If anyone wants to build a big business that grows fast AND endures then they have to build long term strong economic power. Warren Buffett calls this the economic moat that gives businesses the ability to sustain long term competitive advantage. In SaaS companies people rightly obsess about their metrics, and that’s incredibly important. But I’m not convinced they obsess anywhere near enough about digging that economic moat and the role that pricing plays right from the very beginning, with price is the ultimate arbiter for value.
We believe founders must obsess about pricing and the huge impact it can have on their revenues and company performance, and then as an outcome their SaaS metrics.
Patrick Campbell is one of, if not the, world’s leading experts on SaaS pricing and this article is based on a recent interview with Patrick that you can listen to in full here.
What is value pricing thinking?
When you think about your business, and it doesn’t matter what that business is, everything you are doing, whichever team, must used to drive the customer to a buying decision. You are exchanging the value of your product or service for cash. And if you don’t understand what the price should be, you don’t understand how to translate that value into the right amount of cash then you don’t really have an efficient business.
We see this in the data, those companies that take on pricing as a major growth lever, that means they are reviewing pricing consistently as their product matures and their value increases, are far outgrowing the companies that aren’t. And in the recent environment we are finding that customer acquisition is becoming harder and harder and those companies that want to sustain their growth must use pricing to drive retention and revenue expansion.
How does an entrepreneur instil value based pricing from day 1?
It’s less about thinking about pricing at the start. It’s about thinking about the customer. We didn’t learn pricing at school and we are scared of thinking about pricing. But most pricing theory comes down to understanding your customers and, in the early days, following the proper framework you learned from every successful tech entrepreneur, which is doing your customer development work, talking to your customers in a non-sales capacity about what they want and need, what they do and don’t value about what you offer. What level do they value certain things at. Because pricing is about more than the number on the page, it goes to packaging and positioning and if you are talking to those customers you won’t necessarily get the perfect price but you will avoid certain mistakes in the early days by charging on the wrong value metric. For example if it turns out they don’t really value based on users, but on customer visits then you need to price accordingly.
So you need to ensure to understand what your customers value and price accordingly.
How do you isolate the value customers really care about?
The first stage is just talking to customers. More often than not, we are not talking to our customers about anything except sales. We are not talking to our customers about features and capabilities and impact. The average number of customer development calls tech companies are making, across the industry not just early stage, is 10 per month. And I think that is really scary if you think about it.
But it is also important to think about how you talk to your customers. At some deep level people are nervous about talking to customers about price because they think it might scare them off. But it’s pretty simple to go to someone and talk to them about features and propositions is to use max diff techniques to understand relative preference.
So for example if you want to learn about what customers want then going to them and saying, “Here are all the features we offer, which on the list is the most important and which is the least?”. And then doing some basic maths you start to see rank order and magnitude and you can start to see that those five things on your roadmap you thought were most important, only one really is and the others no one really cares about.
And then when it comes to pricing it’s even easier. I can ask someone two really simple questions:
- At what monthly price is this way too expensive?
- At what monthly price is this such a steal that you’d sign up today?
And when you take that data and again do some fairly basic maths you can start to see a price elasticity curve and you can start to understand if I move the price what impact would it have in terms of numbers of customers and revenue growth.
And you can use those techniques qualitatively through interviews or quantitatively through surveys, but it all comes down to talking to your customers that is where and how you learn.
Is this analysis robust enough?
It does come down to the extent and quality of the work. If you are using our algorithms then it comes down to an accuracy of plus or minus 3% and there is a lot of work involved in that.
But if you do the basics you will get an average of plus or minus 15%, which clearly is a wide range, but at least you are getting an idea of the ballpark you are playing in.
Most of the time we hear objections about survey bias, but what we find is that most of the time the questions will take into that account and you take out any really anomalous data. You aren’t looking for perfection. You will get a variance of responses, they will be slightly different.
How will this analysis inform decision making?
What I’m look for insights into some really profoundly simple insights. Is this a $100 product or a $1,000 dollar product, so where do I sit and what is the profile of the elasticity. In other words, “How commoditised is my market?”.
For example, if I survey customers about a known product such as a cup of coffee or a CRM then I’ll get fairly rigid responses. There isn’t much elasticity. But if I’m asking about something new and innovative such as AI or Machine Learning then I will get a wide range of answers, and that’s incredibly important to understand and because I have that I can make better decisions and start to use pricing in a way that I can track my trajectory in terms of value. And it’s never going to be 100% until you put it out there but what you are doing is hedging the risks of your decisions and learning to be able to make better decisions for your company.
There are lots of people who will object to doing this analysis because they’ll say “We just don’t have enough customers!”, but you can’t allow that desire for perfection to be the enemy of good you need to ask these questions right from the beginning and understand the willingness of customers to pay to receive the value you create.
How do you think about pricing as it relates to the speed of customer acquisition and then revenue expansion?
What we find is that when you think about your funnel and post funnel – acquisition, conversion and then retention to keep it simple – your pricing has a lot of influence on how smooth the transition from one stage to the next is and how long customers will stick around.
So if you have really easy to understand pricing, with a low initial price point, maybe freemium, then you will have some really good frictionless growth. Someone comes in, makes a quick decision, and will stick around and buy again so long as they are receiving value.
Your pricing must fit the customer and that you are pricing according to a value metric. This could be per user, which really shouldn’t be the default, or could be per data integration or hundred this or that. The reason this is so powerful is that if I’m a small business coming to a start up for a new service and the price is say, £1,000 per month, I’m going to be spooked. But if you show me something that is free or cheap I can taste the product without a tonne of decision making on my end. Now once I get in and start using the product and consume more of the product and gain more value and I’m willing to pay more. Relatively quickly I’m paying that £1,000 per month and beyond. And for a mid-sized company I’ll be paying more and more. It does mean you need to consider a few things, for example: “How complex am I going to make this pricing?”. The more consumer the simpler pricing has to be, while at the enterprise level, say $1m annual, the pricing may be pretty complex.
But there are some really interesting companies in the middle. They found a sweet spot that is still relatively affordable, justifies a sales team, but allows the customer to grow.
So there is this price level and complexity spectrum you need to think about.
And you have to think about how you are growing your customers you are continually adding and extracting value.
What’s the perfect pricing model?
Many organisations will rightly have a business model that is based on targeting specific types and sizes of organisations. But their pricing needs to work across the board, so that an organisation can enter at a level that is right for them, can scale with the product as they receive value and the SaaS company can extract that value in line with the customer.
How does pricing thinking at the scale up phase?
If you do not have a full time product person dedicated to pricing at this stage, as you move past $20m ARR, you will be missing out considerably. There is so much complexity that happens you will probably have a sales team of some sort, that may be a little anarchical as they try to hit targets, the product will be moving fast.
So you need someone who is tracking the value, pretty much full time, focused in in on pricing.
You need to be using pricing as a growth lever, changing an element of your pricing every three to six months to ensure you are taking into account the feedback from customers and the increased value you are delivering. Putting this in context, most companies change their pricing every three to six years!
As a start up, your brand is changing fast and your product is constantly improving, and you must capture that in some way. That might be moving a feature from one tier to the next. It might be upping your initial price or lowering the value metric so that you are keeping your product and pricing in sync.
Your pricing is the exchange rate on the value you are creating. And if you think about pricing in that manner, value in fast growth business is scaling so fast and you want to ensure you are capturing that.
At whatever stage you are at, if you are not thinking about value in this way and aligning pricing accordingly you are leaving revenue and growth opportunities on the table.
Pricing thinking in a high growth company is constant. It shouldn’t be a five month project in your fifth year of doing business, you should be doing ongoing customer development and making incremental changes every quarter and rolling out larger changes at most every 12 months.