3 Things to Consider When Pricing a SaaS Product

October 12, 2022

SaaS companies spend a huge amount of time (and money) on customer acquisition and retention. All that’s well and good. But curiously, these same businesses dedicate very little energy to correctly price their own product. In fact, pricing is often treated like an afterthought.

This is a big mistake. Pricing is arguably the most important lever a SaaS company has. If you price your product too low, you’ll leave lots of revenue on the table. Prospective customers may also get the (wrong) impression that the low price implies an inferior offering. On the flip side, if you price your product too high, you’ll scare potential customers away.

In what follows, we detail what you should consider when pricing your SaaS product. These insights are courtesy of Paul Lynch, Venture Partner at our sister company, Scaleworks. Paul has deep expertise in this topic, having been both an investor and an operator of many SaaS companies (including a number of successful exits).

1. Know Your (Product’s) Worth

This may sound like the kind of advice you find in an article about dating (“Know your worth and don’t settle for less!”). But it’s equally applicable to SaaS products.  Many founders, in our experience, have what amounts to an overwhelming fear that customers will abandon them. They massively undervalue their own sweat equity and price their product far too low.

We see this when a company adds amazing new features but decides to keep the price the same. Say your start-up initially offered a single-use product (such as analytics) and later added on another use (perhaps a time management tool). Maintaining the original price amounts to giving the new feature away for free. When you go to a movie theatre, you pay extra to stay for a second film. Same with SaaS. More features should lead to a higher price.

Speaking of movies, Netflix is a great example of a company that flourished in part because it knew its worth and priced its product accordingly. Initially, Netflix started as a mail-order DVD business. Then it changed course (pivoted, to use today’s lingo) and became more of a tech firm. Consumers could thus stream movies on their computers, and while the content library wasn’t great, the convenience of it sure was.

After Blockbuster disappeared, Netflix changed course once again. Its technology was improved (no more lags when watching), but the real innovation was to become a content company. In addition to spending boatloads on third-party movies, shows, and specials, Netflix invested in its own original material (think House of Cards). Crucially, as their content became better, the company kept raising the cost of a subscription. In 2013, Netflix set you back $7.99 each month. Seven years later, the price had jumped to $13.99.

Knowing your worth cuts both ways, though. Netflix today, if anything, is a bit overpriced, and as a result, it’s now losing customers. The lesson of all this for SaaS companies? You need to constantly re-evaluate your pricing based on what you offer to customers. And don’t let insecurities or overconfidence guide you.

2. Know Your Competitors

A common way of pricing SaaS products is to use competitors as a benchmark. Maybe you’ve developed an organizational tool, and the current market leader sells its version for $100/month. Their price can give you a ballpark of how much yours will be. You can undercut them somewhat or try to stand out as a premium product by pricing yours higher.

This kind of benchmarking can be effective, but you must be certain you know who you are really competing with. The plight of Quibi is instructive in this regard. In 2018, former HP head Meg Whitman teamed up with ex-Disney honcho Jeffrey Katzenberg to launch a new streaming service. They correctly saw that the 15-24 demographic had a lower attention span. This cohort is far more likely to consume smaller amounts of content at a time, and they overwhelmingly do so on mobile devices.

Recognizing these trends, Quibi set out to de-throne Netflix, and sought to steal market share by pricing their product at only $5/month. There was just one problem: Netflix wasn’t really Quibi’s main competition. TikTok was—and TikTok is free. Quibi evidently didn’t realize this, and, it seems to have been a major reason why the company never really got off the ground.

The lesson for SaaS companies? If you’re going to price based on competitors, do your research so you know who they truly are. You don’t want to end up like Quibi.

3. Know the Value Your Product Creates

One way to price a SaaS product is with a cost-plus model. You figure out how much your product cost to deliver, and then mark that up to earn a profit. This isn’t the best way, though. Instead, you should look at the value you’re creating for customers, and charge accordingly (a “value-based model”). Maybe you develop accounting software that allows small businesses to stop using outside bookkeepers. If you can price your product so they end up saving a lot of money, odds are good you’ll retain them as customers.

One subset of the value model that’s becoming very popular in SaaS is known as utility-based pricing. Case in point: Historically, if you needed hosting for your website, you had to pay a flat rate per month, regardless of usage. Then Amazon came along and offered hosting, where you only paid for the server space you used. To use an analogy from the music industry, customers often want to buy the songs they like, not the full album.

If you believe in your SaaS product, value-based pricing is nothing to fear. The market will see that what you are offering is compelling, and they’ll be willing to pay for it.

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