Pricing as a Value Metric
Many people think that pricing is just a number, but they don't realize how many other things impact that number or that perception of the number.
What is a value metric?
A value metric represents the exchange rate of the value that your business provides. What does that mean? At a very high level, it means you've created some sort of value as a business and then you're saying ‘because we don't trade goat for wheat in the economies we're playing in, this value is worth this much’. What that means is that every aspect of your business, from your sales and marketing teams to your engineering and product teams, is used to either convert customers or justify your product's value and price.What that means is that every aspect of your business, from your sales and marketing teams to your engineering and product teams, is used to either convert customers or justify your product's value and price. There are a lot of things that influence that exchange rate on the value called a price e.g. who you sell to (like going upmarket or down market, different verticals), how you package the products (like what your value metric is, in which tier should we put this feature? Should we make this feature an add-on?) and obviously the actual number. Of course, this understanding makes things more complicated internally because it's not just a product person realizing, ‘oh, we should do X’ and collecting some data. It turns into like, ‘oh, I'm gonna collect that data, but then I gotta go get buy-in from John in sales and Judy in customer success and Peter in marketing, etc.’
The Importance of a Value Metric
I always recommend starting with the value metric when it comes to pricing. Whether you are bootstrapped or funded, you need to evaluate and reevaluate your value metric. This value metric is how you charge per user, per video, per thousand contacts, etc. It doesn't matter what it is in the grand scheme of things, but it's important to make sure that it's right for your business. Then you use this value metric to ensure that the amount you're giving away for whatever tier is adjusted in accordance with this ‘exchange rate on product value’. The most important piece of pricing is getting your value metric right because if you do, everything else in your pricing can be suboptimal and you'll still be fine. The reason for this is that if you get your value metric right, you're baking growth into your pricing. You get this natural expansion revenue For example:
- Having a value metric means that if a customer starts using 10 users and then three months later they're using 20 users, you don't have to convince them to upgrade to another tier, you just send them an email saying congratulations, you're now using 20 users and your pricing will adjust accordingly.
- Having a value metric that ensures that when Disney comes in and wants a thousand seats, you're not charging them the same amount of money as some Johnny or Jane's startup that only wants five seats.
Why you should invest in your pricing:
Most founders underestimate pricing. A survey discovered that most companies spend about 15 hours on their pricing a year and only make changes to their pricing once every 3 years. This is a mistake. There are three growth levers in a business:
- Acquiring a customer
- Monetizing a customer
- Retaining a customer
If you are not doing anything about the middle one (monetization), you're not really doing anything with retention either. 60 to 65% of budgets go to sales and marketing as typical in growth companies so it's kind of amazing if you miss out on a very big growth lever like monetization.
[Pricing] it's also one of the most effective growth levers. Improving pricing pound for pound has a bigger impact than improving your acquisition or even your retention. - Patrick Campbell, CEO of ProfitWell, speaking on the alphalist CTO Podcast Episode #68
But it is one of those things that you have to focus on. Most people don't do anything with their pricing and I think it is because of the middle nature of it. They think it is going to be hard because they have to go get everyone's buy-in on something. Or perhaps they think it's this like a black box. Oftentimes, pricing is just like any other process within your business. It's just like product development, marketing, development, etc. Like if you are setting up a deployment, you need to think through the problem, you deploy, and you find a mistake so you revert and fix it…
When people start to realize it's just a process, they tend to do a lot better with it because they realize there's going to be a lot of changes over time versus thinking it's like a one-and-done exercise. - Patrick Campbell, CEO of ProfitWell, speaking on the alphalist CTO Podcast Episode #68
How to continuously optimize your pricing
What kind of tweaks should you be making to your pricing on a regular basis to reach the optimal price? Here are some examples of goals you can have each quarter:
- Work on a localization strategy where you adjust your pricing across different geographies rather than having the same price overall.
- Fix your value metric, like how you charge per user, per videos, et cetera
- Actually increase your prices for the first time in three years
- Change up your discounting strategy
Usage-based vs. User-based vs. Tiered Pricing
I think that some sort of value metric beats tier-based pricing on every measure. You can combine both usage-based and tier-based though. I have seen plenty of pricing where it's like: this tier is per user but it includes these features. If you upgrade here, you get these features for each user, etc. I think it just depends on the type of product. For example, AWS is pure consumption/usage. But I think a value metric doesn't have to strictly be usage. For example, for a retaining product that lowers churn automatically, we charge based on how much money we recover for you. That is not really a usage metric, it's more of like ‘here's the value you're getting’ and we're able to charge perfectly on that value.
Batching consumption pricing
Sometimes you want to put it in tiers because sometimes people don't want a per API-call type pricing. They want a batch, like every 100 API calls, or a range like a price for between 0 and 10,000 API calls and a price for between 10,001 and 25,000 API calls. You have to figure that out a little bit depending on your customer base. But there should be some sort of usage or consumption-based metric in everyone's pricing. For consumer companies, it is harder to do consumption-based pricing but if you do it, you should do it.
The problem with user-based pricing
User-based pricing does not work when use varies across the company. User-based pricing came from when we sold perpetual licenses. When we moved to the SaaS model, we decided that instead of pricing per license we should price per user. But for most companies, that's not really where the value is. Typically, user-based pricing is not the answer unless everyone is going to have a different experience based on their user. Otherwise, you are paying the same amount per user regardless of how the user is using the product. For active workflow-type products (e.g. Google Workspaces, Salesforce for a salesperson, etc.), it makes sense to bake the per-user cost into the price of a team member or an employee. But for most products, usage across the company varies widely. Let’s take Miro for example. A company might be paying for its entire company of 100 users to use Miro. But only 35 of those users actively use Miro to create boards while the others just use their username to just view the output of other people’s work. The company does not want to same the same price per user so why pay for inactive users? In fact, when they decided to use Miro companywide they were only saying that they want to choose Miro over other items on the market but they don’t need all their employees to use Miro. What products in this scenario usually do is that they usually don’t charge per user (because not every user does the same thing), but they charge by some other consumption metric like per number of boards or they charge based on the number of files, etc.
Should you do role-based user pricing?
One thing we mentioned on the podcast is a polling app in which there is a debate about whether they should create a model around a low user fee + pay-per-user-action (e.g. poll creation or vote) or if they have role-based user pricing. The problem with the latter is that things become fragmented. Some people are power users, some are not. Some companies might also allow read-only users for free, but what if a read-only user did one action - would they be charged full price like an active user? It gets difficult and it really depends on the product, but this is where you do need to think through like clever solutions.
How to find the right price for your SaaS Product
Multivariate testing in big companies
Ideally, if you were a large consumer company like Amazon, you would perform a multivariate test. If you have 3 tiers and three or four features differentiated within those tiers - you might have 80+ technical permutations on your pricing page. You then run a test of all those permutations. (Perhaps even just an A/B test depending on the proposed change.)
Why you probably aren’t big enough to A/B test
Yet while Amazon has enough traffic to do a price test every 30 seconds, most companies don’t have enough traffic to A/B Test their prices. This is because in a subscription space, you're not just looking for the completes (e.g. conversions), you're also looking at the LTV and the retention. This is because plenty of people will convert and you'll be like, “oh, that $10 price test was right”.But what if they were converting because of the $10, but then they were leaving immediately because they just weren't the right customers? So if we can't A/B test or we only have traffic for one A/B test or a split test, what do we do?
Talk to customers
So what do you do if you don't have enough traffic to run an A/B test or a split test? The answer is to talk to your customers. Conducting qualitative research through one-on-one conversations with customers is a great way to get a better understanding of their value perception and how they would respond to different pricing options. I know people are scared to talk to their customers about price, but here's the thing: your customers know things cost money. So what you got to do is you have to ask in the right way. Human beings and economists and psychologists have studied this for a long time so this is not just me bringing this up.
How to get User Opinion on Pricing
1.Select a question you want your research to answer.
You want a tight question in line with the format of basic market research. You should focus all the research on one problem and in this case, it should be: Should we raise our prices? If so, by how much?”.
2. Invite 10 -15 customers for a one-on-one conversation
Go talk to some customers and say, “hey, I got some questions about value in pricing”. People love to get on those calls because they're a little sensitive to like pricing. Simply ask some questions and you will get the information you need.
3. Ask them qualitative-type questions
Remember, in qualitative research, it is important not to ‘ lead the witness’, ‘Value as a Spectrum’ Type Questions
We think about value as a spectrum. We don't think about a value as a single point. - Patrick Campbell, CEO of ProfitWell, speaking on the alphalist CTO Podcast Episode #68
We think about value as a spectrum. We don't think about a value as a single point.So if I asked you like how much this cup should be, it's actually kind of a hard question for you to answer. And the reason it's a hard question for you to answer is that you immediately go “well, have I purchased a cup lately? Is that worth more or less than the last thing I purchased?” But if I asked you “is this cup worth more than my phone?” It would be easy for you to say no right now. But if I put you in a situation where you were in the desert for three days without water, all of a sudden this cup would be worth more because - all of a sudden our change of perception has changed the value in our heads. In pricing, we can take advantage of that.
A model I really like to use is called the Van Westendorp Pricing Model. Van Westendorp is a Dutch economist who came up with this way of asking ranged questions. While Van Westendorp’s isn't the most accurate model, in terms of how cheap it is timewise and how much you get out of it, it's really good. There are other models out there depending on how much money and time you have. The questions are something like this:
- At what point would this be way too expensive that you would never consider purchasing it?
- At what point is it getting expensive but you'd still consider purchasing it?
- At what point is it a really good deal?
- At what point is it too cheap that you question its quality of it?
For most non-US companies, that last question is really important. We just historically see a lot of non-US companies are priced way too low. When non-US companies raise their prices, not only will their revenue per customer increase, but also their conversion rates. After performing data cleaning on the results of these four questions and from other question sets you might use, you probably get between 20 - 25% of your real willingness-to-pay. Now you might be thinking that that is still a big range. And yes, it definitely is a range, but when you're just starting out,(and I would argue until you have enough like a customer base where 5% matters), then you are just trying to figure out if you are a $10 $100 or $1000 product. You don’t need to figure out right now if you are a $10 or $11 product. Collecting that data is really, really powerful. Of course, if you have a math or economics background, you can get the accuracy down. With a bit of extra modeling, you can probably get it down to about +/- 10 to 15%.At ProfitWell, over the last 10 years, we have gotten it to about +/-3% - but we created software to do it. Keep in mind you're trying to figure out what ballpark you should be in. When I'm on a sales call, I won't ask all three questions, but if I'm researching pricing, I'll talk to a potential user, demo the product and bring up some questions during the conversation. For example, I might ask “at what point is this way too expensive? Like you're not going return my next call”. The user might struggle for a bit but will give me some data. Then I'll go, “well, at what point is that a good deal that you'll sign the contract today?” With just those two questions, I can get a sense of where I'm at from maybe 10 - 15 people, and then I can consider other factors like CAC and LTV.
The second set of questions I like to ask is something called MaxDiff. In MaxDiff, we ask about features because people who like certain features will typically pay different amounts for them. It's really good to know. So this question is really simple. After demoing the product to a potential user, ask them “great, we talked about these five modules/features out of that list, what's the most important to you?”. They might struggle for a moment but will still answer. Then you ask them, “what's the least important to you?” When you do this to 10-15 people you get a good idea about features. (Obviously, if you want to ask hundreds of people, you can get even cleaner data.) From this, you can see that this segment really cares about features X and Y and they don’t really care about feature Z at all. So why are you prioritizing feature Z on your road map? Why are you putting it as a value driver in your pricing?
4. Spot trends:
After talking to 10 to 15 people, you will start to see some trends.
5. Create a survey if you have thousands of customers.
If you have only 50 users, the qualitative information you get from 10 to 15 users will be enough to extrapolate from. (It would be pointless to run a survey if you already spoke to people 1-1). But if you have hundreds, thousands, or even tens of thousands of potential customers, you are going to want to survey them. I suggest you structure the survey questions based on the feedback you got qualitatively. The point of the survey is to get massive data that you can segment as you see fit.
6. Analyse the Survey
Cut that data up based on whatever factors you think are going to influence things and affect willingness to pay. You are going to see some trends. Now you need to earn your paycheck and make a decision.
Making a decision
Asked in both qualitative (like I mentioned) or quantitative (e.g. survey) ways, these questions bring you a lot of useful information about what numbers should be - which is really powerful. Because if you segment the data against who is answering it, you all of a sudden have a really good picture of “well, I'm going after this user and their willingness to pay us is here, therefore we should set our prices up accordingly ”
Don’t try to be everything to all people
The one biggest mistake people make is they try to be everything to all people. So you might have a cohort of customers or potential customers that are willing to pay a hundred dollars. You are able to retain them and they love the product. But then you also have a cohort willing to pay $50. How should you price your product? Most people their answer is, “oh, let's put it at $75”. But then you're like, “well now I'm too expensive for one group and I'm too cheap or at least not really maximizing revenue on the other group…” What you need to do is decide that you are going to be a $100 product and are just not going to cater to the $50 cohort as they are not great customers for you. You can't be everything to all people. That's a big mistake a lot of people make when they get into the numbers and they get into setting up their pricing as well.
Tips on Changing the Price of your SaaS Product
There is a jump from the science of the data to the art of making product decision of what that pricing change should look like.- Patrick Campbell, CEO of ProfitWell, speaking on the alphalist CTO Podcast Episode #68
Consider Recent Customer Experience
When it comes to rolling out a price increase for a customer, it's important to approach the decision with a strategic and data-driven mindset. it's important to consider factors such as past bugs or downtime, as well as the overall health of the business, before determining the appropriate amount of the increase. For example, the data might tell you you could justify a 50% increase but then you need to factor in a recent spate of bugs and some downtime. This could mean you need to wait two months and then only roll out a 30% increase.
Test out the new price on new customers
You might want to test the new pricing before rolling it out to all customers. One approach could be to launch the new pricing for new customers first and monitor the impact on conversion rates for a set period of time. This works well as new customers don't have a history. This works sort of like an A/B test and will give the business the confidence to go back to existing customers and potentially raise prices.
Communicating a price increase: It’s about them not you
When communicating a price increase to your customers, it's important to remember that it's about them, not you. Instead of emphasizing the reasons why the increase is necessary for your business, such as cost increases or inflation, focus on how the increase will benefit the customer. You can do this by highlighting how the additional revenue will be used to improve the product or service for the customer, or by emphasizing the value that the customer will continue to receive. It's also important to avoid playing the victim of external factors such as recession and remember that customers are primarily concerned with their own costs, not the costs of the business. If you bring up the recision your customer will be like “it's tough for me right now and it's tough for you, but it should be tougher for me because it's tough for you. That makes no sense”
Don’t be afraid of churn.
Even a well-executed and communicated price increase will result in churn, but you should focus on the increased revenue - not the churn. This price increase will mean that customers who were on the fence will be reminded they are buying something and they will churn, but in the long run, the churn will go down below the baseline because what you really did was bring forward the churn of those who would probably churn anyways while increasing the revenue you get from your ideal users.
Use legacy tiers cautiously
You have to use your best judgment, but from a math perspective, it is not a good decision to grandfather your customers long-term. There are only 2 circumstances that offering a legacy tier would be a good idea: - If it is deeply ingrained in your company's culture and values to always keep prices the same for certain customers. - If your company has a massive TAM, there will be enough potential customers at the new price to grow the business. Most companies do not have that. Even if you would like your company to have the value of not increasing prices, people know things cost and they also know that your product has theoretically improved over years and you've never done a price increase. So the value differential is off, meaning you've provided a lot more value, but you've kept people at the existing price. This also means that old customers and new customers are getting the same thing for different prices.
Also, from a tactical perspective, it gets really gnarly because now you've grown to $5M or $10M ARR, and how you have gotten there may not have been easy and now the easier part of market share- like getting each incremental new customer - actually gets harder because, depending on how your marketing goes, it's really hard to get a hundred percent market share. So if you're not going to get more market share, you're basically saying, “Hey, this base of customers who are happy are getting more value. We're just choosing not to take advantage of that growth lever. “
But most of the time it's because we have a false sense of ”oh, they're going to be upset” when they're not going to be upset at all. Like, there's going to be a couple of people upset because you didn't answer their support ticket and yet you still raised their price, but we can’t make decisions based on that one person, right?
So I think a legacy price is good for your earliest of earliest customers or if you have some zombie MRR (inactive customers and you don’t want to rock the boat with them with a price increase email), but for most customers, if your NPS is over 20, you've done your pricing research, and you realize there is a delta there - you should raise your prices.
Freemium vs. Free Trial
I am a big proponent of freemium for several reasons. Firstly, customers who convert from freemium typically have much lower customer acquisition costs (CAC) and higher lifetime value. Secondly, they are retained at a much better rate and have a higher Net Promoter Score (NPS). This is because freemium allows you to nurture the customer until they are truly ready to convert, rather than forcing them to make a decision within a limited time frame, like a 14 or 21-day free trial. It's important to remember that freemium is not just a pricing model, but it's an acquisition strategy. Think of it like a premium ebook, it's a way to give customers a taste of what your product is like before they make a purchase. It's especially useful for products where customers may not see the value right away, such as a URL shortener. By giving them the opportunity to use the product first, they can see the value and be more likely to upgrade to a paid version. Another benefit of freemium is that it can create a sense of lock-in for customers. For example, with a URL shortener, you might allow customers to shorten 50 URLs for free, but once they exceed that number, they must upgrade to a paid plan to continue using the service. Then customers will be like ‘I've used it so many times that I want to make sure I keep using it so I will upgrade.”
Monthly or Annual Billing
When it comes to billing models for SaaS products, one of the biggest decisions to make is whether to offer monthly or annual billing. In my experience, annual and quarterly customers tend to have much higher lifetime value than monthly customers. This makes sense because when customers commit to a year of service, they are less likely to churn within that year, compared to a monthly customer where there is a potential churn every month. It’s a game of lifetime value. I think that a lot of people aren't fighting as much as they should. I'm a big fan of getting as many monthly customers onto longer-term plans within reason. This is how I would do it. - At sign up: I'm a big fan of like asking them when they sign up but realizing that you shouldn't be getting most people there because they haven't had the value and they haven't experienced your product - From the first month to the 10th month: Pitch the annual plan to them every 60 -90 days. - After 8 to 10 months: No need to bother them anymore. They are kind of committed to the product so I'm fine with paying the extra monthly fee.