Common SaaS Pricing Strategies

The first rule or SaaS pricing strategy is you should actually have a price. Why? because pricing is information. The only way to know if people will buy your product in the future is if you can successful charge for it today.

2 years ago   •   7 min read

By Leo Moore

The first rule of SaaS pricing strategy is you should actually have a price. That means that if you are a early stage founder and you intend to eventually start charging for your product then you should start doing it now. Why? because pricing is information. The only way to know if people will buy your product in the future is if you can successful charge for it today.

However, many founders are uncomfortable with pricing and frequently have great difficulty putting a price on their creation. There are lots of reasons but for most is the fear of rejection. They want people to buy their product and think that the best way to get people to "buy" the products is to make it as cheap as possible or even better "free".

This is the tyranny of free. It is is based on the theory that the cheaper the product is then the more products you sell. This means you will sell more at the lower price 2 than higher price 1. This is what is called price elasticity in economics. You can't get cheaper than "free".

price elasticity graph

Greed is Good

Well maybe not greed, but it is important to make money or eventually your product or service will become unsustainable and that in not in the best interests of you or your customers.

To make money you need to charge money so that you can reinvest in the business. The price does not have to be perfect. One of the great advantages of SaaS is that the running costs are generally low so you can afford to increase the price for the new customers and either grandfather in your existing customers or better still increase your prices. Think of it, the easiest way to increase the value of your sales revenue is to increase your prices. After all, how many customers would be bothered changing if they had to pay 5% more?

Pricing is Information

Your price also gives you valuable information. The first and most valuable piece of information is have you achieved Product-Market Fit? The simple fact is that if your product does not  solve a problem for your customer than no matter how low the price goes, people will not buy the product, even if it is free!!

Once you have established  that people will buy your product then the next thing to establish is at what price they are willing to pay.

Shop front with 50% off Black Friday poster

Remember too, that pricing information is a two way street. In the mind of the customer the price of a product and the value of the product are related. They don't expect that a cheap product is as good as an expensive one but if you charge high prices then the customer expectations will be higher too.

Efficient Pricing

The objective of pricing is to get the maximum number of customers paying the maximum price. That can be harder than it seems. People buy what they feel will be of value to them and because founders are often involved in the product development they often focus on the flaws in their product like the missing features, minor bugs etc. without fully appreciating that a basic product can still provide a lot of value to the right customer.

This makes then less likely to charge an appropriate price for their product.  

Luckily, when it comes to pricing there are lots of pricing strategies that can be used to help. Here are a few to consider:

Competitor Based Pricing

This is also called market based pricing. Essentially, look at what people are paying at the moment and the best way to see that is to look at what your competitors are charging. For most people, this is probably the best place to start as your competitors are probably in the market longer than you and have more information.

To do this properly, you should map each competing product features to your own. As a rule of thumb, if your product has similar features to the competing product then you would expect that your product should have a similar price. However, if your product has more advanced features or is significantly easier to use then you can charge a premium. Similarly, if your competitor has relevant features which you are missing then you may have to charge a lower price.

It is normally hard to do an exact comparison as your competitors may be charging a particular price for different reasons. For example, their business model  may allow them to charge a lower initial price because they charge more for associated services. Also, bear in mind that some prices are simply not sustainable. Competitors may offer discounts or extremely low prices initially but eventually be forced out of business because they are not able to cover their ongoing costs and run out of cash.

So Competitor Based Pricing is a useful guide to get you started and you adjust the price from there.

busy shopping street

Cost Plus Pricing

Every product costs something. Even if you were selling fresh air, you would probably still have to market it. For most physical products it is easy to calculate the cost to produce an additional unit of a product.  This is often called the unit cost. Just take your fixed costs are like rent, equipment etc and include the additional variable cost it takes in time and materials to if you are make another one or the purchase price if you are buying one from a supplier.  You sales and marketing costs should also be included when considering your unit costs.

It is a bit trickier for software because the unit cost is normally low. But the basis remains the same, if your SaaS product is largely a self-service application then  your additional cost is low, if your product is more high touch or requires a customer success person to help them with on-boarding then your unit cost will be higher.  

The basis of cost plus pricing is that you look at your cost per unit and decide what margin you need to make it viable. so if the unit cost is X then you will charge X plus say 35% (or whatever). The most important thing about cost pricing is that it helps you determine your lowest possible price. Anything below that and you are losing money,

female factory workers in blue overalls sitting at workstations assembling products

Value Based Pricing

To paraphrase a saying "value is in the eye of the beholder". Value based pricing is focused on the value (or perceived value) your product brings to the customer. The idea it to align the price you charge for the product to be a proportion of the value to the customer. If you do this effectively then your can maximize your price and the customer still feels they are getting a good deal.

It can be a bit trickier in practice as it can be hard to quantify the value to your customer. The easiest way to start is to look at how much time your product can save your customer. Staff are expensive, and saving a few hours a week has a very quantifiable value.

Sometimes its not all about the time saving, it can also save people from doing task they dislike, although in many cases difficult or boring time consuming tasks are what people dislike the most. That's why TurboTax is so popular. The problem is that unlike staff time saving it is hard to quantify the value to the customer.

The best thing about value based pricing is that it forces your to think about how your product helps your customers. Inevitably, some product features are more valuable than others, so a common strategy is to have a tiered pricing strategy where valuable features are only available in higher priced premium versions of the product.

apple watch on persons wrist

The Power of Price

The important thing to remember is that:

Pricing is information

The first piece of information is to understand if the product will sell at all (i.e. Product-Market Fit) and to do this you have to have a price. Customers have to part with money so you can establish that the product has value. The second piece of information is to figure out that value (bearing in mind the value may be different for specific customer segments).

Many SaaS companies often make the mistake of initially charging a price below their unit cost because they fail to include all their costs (in particular their work time) in the calculation. It is important to know your costs because if you are pricing below cost in not sustainable in the long term.

The most optimum strategy is Value Based Pricing as this allows you to maximize revenue but because of the difficulty with establishing the value to the customer the safest way to start is to go for a Competitive Pricing Strategy at least initially and then adjust from there.

A final point to remember is that the pricing environment is constantly changing. Competitors will offer discounts, new products will come on the market, customer value perceptions are always changing, so what was  a premium feature yesterday is a basic feature today.

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