The art and science of SaaS pricing: Finding the right model fit

As an investor and board member in many early stage B2B SaaS companies, it always strikes me how little attention is given to pricing. At the very beginning, that makes sense; the product is still evolving, customers are few, and use is inconsistent. But as the product matures, and as go-to-market motion and the customer base start scaling, startups often never look back at their pricing.

When you stand back and consider how much effort these companies pour into R&D and sales and marketing, it is surprising how little effort is spent on researching and optimizing the pricing strategy and model. Given its central role, pricing might be the single most impactful lever to growth, retention, and unit economics that many SaaS companies continue to overlook. And pricing is especially consequential in the age of COVID, when business SaaS buyers are more cautious about approving larger purchases.

Winning the customer, even at a lower initial annual contract value, and then quickly growing revenue with that customer is key to achieving high customer lifetime value and offsetting the already incurred customer acquisition cost. But not all SaaS vendors have the right pricing model to do this.

Much has been said about the fundamentals of SaaS pricing that doesn’t need to be rehashed here. But from speaking with product leaders in my network and from my own two decades of being both a Chief Product Officer and a VC investor, here are some key learnings:

Copycat pricing

The cloud application market has developed a few patterns of pricing and most SaaS companies, understandably, follow those models when they get started. Sometimes blindly. One such pattern is what we call the “pricing pan flute.” Basically, this approach consists of tiering the offering into a “basic-premium-pro” type pricing grid, with the price increasing as the “flute” of features gets longer with each tier.

It is a well-established model, particularly with B2C apps and B2B SaaS vendors addressing large horizontal markets. And it works really well, provided you design it thoughtfully. I spoke to Craig Shull, GM of CX Solutions at SurveyMonkey and previously SVP Pricing & Product Strategy at Salesforce, where he built the company’s pricing model over many years.

“The pricing pan flute is a segmentation tool, if you truly understand customer use cases and the different requirements customers have,” he explained. “In my experience it doesn’t always work as a land and expand, self-service upsell mechanism. Customers tend to settle for the choice they made and not look back. Your sales team likely needs to help them find their way to a higher plan.”

All too often, the pricing pan flute is poorly designed, usually by an inside-out product-centric view of what “advanced features” customers ought to pay a premium for. What is needed is a deep understanding of your different buyers and market segments and their respective needs and concerns and willingness to pay. If you do not yet have that level of outside-in insight, you are usually better off keeping things much simpler. My advice: Don’t have a flute just because it looks good on your website.

Less is more – or is it?

Another question is how aggressively to price and when to keep things simpler and more modest. There are different cases and schools of thoughts here. Oji Udezue, VP of Product at Calendly and formerly a Head of Product for Atlassian’s communications products, has a unique perspective: “At Atlassian we knew the TAM (total addressable market) was huge. So I think we priced to penetrate the TAM as quickly and deeply as possible. We wanted to provide value beyond the price and then later have the optionality of a price increase along with additional features and make it an increase we had already earned in customers’ minds.”

That view is fairly well supported by data: Tien Zuo, founder and CEO of Zuora, the subscription management company, recently published an interesting article leveraging insights from real-world data of thousands of subscription companies (using Zuora) and correlations between pricing models and growth rates. It shows that companies with simple pricing models consisting of just a single product grow faster than those with more complex pricing models.

Quite simply, complexity is not a marketer’s best friend, and for B2C and horizontal B2B apps that address very large markets, it pays to keep the message clear and pricing unobjectionable and focus all energy on adoption. Zuo’s examples — Docusign, Okta, and Zoom — are all posterchildren of this strategy.

But is that true for all B2B cloud apps? I don’t think so. A great many successful cloud companies serve markets that are different, comprised of far fewer but large enterprise buyers with diverse and complex needs. Here, success is more about what we call the value runway, the ability to cross-sell those customers with more and more products, embedding yourself deeper and driving ever higher value to your customers. Think of companies like Workday, Veeva, or Coupa. Their pricing models tend to be fairly complex — and need to be — in order to adapt subscription price to the value delivered across a highly diverse set of customers.

So, yes, less is more, generally, but not always. And a more involved pricing model can be the right answer. Be very aware of the context.

The power of business freemium pricing

It goes by many names. Free tier, auto-convert, product-led growth. My team calls it business freemium. It’s a pricing flute that starts with the lowest tier being free — not just a free trial but free for good — up to some usage limit (users, minutes, etc.) and with limited functionality. The strategy is to attract free users and convert enough of them to a paid tier at a much lower customer acquisition cost, even when including the ongoing cost of the large free user base. When it works, it can be incredibly powerful with unit economics that are hard to beat. Zoom and Mailchimp are well-documented examples.

As consumers we are very familiar with the freemium model. We sign up, we use for free, find value, and eventually take the plunge and swipe our card and pay. We know what we are getting and have decided it is worth it. Calendly’s Udezue calls it “[giving] customers an onramp that is a psychologically safe entry point. Then go for scale. Price generously relative to the value provided. Trust you will be rewarded later.”

But business apps are different. Says SurveyMonkey’s Shull: “You have to realize that the free user in most cases is not the one making the company buying decision. You have to actively find that person — whether the CIO or head of a department — and sell to them. And most of the time you need an additional compelling value proposition for them. A simple volume discount or governance and control argument are not usually enough.”

The auto-convert model assumes the free user herself will swipe her company card and expense the SaaS fees. That works for smaller purchases and for narrow adoption. But business freemium can also lead to big ticket purchases if it is used in conjunction with an assisted selling motion. Says Shull: “I think free plans are really a marketing tool, a lead generation tool. Once you have enough adoption of the free plan, start looking for companies with many individual free users and find a compelling set of add-on features bundled in an enterprise plan that you can sell at the department or company level.”

But how do you design that pricing mode? A common mistake is to be too hesitant with what is included for free. “If you worry too much about holding features back for your paid plan, you might never get the free plan to be compelling enough to scale,” says Udezue. “Instead, be generous with the value in the free plan and then listen really well to what other needs users have and build that into your paid plan. Even if you don’t know what that might be when you first get started.” Sage advice.

In part 2 of this series, we will explore how to scale pricing, discuss if user-based “seat pricing” is past its prime and what is involved in using other pricing units.

Andy Stinnes is Venture Partner at Cloud Apps Capital Partners.