Pricing Strategies For SaaS Providers

Duncan Jones
Duncan Jones

Most leaders of SaaS providers understand the importance of minimizing Churn and maximizing account enrichment, but few fully appreciate how vital to those goals is a good pricing and licensing strategy. My newly published report Pricing Strategies For Software-As-A-Service is a must read for any business software company that sells or is thinking of selling via a subscription model. Here is a quick overview for anyone who isn't yet a Forrester client.

Some industry experts talk about the "magic ratio" of lifetime customer value to acquisition cost. Aligning the price you charge each customer more closely with the value they are likely to receive from your product is vital to increasing the former and reducing the latter. Simplistic pricing undermines lifetime value by undercharging those customers who get the most benefit from your product. Don't think you can fix this error later if you get it wrong at the start - I've seen many start-up vendors limit their growth potential in this way. Flat rate pricing helped them get traction early on, but then when they wanted to accelerate revenue growth they found it impossible to persuade those early adopters to switch to a variable pricing structure.

SaaS Pricing Models

Perpetual license sellers can get away with mis-selling and over-charging because they've banked enough lifetime customer value before the customer realizes its mistake. SaaS providers can't do that. This article from billing vendor Chargify explains how over-selling to the wrong customers can seriously damage a vendor's health, not only from higher churn, but also from customer complaints and misguided efforts to save doomed accounts. Therefore, sound analysis of how your product delivers real, measurable business value - and alignment of your pricing strategy with that analysis - is vital for long term success. My report explains how to optimize the three key elements of that strategy:

Packaging, of your software into a few core products and optional extras. You should give customers some choice, and allow them to omit some modules from the initial deal so you can upsell those later, when the customer is ready to deploy them. But don't give them too much choice so your pricing confuses them, or they can omit something from the deal in order to save money that they really shouldn't have left out. For instance, I was helping one SaaS provider client with its pricing strategy, and found it was charging extra for a back-up service, because it cost them extra to provide that service.

  • "Would you ever advise a customer to live without that backup service?" I asked.
  • "No, not really."
  • "Then why is at an optional extra? Simplify your pricing by bundling it into the core product."

Licensing each product by a relevant value-based metric. Think of your existing and potential customers and work out how you can measure their size and complexity, in your product's context. On premise vendors can assume that the amount of processing power the customer throws at their application is a good indicator of size and complexity. SaaS providers can't do that. Many rely on counting users instead, but that doesn't work for categories such as integration middleware, process automation, and big data analytics. Its also problematic if the software has a diverse user population, or is customer facing.

Pricing that balances science and art to decide how much to charge each customer. SaaS providers need their pricing multipliers and discounting tables to be more  structured, whereas on premise suppliers can leave more room for salespeople's art in determining the optimum price. SaaS pricing should be transparent and conspicuously fair, else customers will resent paying more than their peers for the exact same service. Don't think you can get away with unfair arbitrary pricing and hide it via gagging clauses - excessive secrecy about pricing is a warning sign to customers of a fake-SaaS company.

Bottom line: Let Forrester help you increase your magic ratio, by working with you to optimize your pricing strategy. Take time to get it right, right now, before it is too late. 

Duncan Jones is VP and principal analyst at Forrester Research, where he serves sourcing and vendor management professionals.