For every digital-first brand, a well-devised SaaS pricing strategy can be the make-or-break decision that decides the fate of your business. Take it from Warren Buffett himself: the billionaire CEO and investor once famously declared that, “The single most important decision in evaluating a business is pricing power.”
McKinsey notes that a one percent increase in prices can lead to an 8.7% gain in operating profits. While there’s always a balance between pricing for profitability and pricing to reduce churn and maximize growth, the consultancy estimates that around 30 percent of all pricing decisions fail to deliver the best value for those businesses.
No matter how great the business solutions might be, SaaS companies need to recognize the importance of choosing a SaaS pricing strategy that offers a path to profitability and sustainability. Read on to learn more about the importance of choosing a SaaS pricing strategy, the pros and cons of various SaaS pricing strategies, and the consumer psychology tactics to keep in mind when developing a strategy for your business model.
What is a SaaS Pricing Strategy?
The rise of cloud-based software has revolutionized how software companies deliver their products and services to customers. Instead of purchasing business software to be installed on local devices—and having to buy updated software periodically to evolve your business technology—software-as-a-service licenses out access to cloud-based software on a subscription basis.
This cloud-based approach enhances the customer experience by giving them instant access to the latest and greatest functionality deployed for those software solutions. But the switch to licensed access also created the need for a new financial model that generated revenue through subscriptions, rather than one-time purchases.
SaaS pricing strategies were developed in response to this evolving vendor-customer relationship.
Why is a Pricing Strategy Important?
Although the benefits of implementing a SaaS pricing strategy may seem obvious, the process of selecting a specific SaaS pricing strategy can involve complex considerations and tough decisions related to your target buyer personas, the existing market for your SaaS solution, your business goals and related metrics, and other criteria.
This means your pricing strategy can’t be discussed without also considering the larger goals of your organization. Pricing strategy might start in the CFO’s office, but the ultimate decision-making process requires the input of all executive leadership.
SaaS Pricing Strategies
Whether you’re choosing a pricing strategy for a new SaaS business or you’re searching for a better approach than the strategy you’ve used in the past, you’re likely to settle on one of a handful of strategies widely used by other SaaS brands.
Let’s take a look at each of these pricing strategies, explaining how they work and identifying the biggest pros and cons of each approach:
This pricing model is popular across a wide range of businesses and industries. It offers a simple calculation to determine pricing: after adding up all of your associated business costs, your company adds a percentage onto that figure that represents your target profit margin.
For example, if your business wants to aim for a 30 percent profit margin on its SaaS subscriptions, you would add 30 percent to your total operating costs to arrive at the target market price. This model can be particularly useful to SaaS small businesses and startups that want to be mindful of profitability when scaling their customer base.
- Pros: This pricing strategy is easy to develop and adapt over time as operating costs change. It’s also one of the most reliable strategies to guarantee profits from a new client.
- Cons: This pricing strategy doesn’t account for market competition, the established market prices for your services, or the degree to which your customers will be willing to pay that amount, which could lead your business to a price point that drives away would-be customers.
A captive pricing model aims to sell one core solution at a lower price in hopes of driving additional purchases through software add-ons and other upselling - think of the cost of a new printer versus the cost of replacing the ink. The goal of this pricing model is that it adds a lot of new customers at a lower price point while creating a relationship that leads to additional purchases and a higher customer lifetime value (LTV).
Captive pricing is a great option for SaaS companies that offer a suite of solutions or accessories that can be integrated with the core solution.
- Pros: Creates a lower barrier to entry that can lead to a high volume of new customers, supports customer retention, and potentially decreases your customer acquisition cost.
- Cons: This pricing strategy doesn’t offer value if your SaaS company doesn’t offer supplemental solutions or features to sell to customers.
For upstart SaaS brands and SaaS solutions entering a congested market, penetration pricing can be an effective strategy to acquire new customers who defect from competing brands. Penetration pricing sets prices low with the hope that existing customers of other higher-priced brands will switch to a new SaaS provider in exchange for cost savings.
This pricing model is most effective in an established market where multiple SaaS brands are offering similar solutions in direct competition with one another.
- Pros: Penetration pricing can help businesses quickly gain visibility and new customers in a saturated SaaS market.
- Cons: Low prices can lengthen a company’s runway to profitability, generating net losses in the short term without a guarantee that customers will stick with the business as prices rise.
The opposite of penetration pricing, a skimming pricing strategy sets a premium cost for a new SaaS product or solution and gradually lowers the price as new market competition develops. Skimming allows a business to maximize its profit potential in the early stages of an innovative SaaS product launch, capitalizing on a lack of comparable solutions.
Skimming is often seen when new types of consumer products enter the market. This product pricing strategy is best for tech brands releasing a first-of-its-kind SaaS solution.
- Pros: Skimming can offer significant early profit margins that can be used to fund marketing and maintain the brand’s market leader position as the marketplace matures. It can also offset the costs of research and development preceding the solution’s launch.
- Cons: Revenue generation from a skimming strategy can be particularly volatile to market changes. High prices may also prohibit a larger customer base that could ultimately deliver greater long-term revenue.
Prestige pricing sets premium prices for a product in the hope that customers will see this high price as a sign of the product’s quality.
Apple is one of the best examples in tech of the benefits of prestige pricing. Because of the company’s reputation for high-quality, stylish products, its customers associate the brand’s premium prices with premium product quality.
Consequently, this pricing strategy is best utilized by brands with a sterling reputation and a dedicated customer base.
- Pros: Prestige pricing can grow your company’s profit margins just by leveraging the reputation of the brand.
- Cons: Successful prestige pricing strategies are often driven by heavy investments into advertising and marketing, which can cut into profit margins—especially in the short term.
Competitor-based pricing is a strategy that sets pricing based on the current pricing landscape. If your SaaS brand views itself as a mid-tier or premium solution provider, for example, you would likely set prices at or near the levels of other mid-tier or premium solutions.
While a wide range of brands may consider using competitor-based pricing, it’s often best suited to startups and new market entrants that want to establish their initial position in the marketplace.
- Pros: This is one of the easier pricing strategies to implement, and makes sure your brand and your pricing strategy are aligned.
- Cons: Competitor-based pricing doesn’t account for your operating costs and could become an impediment to achieving profitability.
Value-based pricing is a strategy that sets prices according to the customers’ perceived value of the SaaS solution.
This pricing strategy is a great option for companies that offer SaaS solutions that either deliver new functionality or experiences, or solutions that have been proven to offer better results and value than the market competition.
- Pros: Unlike skimming and prestige pricing, which inflates prices based on market conditions and brand reputations, value-based pricing can increase profit margins while pointing to its value proposition.
- Cons: If businesses overestimate the value of their SaaS solutions to their customers, this pricing strategy could set prices far too high and inhibit new customer acquisition.
Tiered Pricing (Strategy)
Tiered pricing plans are a popular SaaS pricing strategy that offers different solution experiences at different price levels. Each level may vary in terms of the number of active user accounts allowed, the specific set of features offered, cloud storage space, usage-based pricing considerations, and other criteria.
- Pros: A tiered pricing model is more scalable to each customer’s needs and offers lower price points to onboard customers who may later upgrade to higher pricing tiers. This tiered approach can give customers a better user experience by increasing their control over what they’re paying for.
- Cons: Not every SaaS solution can be easily adapted to a tiered pricing strategy. Maintaining ideal profit margins across each tier isn’t always possible due to the static operating costs your business will incur.
8 Consumer Psychology Pricing Tactics
When choosing a SaaS pricing strategy, it’s helpful to consider the role of consumer psychology in your pricing decisions. While the financial side of your business needs a pricing strategy that offers a path to profitability, this pricing has direct implications for your relationships with current and potential customers.
Here are eight key consumer pricing tactics your SaaS business can use to support its pricing strategy and maximize revenue generation.
Price anchoring is all about setting a price figure that becomes a point of reference for consumers when considering a purchase. The most common way to use this is to highlight the savings offered in any SaaS promotion, such as “$100 off when you subscribe” or “save $250 in the first year.”
Price anchoring typically works best for brands employing a penetration pricing strategy or competitor-based pricing. It’s not an effective strategy for prestige or value-based pricing, where cost is not a primary factor in the purchase.
Charm pricing uses psychological associations with certain numbers to increase the perception of value in a price. The most common example of this is pricing something at $14.99 instead of $15 flat or setting a subscription price at $9 per month instead of $10.
Tiered pricing, penetration pricing, and value-based pricing strategies can all benefit from the charm pricing tactic. In some cases, though, such as prestige pricing, this tactic can actually undermine the perceived value or appeal of your solution.
Trial pricing uses a free trial or slashed flat-rate pricing to incentivize customers to try out a service.
It’s a common tactic in SaaS pricing models, and it’s particularly useful for tiered and penetration pricing where businesses want to minimize the financial barrier to entry. For SaaS solutions that require a longer span of time to demonstrate value, though, these trial windows can set up an unfavorable expectation for fast returns.
Decoy pricing attempts to drive a purchasing decision by convincing consumers they need to make a choice. In tiered pricing strategies, decoy pricing can put pressure on the prospect to choose a package. In competitor-based pricing, decoy pricing can prompt the consumer to choose between your company’s solution and a competitor’s offering.
Decoy pricing also runs the risk of pushing the consumer to abandon their customer journey, so it must be implemented carefully in any pricing strategy.
Odd-even pricing is based on the psychological impulse to associate odd numbers with value and even numbers as luxury.
While odd numbers are typically better-suited to tiered pricing, penetration pricing, and competitor-based pricing, even numbers may offer more value to prestige and value-based pricing strategies.
This pricing tactic attempts to motivate customer purchases by presenting a higher “value” price to emphasize the affordability of the lower price of the service. This is a common tactic in retail stores, where clothing tags may feature both the original price and a sale price to highlight the value of the purchase.
SaaS companies may want to use high-low pricing in tiered pricing, value-based pricing, or even in a skimming strategy as prices start to decline. Be wary though, overuse of this tactic can lead customers to mistrust or undervalue your brand if they see it happening too often.
Product Bundle Pricing
A product bundle pricing tactic increases the savings offered in exchange for a larger financial commitment.
Similar to a captive pricing strategy, this strategy works best for SaaS brands that offer a number of different add-ons or complementary solutions that could be paired with a SaaS solution.
Center Stage Effect
The center stage effect presumes that most consumers, when presented with a set of options, will gravitate toward a choice in the middle. This is commonly seen in tiered pricing strategies where SaaS brands will emphasize the middle tier as offering the “best value.”
Competitor-based strategies targeting a mid-tier position may also use visual tools to present their business toward the middle of the market spectrum.
As Your Business Evolves, Your Pricing Strategy Will Need to Adapt
No CFO or other C-suite executive can predict the future. As SaaS companies grow and evolve, it’s possible that today’s pricing strategy won’t be the right fit for tomorrow’s business landscape.
Every CFO needs to anticipate how changing business dynamics may prompt the need for a new SaaS pricing strategy. By paying close attention to both the benefits and limitations of your existing pricing methods, you can lead your organization in making proactive changes that strengthen the company’s long-term financial footing.
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