes, bag, jewelry or shoes you were purchasing not disclosed until after you added it to your cart.)
(b) Offering a time-limited free trial—especially for the entry level software product
(c) Offering a proof of concept (Poc) at a free or meaningfully reduced price point which becomes payable if the contract is extended beyond the PoC.
(d) Be able to clearly articulate how quickly you will be able to onboard a new client to full functionality. Software buyers are naturally fearful of the slow onboarding process and difficulty in learning how to use the product fully.
Is There A Right Answer to Pricing?
As stated in our first piece, getting pricing right is neither easy nor straightforward. And there is no single right answer. Here are some principles that will improve the “success” a business has with its pricing and pricing strategy.
Have a single person or team leading your pricing effort (knowing multiple parties influence the final decision made by the CEO). Fewer than 20% of software companies identify having a person (other than the CEO) responsible for pricing in their job description.
Do customer research to understand how they continue to use your product and what metric is most aligned with how they generate value from the product.
Be open to testing new pricing approaches. Yes, it will add to complexity in the sales approval process and in billing/customer support. And, limited experimentation will be worthwhile.
Knowing that sales people will want to offer discounts, have a written structure for how incentives and discounts are offered. Take into account items such as payment timing (cheaper for all in advance), contract length (multi-year discounts). Also remember in large enterprise sales, there may be a second negotiator of discounts in the form of the procurement team.
Offer ongoing training to the sales and marketing team members so that they can articulate the value of your product clearly, and so they know the relative margins of your different products and services.
CEOs, Sales and Marketing Leaders—spend time on pricing and pricing strategy, even though it is hard. Give it the due it deserves alongside product, positioning, leads/opportunities and demand generation.
Do the difficult things while they are easy and do the great things while they are small. A journey of a thousand miles must begin with a single step. Lao Tzu