SaaS pricing as foundation for sustainable growth and profitability – interesting study of 103 SaaS companies

Pricing of any software solution is a pain. During my 20+ year software career and tens of different market entries with both our own products as well as our clients, I have to say that pricing is one of the most difficult decisions to make. I will never forget the “friendly advice” I got from the largest enterprise company in a specific vertical (the CIO told me) that I almost lost a sales case in the US market as I was too cheap and therefore the perceived value and competitiveness was seen as weak. This was 10years ago when I was running a business intelligence software company. I learned from this case how to price for large multi-billion dollar enterprises and how the CIO’s budgeted the acquisition of software. I came from the technology side, so I had to learn how to price our solutions specifically in the US marketplace.

So, what should you be basing your pricing on? Some say that it should not be based on what competitors ask, but rather on what the perceived value is for the client. However, what if you sales does not know how to articulate the value proposition? What if you lose the deal to a competitor as you were too costly? What if you lose as you are too cheap? How should you deal with international pricing? Fortunately, there are quite a few companies that have already tried and tested many different models and there is quite a lot of good data available of these. What SaaS companies and companies that have a desire to enter the SaaS space, need to study and learn of other companies past mistakes. That is always the best way to avoid costly mistakes. Unfortunately, we humans are lazy when it comes to learning and I guess some will always have to go through that hard learning curve. Let’s learn from an interesting blog entry that includes some findings of 103 different SaaS companies.

I read an interesting article from Bernard Lunn, a serial entrepreneur and former COO for ReadWriteWeb. He made a study of 103 SaaS vendors and how they handled pricing. The sample that he had consisted of three types of companies: VC funded (62%), bootstrapped (16%) and publicly traded (22%). The findings that Mr. Lunn was able to identify were fascinating: 30% of the companies had web-sites that were actionable where the sales could be contacted. He did not count the 800 number or other switchboard number that was found on the web-site. Mr. Lunn concluded that the reason for this could be twofold:

• The company is selling with a price so low that it is not economical to have inside sales doing it.
• The company is thinking too much in the old-fashioned enterprise sales way….. Fill the form and we will get back to you…
• The company just does not have the money to build the inside sales force

The study continues to conclude that only 24% show the price online, in a transparent manner like should be done in respect to SaaS solutions. Mr. Lunn mentions Zoho, 37Signals, Constant Contact (we use them), Xero and Timebridge as leaders in the transparency.

Only 6% had a Freemium plan and this is something that I stated in my prior blog entry that it could be a fallacy for a SaaS vendor and that a vendor could even attract wrong types of customers using the solution. Mr. Lunn provides two explanations to why organizations are not using Freemium models: they might have read the work (The Reality of freemium in SaaS) from Lincoln Murphy or the vendors are just too much “locked into” the enterprise sales model of SaaS.

The final conclusion that Mr. Lund provides is data about the CAC Ratio (customer acquisition cost). Based on my research and discussions with companies, this is one of the key metrics that a SaaS company needs to monitor and I am planning to do another blog entry about SaaS key metrics going forward. Mr. Lunn refers to the definition of Bruce Cleveland that he interviewed (Cleveland is a former Siebel executive) and the way he sees CAC Ratio is as follows:

CAC RATIO = ($Total Sales + $ Total Marketing)/$ First Year Contract Value

If this value is less than 1, it means that the customer acquisition cost is paid in less than a year. However, this is obviously something each company has to evaluate themselves and also take into account churn (how many clients disconnect the use of the solution) that has been a key ratio for a long time specifically for telecom companies as Mr. Ulf Avrin emphasized to me today. In any investment calculations, the timeframe under which a company expects to be paid back is dependent on multiple factors such as required return on investment, cost of capital and many other factors. This is where Invest for Excel comes to play that enables organizations to simulate different types of scenarios of pricing, sales forecasts and other key factors that are part of an effective business model for a SaaS vendor.