How to Determine a Test Pricing Strategy for Your SaaS Product
SaaS pricing changes as a company grows and matures. Research states that 98% of SaaS businesses have shown positive results as an outcome of changing core aspects of their pricing policies.
2022 is the year for your business to revisit your pricing. Due to a growing market, difficult competition, and the fast-paced industry, many SaaS companies are testing and adjusting new concepts with their pricing models to meet their customers’ needs.
According to openviewpartners.com, 43% of surveyed SaaS companies are revisiting pricing more than once a year.
At Insivia, we believe that you can learn a lot about what the market will bear by looking at alternatives (as opposed to competitors) in different segments to gauge ranges to test. If you get too close to competition, it can quickly become a race to the bottom, but framing your solution versus alternatives allows a different pricing perspective.
Why Your Business Should Test SaaS Pricing
Price Intelligently has found that most companies spend only about 6 hours on their pricing strategy…ever.
The economy and the world of SaaS are both changing regularly. Because of these constant changes, pricing needs to be reassessed continuously. To bring in the right customers for your business, pricing has to meet their needs and budget.
Regular Pricing Strategy Refresh Drives Growth
When we think of growth tactics, most companies view this as customer acquisition. However, pricing is often one of the most overlooked and powerful growth tactics out there. Pricing is imperative to your business and has the strongest ability to impact growth.
Study by Price Intelligently about growth levers and impact
Monetization drives a much larger impact on the bottom line than other growth levers. Growth means increased revenue, not simply increased customers. The way current customers are monetized is a key factor to your business’s bottom line and success.
Pricing Optimization Increases Efficiency
Price optimization is a catalyst for business efficiency. Companies that regularly adjust their prices based on the current landscape showed strong efficiency in their lifetime customer value (LTV) and customer acquisition cost (CAC) ratio.
Study by Price Intelligently about pricing’s impact on efficiency
Companies who review their pricing yearly show strong growth potential, with a 3.23% LTV/CAC ratio. However, companies that continually price optimize take it to the next level at 11.09%.
Increased Payback Period for Continuous Pricing Optimization
The CAC payback period is much shorter in a business that regularly price optimizes. For a company that continuously price optimizes, the breakeven point occurs around month 4, and profitability increases from there. A company with a faster CAC payback period will overall have healthier accounting and more financial ability to drive more growth.
Graph by Price Intelligently indicating price optimization payback period
After one year, a business conducting continuous price optimization shows significantly higher revenue on average than businesses with no pricing function or only a yearly pricing review.
SaaS Pricing Models
SaaS businesses frequently operate out of 7 popular pricing models. These models are:
- Freemium
- Subscription based / flat-rate
- User-based
- Usage-based
- Tiered-user
- Per active user
- Feature pricing model
As of the 2021 openviewpartners.com survey of SaaS businesses, 41% of businesses use seats/users as the primary pricing metric, but usage/transaction-based pricing comes in as a close second at 39%.
Survey results of primary pricing metric by openviewpartners.com
Freemium Pricing Model
A freemium model offers a product that’s completely free to use, with an option to opt for additional paid packages for elevated service, more features, or an ad-free experience.
By providing customers with a trial, a “lite” version of features, or an advertisement-driven platform helps get a foot in the door to encourage customers to upgrade to a paid tier. Popular examples of SaaS freemium pricing models are Slack and Dropbox.
Slack freemium pricing tiers
Subscription-Based / Flat-Rate Pricing Model
Subscription-based pricing (or flat-rate pricing) harkens back to the early era of software. On a subscription-based pricing model, potential customers pay a price for the product either typically on a monthly or annual payment schedule. This payment then provides the customer all features of the product.
Fewer companies are using this form of pricing due to complexity of customers and services offered. With current trends in the SaaS space being around unbundling and customization, this model is not as popular anymore.
One SaaS business that uses a flat rate for business is Basecamp
User-Based Pricing Model
In a user-based pricing model, SaaS businesses charge customers on a per-user basis. Due to the ease of scale and the appeal to both large and small companies, the method has been attractive to both SaaS business and customers. The simplicity makes it very easy for SaaS businesses, particularly in the early stages, to manage revenue.
However, it’s common for customers to share accounts to save on buying more seats, and churn likelihood can be high.
Salesforce Sales Cloud prices customers on a per user basis
Usage-Based Pricing Model
The usage-based pricing model can also be called the pay-as-you-go pricing model. The name explains it pretty well: the more you use the product, the more it costs. The less you use the product, the lower it costs.
This pricing model started out being more commonly used with infrastructure or platform software companies. Customers would be charged as a result of how much data was used, for example. However, usage-based pricing models are becoming more widely adopted with other types of SaaS companies.
The benefits are that there are typically few barriers to actually using the product, and customers easily understand how their usage affects their price. However, for a SaaS business using a usage-based pricing model, it can be difficult to predict revenue, and customers may not realize how much they’ve used a product and be surprised by their bill.
Amazon Web Services offers usage-based pricing
Tiered-User Pricing Model
Tiered-user pricing models are very popular among SaaS companies. Tiered pricing gives customers the ability to find a package that fits their needs best. Companies that use tiered pricing are able to create offerings that have a wide appeal across different customer bases.
The average amount of packages offered by SaaS companies is 3.5. At around 3 packages, these are typically created as a “low, medium, high” price point option. However, companies are free to create as many packages at different price points as they wish.
HubSpot’s Marketing program tiered user pricing model
Per Active User Pricing Model
The Per Active User Pricing Model ensures to customers that they will need to pay only for users who actively use the product, not users who are sitting idly.
One concern with “per user” pricing is that a new customer could spend a large sum of money for a new enterprise-tier SaaS product, only to have their employees never use the software. The per active user pricing model reduces this risk to potential customers by ensuring that only active users of the product will actually need to be paid for.
Looking deeper into Slack, in the pop-up where they share their Pro tier cost is $6.67 USD/mo, Slack shares that this figure is per active user per month.
Slack pop-up defining how only active users need to be paid for.
Feature-Based Pricing Model
A feature-based pricing model puts the monetary value on the total number of features, rather than the total number of users such as with the user-based pricing model. This pricing model also bears a resemblance to tier-based pricing, as there are different packaging options in feature-based pricing models. However, in this model, the prices are based on the total number of features that a customer can use.
For QuickBooks customers, the higher the tier, the more features are unlocked.
SaaS Pricing Strategies
5 Common SaaS Pricing Strategies
Free Trial Pricing
If you’ve ever been on a SaaS site, it’s likely that you’ve seen a free trial before. According to Bay Leaf Digital, 75% of SaaS companies have free trials. Free trials or offering a freemium plan are a common SaaS tactic, used to entice customers to try the product risk-free and create a relationship.
By giving potential customers a short time frame to experience the product for free, your business gets your foot in the door. Customers who found their experience valuable have a likelihood to upgrade at the end of their trial periods and purchase your featured subscription.
Prestige Pricing
Prestige pricing can also be known as premium pricing. When a business uses prestige pricing, they maintain high prices in order to indicate that the product is of high quality, is exclusive, or is a luxury brand. This strategy drives a smaller customer base of high-value customers.
This strategy can be used in a few different ways. If high profile companies use your product, your reputation will precede you and allow you to charge higher. If your brand is well known, this also can help lead to prestige pricing. Additionally, if you offer a tiered pricing model, you can offer a high-end “premium” tier to offer prestige pricing.
Cost Plus Pricing
Cost plus pricing is where a lot of SaaS companies find themselves starting in their pricing strategy journey. Cost plus pricing occurs when all costs are accounted for, and a target profit margin is added to those costs, such as 15-20%. The price for customers then becomes the cost of operating plus the target profit margin.
Competitive pricing, value perception, price sensitivity, and economic factors aren’t taken into account when deciding on this type of pricing. However, this is a solid place to start for a budding business with limited information, and can be a great framework to begin the pricing process.
Skimming Pricing
Skimming is the idea of starting high, and gradually going lower as time goes on. A company charges the highest price that customers will pay initially, and gives “early adopters” first access to the new technology as this is the target market that is most likely to pay more for new products. As the product matures, the prices are then reduced and appeal widens to the later market.
Tech products are often a great example of skimming pricing. New smartphones are often introduced at a high price, and receive discounting in the months after introduction.
Value-Based Pricing
Value-based pricing is also called value-optimized pricing. Prices are set to match up with what the estimated/perceived value of a product is to the customer - not the cost of the product. This is a long-term strategy, requiring a lot of strategy and research to enact it.
Value-based pricing is essentially the opposite of cost-plus pricing. It focuses more on the customer and the perceived value of the product itself. With value-based pricing, companies are more focused on improving value and conducting research on customers’ perception of value.
Value-based pricing has been a highly recommended focus for SaaS companies due to its focus on building a strong product, understanding of the customer, and understanding of willingness to pay.
Value Based Pricing offers potential steady profit increases according to Price Intelligently
SaaS Price Testing Framework
It’s important to go into your SaaS price testing with a plan and a north star. Every business’s approach will be different based on goals, needs, and capabilities. Here’s a framework to help your team build a path to price testing.
Set Goals
Don’t go anywhere without determining why you’re doing it. What does your business need right now, and what are you hoping to achieve through price testing?
Some examples of SaaS goals:
- Top-line revenue growth
- Profit margin growth
- Market penetration for new product category
- Attracting new segment of target customers
Once goals are determined, hypotheses can be created to test to help reach these goals. For example, if you’re trying to attract a new high-end customer base, you can ask questions such as, “If we offer a premium pricing tier, will our segment of high-value customers increase by X%?”
Additionally, price testing can be done on particular actions. How does bundling affect sales? How does the order of pricing tiers impact which tier is selected?
Always start by identifying your goals and building out your hypotheses for testing.
Align Your Business Around Pricing
Build a pricing committee to have representation from all across your business. A pricing committee is a group of advocates with cross-divisional knowledge that focuses on your pricing strategy’s strengths, weaknesses, and drives pricing forward.
There are two main intentions with a pricing committee: organization representation, and a dedicated focus on pricing.
Price Intelligently’s recommended pricing committee
Determine Product Groups for Testing
The next stage is identifying what product groups you’ll test pricing for. Ideal categories are high volume sellers, so you can reach statistical significance faster. You should start your testing by using similar products as your sample.
In your product category, keep one product as a control and another as your test variable. Make sure that both of these products are within the same category or else it will be hard to compare!
Collect and Measure Data
Once your goals are set and you’ve identified which tests your running on which products, it’s time to implement your tests and collect data throughout the process. Measuring and analyzing results is key to learning from your pricing tests.
Make sure price changes are incremental - small changes will help you identify sweet spots and detractor points. This will also help with benchmarking. Ensure you gather enough volume of results to ensure you have a large enough sample size.
SaaS Price Testing Mistakes
Strictly A/B Testing
A/B testing is great for website changes - but not for something as vital as pricing. A/B testing different prices can lead to mistrust for customers. Customers finding out they were charged more than other customers for the same product will lead to a negative relationship, and ultimately damage the product and company’s reputation and bottom line.
Small Sample Size
If a sample size is small, you’ll see a lot of variation in your results and not be able to have a conclusive finding. Price testing needs a sample that’s large enough of two segments: customers who saw one price, and customers who saw another. If either segment is too small, your results will be misleading.
No Understanding of Competitor Pricing
What are your potential customers seeing out there when they’re trying to determine the right solution? Your customers are seeing other prices, and it’s very easy to compare across marketplaces. Competitor pricing will certainly impact your price tests. Understand the landscape of your competitors and make sure you’re aware of how these will impact your pricing test.
Minimum Price Offering
Simply dropping prices to the lowest price possible will lead to higher sales. However, this won’t necessarily bring higher profits. Rather than testing dropping prices to all-time lows, we recommend offering temporary discounts.