This is Kristen O'Brien, Managing Editor at NFX, and this is the founder list. Audible versions of essays from technology's most important leaders selected by the founder community. This is Scalable Pricing, a key tool for SaaS success, written by David Scock, Pete at Matrix Fund, red by NFX. Scalable pricing is a powerful tool to grow revenue in a SaaS or software business.
It allows you to capture more of the revenue that your customers are willing to pay without putting off smaller customers that are not able to pay high prices. It also provides a great way to continue to grow customers. This post looks at how to create scalable pricing using multiple pricing axes and discusses the different types of axes that can be used. Introduction. Many SaaS startups begin life with one product that has a simple pricing model.
They might have initially only one version of the product to keep their lives simple and use a single flat price for that version. To make that product as attractive as possible to a wide range of potential customers it is not uncommon to see the founders set the price low, so price sensitive users are not put off. This is a smart strategy James in the early days, it is far more important to get lots of customers than to optimize profitability per customer.
However, as time progresses, they may hear comments like I would have been happy paying far more for your product as it provides such great value to me. I didn't consider your product as it was too cheap and didn't look like a credible option to handle our more advanced needs. I only needed a subset of your functionality and your product was too expensive.
These comments indicate that there's a variety of different user types in the market with differing levels of value they can extract from use of your product and as a result, differing willingness to pay. All of the above point to the limitations of a simple pricing scheme. Let's look at these items separately. Value extracted from one use of the product, Pete are some examples of how different customers can get differing levels of value from your product.
They are a larger company and many more employees are using the product. They're using fewer or more of the features in the product, or they have a greater number of items that are being processed by your software, For example, if it is an email marketing software, they may have a very large mailing Flint, or if it's a backup service, they may have a very large data set that they're backing up, etcetera. Emotional willingness to pay.
There is a very significant difference in the willingness to pay among various customer types, Car manufacturers have known this for a long time and usually include a higher profitable model at the top of their range that appeals to the non price conscious buyer. Who likes to feel that they've bought the very best. Take a look at the Mercedes Benz s class as an example.
The base model s Five Fifty starts at 94 k But for those that aren't price sensitive, they sell an S600 version for 160 k or an S65 AMG version for 211 k. The main difference is a slightly bigger engine. But if you look at the profit margins for these models, the margins increase greatly for the higher end models. What's important to recognize here is the mentality of the customer. In the business world of software buyers, the emotional thinking is slightly different.
The driving emotions that can make them want or expect to pay a higher price are their problems are so important to them that they're looking to make sure that they have taken the best possible steps to address them. They want a serious commitment on behalf of their suppliers, and they have a status need to own the best. Those buyers will not feel comfortable buying a cheap solution. Scalable pricing is the answer. The solution to this is to introduce pricing that scales up or down.
If designed correctly, the pricing should scale down to allow you to capture the smallest cheapest customers that are still profitable up to the largest customers that are willing to pay a great deal. To architect scalable pricing, we will use 1 or more axes. Let's take a look at some common James for scaling pricing. 1, product features. A very common way to differentiate pricings is to package up different versions of the software with more functionality available at a higher price.
2, number of users. The theory here is pretty simple. As more people use the product, the customer derives more value. And 3, depth of usage. By depth of usage, I mean an indicator like the size of a database used, the number of people on an email marketing list, the amount of storage used, etcetera, These all indicate that the customer is getting greater value from the product and therefore is likely to be willing to pay more.
Other James that I've seen used Some other examples of factors that can be used to scale pricing include number of websites created, number of servers slash virtual machines, though not applicable to SaaS, quality of support, response time, 2 hours versus 24 hours, email support versus phone support, number of support incidents, dedicated support representatives, number of sites where the software is installed Morgan number of James support contacts.
Automatically increasing revenue from existing customers. As a SaaS business grows larger, it starts to accumulate a large customer base. An important factor to look for in selecting a pricing axis is to look for ways to automatically get more and more revenue from that customer base. A good example of this is pricing around storage usage companies find it hard to throw things away, and the amount of things that they want to store keeps increasing.
As a result, storage growth in a typical company is around 60% per annum. If you can tie your pricing to something like storage where there will continue to be annual growth, you have an excellent way to grow your business without having to do any more selling. How many pricing axes is optimal? If you're going to build a low cost sales model, it will be useful to have a very simple pricing model that the customer can immediately understand.
I would argue that this means no more than 3 pricing James and perhaps 2 is the optimal. Cross sell James. Another very important way that one can sell more into an existing customer base is to cross sell them. By cross selling, I mean, selling them on an additional product or service. For a SaaS business, there are a few interesting ways one can do this. Buy or build additional products that are closely related to existing products.
Sell add on modules that integrate nicely with the existing product, create an app store, and sell third party products taking a cut of the profits, create a services marketplace where you connect partners that provide services offerings around your products and take a cut at the transaction fees. Look for other fees that are created around the usage of your product.
For example, payment transaction fees and e commerce, advertising revenue, etcetera, and ask yourself if it is possible for you to extract a portion of that revenue. These ideas are important as they essentially allow you to go beyond the 2 or 3 axis pricing that we thought was optimal in the previous section. The beauty of all these ideas is that they provide more and more value to your customers.
And wherever you are able to do this, you can increase customer satisfaction and loyalty as well as getting paid more. Getting to negative revenue churn. All SaaS businesses will see some level of customer churn, I. E. You will lose some customers. However, if one looks at revenue churn, which is the amount of revenue coming out of the installed base of customers, it is possible to get negative revenue churn.
The way to do this is to get enough additional revenue from the customers that stay with you to more than offset the loss of revenue from the customers that have churned. The key to achieving this is additional pricing James. How this relates to freemium business models. This topic is very relevant to entrepreneurs who are thinking about using freemium business models. To make the freemium model work well, you need to achieve 2 things.
1, design something that you can give away free that still has very high value to the customer, and 2, design an upgrade from that initial product that is also extremely compelling. Compelling enough to get a significant portion of your free user base to pay. If your free product is not valuable enough, it will not get adoption. And it most certainly won't get viral adoption, which is one of the most powerful things that can happen when you give things away for free.
Step 2 is all about finding a way to introduce a pricing access that scales from free to paying. Value based pricing. You might have noticed how I've tried to link pricing to the value that a customer derives from using the product. I believe that this is a key concept and one that is sometimes forgotten. As the CEO of my own startups, I used to spend a lot of time in front of customers Beller.
As any salesperson will tell you, one of the hard parts of the sales job is justifying to the customer why they should pay you so much money. I found myself wanting to be able to answer that question with ease and comfort. And the only way I could do that was to make sure that my pricing was clearly aligned with the value that the customer would derive from using my product. Once you've come up with a pricing scheme, tested against this simple question.
How comfortable will you feel when talking to your customer about your price, versus the value you generate. Conclusion. If you're running a SAS business or any other kind of software business, it pays to spend some time thinking about your pricing axis. This represents one of the very powerful levers that are available to you to grow your business. I am surprised by how often I find this has been ignored.
As always, I would love to hear your feedback as to how this is applied to your own businesses. Thank you for listening. For more audio essays from the people who've built companies like Instacart, Facebook, Trello, HubSpot, and Dropbox, visit the founder list at nfx.com, or subscribe to the nfx podcast at podcast.nfx.com, or wherever you get your podcasts.