Product
Pricing Design and Operation in SaaS
2024-4-4
As the downside market conditions continue, the SaaS industry is gaining momentum to improve Average Revenue Per Account (ARPA). This is one of the major trends to improve ARPA.
Directly contributing to ARPA is pricing. In light of recent market conditions, there has been a series of cases of qualitative shift from Per User billing. The customer success tool Intercom has introduced add-ons, while the business messaging app Slack has adopted Active billing to reduce the barrier to entry. This article covers the basics of SaaS pricing, from foundational principles to daily operations.
Positioning Pricing
For SaaS, pricing is positioned as very important from two perspectives.
First, from a user communication perspective, SaaS bundles functionalities with use cases and offers multiple price points. The user will see what they can use and to what extent, understand the cost for that, receive sales, and consider implementation. Finally, the user decides whether to place an order or continue considering the product.
In other words, the SaaS product itself is variable through bundling and pricing, and we receive feedback from the user through these processes. aBundling and pricing serve as the medium through which we interact with users.
And if we look within the SaaS company, we find that pricing is the bridge between the product and the business. The product side plans and develops products that create value for users. The business side, on the other hand, delivers the product directly to the user and is responsible for the actual value creation. In other words, the product side and the business side should work hand in hand in bundling and pricing functions based on use cases, which is the starting point for a product to become a business.
Pricing plays an important role as a bridge between the product and the business, but not many companies are taking pricing seriously and working on it. When software was sold as a package, it had to be priced at a fixed price. However, SaaS companies thrive on evolving their products with high agility to meet changing user needs. Therefore, adopting rigid pricing is like flying without one wing of the benefits of being a SaaS.
Somewhere in Japan there is a sense of virtue in maintaining low prices. Of course, it is important to keep production costs down through corporate efforts, but if the value provided by the product is increasing, then the use cases should be properly verbalized and pricing should be re-set.
Value-based vs. cost-based
The two primary approaches to pricing design are value-based and cost-based. Value-based pricing is based on the user value created by using the product. The latter, cost-based approach is designed based on the effects of business improvement through the introduction of the product.
For example, taking a project management product as an example, if the project progress and resources can be managed in a timely manner, and if it is possible to immediately determine whether or not an order can or should be placed when an inbound inquiry is received, sales can be expected to increase. If you do not have any SaaS in place, you will have to go around asking if the Spreadsheet you are operating is up-to-date, and you will manage to answer, which may lead to a fear of missing out on customers. The price calculation based on this sales improvement will be value-based.
Conversely, if a dedicated employee manages clients and projects, tracks working hours, and requests employees to submit their utilization ratios, how much could SaaS reduce the cost of this dedicated role? The SaaS pricing is based on how much the cost of the person who is doing this full-time aggregation will be reduced by the introduction of SaaS.
Naturally, the decision to introduce SaaS should be made on a value basis as a business decision criterion, and pricing can be set higher on a value basis as well. However, how much of an effect it has on sales improvement is still a matter of guesswork, and if conservative decision making is used, it is more solid to use a cost basis. This is why many companies in Japan continue to rely on cost-based pricing.
Charging model and pricing
Two components of pricing are the charging model and price. The former charge model defines the method of charging. Price, as the phrase goes, is a set amount of money.
Specifically, there are five major charge models: Flat Fee, Stairstep, Per User, Tiered, and Volume.
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Flat Fee is one of the most familiar charging models in SaaS and refers to a flat fee. You receive a flat monthly fee for the period you are using the service, such as a monthly or annual fee.
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Stairstep is a slightly evolved version of Flat Fee, in which the amount of usage of some function is divided into ranges, and a fixed fee is charged for each range. For example, in an invoice-related SaaS, you can charge a monthly fee for the number of invoices you send.
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Per User is another common charging model along with Flat Fee. As the name suggests, it refers to a form of charging based on the number of users. There are two types of billing models: one in which a company purchases a quota in advance and allocates IDs, and the other in which active billing is performed based on the number of users who use the service each month.
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Tiered and Volume are easily confused, so they are explained together. Tiered is the amount used divided into ranges, each range is multiplied by the unit price of each range, and the sum is the invoice amount. Conversely, volume is the total amount of usage multiplied by the unit price of the applicable range to arrive at the billed amount.
For example, suppose that prices are set according to usage volume as follows
If the usage volume is 300, the Tiered price would be 100 x 10,000 + 100 x 9,000 + 100 x 8,000 = 2,700,000. On the other hand, for Volume, it would be 300 x 8,000 = 2,400,00.
Thus, Tiered is more profitable because the unit price is higher at the beginning, no matter how many units are bought; Volume is easier to sell in larger quantities because the unit price is determined by the number of units. As shown in the graph above, it is important to note that at the boundary of the range, there will be cases where the price will be lower if you increase the usage volume.
Methods for Setting Prices
Rather than focusing on analytical methods for setting individual prices, product and pricing is the communication between the provider and the user. Therefore, it is most important to capture and determine a series of (1) to whom, (2) when what is provided, (3) what charging model, and (4) how much.
In the case of a product that supports multiple industries and multiple use cases, it is necessary to first organize the user stories that are being realized. First, we will organize the main focus on (1) to whom and (2) what we are providing. Then, qualitative and quantitative research will be multiplied. Speaking of pricing analysis, PSM analysis and contingent analysis are well-known, but in the case of BtoB, the number of target companies is often small, and it is necessary to segment and aggregate to some extent. Therefore, it may be quite expensive to conduct a survey with strictly defined advantages and disadvantages. For this reason, it is more often the case that interviews are the main design element.
The interviews will mainly confirm the Willingness to Pay (WTP) and concretize what is anchored behind it. First, WTP is how much the user is willing to pay for the product. After explaining the product, we will ask the WTP question in the process of confirming whether the user would like to use the product frankly and whether it is likely to solve the current business problem.
Then, there is some anchored object in the amount of money indicated as the WTP. It will be anchored to the sense of the amount of money of the competition or peripheral services, the sense of the price of the company's products, or if the work is entrusted to a part-time worker, the part-time worker's part-time job fee, and so on. If you want to appeal to a higher price than the anchored target, you will need to win in terms of functionality and user value. The amount of money to be spent will be determined by the number of users and the amount of money to be spent. In determining the amount of money to spend, one thing to note is that because of the interview format, interviewees often have a bias that they have to say something good because they have been invited to the interview. In addition, if the interviewee is considering the introduction of a product immediately, that is fine, but if he or she is only planning to consider it in the future, he or she may not have a clear understanding of the competition's features and prices, or may not have the necessary knowledge to answer the question. Therefore, even if they have good things to say, it is best to discount their answers by a factor of about 7.
In addition, among BtoB, in the case of Horizontal SaaS and products for SMB, there may be quite a large number of target users, so only in this case, there is room to utilize PSM analysis and contingent analysis first. You can also consider conducting AB testing and seeing the actual user response before making a decision.
Operational
When talking about operational aspects, pricing really tends to be an afterthought. As described in the introduction, it is an important element directly related to ARPA, and although it is sensible, I think it is important enough to be tackled at the same level as the product roadmap.
New product releases and overall pricing reviews are to be carried out in accordance with the procedures indicated in the pricing method. However, product development is a temporal process, with new features being developed every week or month. Therefore, when a new feature is released, we will consider which plan to band it to. In this case, the product manager, focused on increasing user adoption, often suggests bundling the feature with a lower-tier plan. On the other hand, when the business side is considering the plan, they want to improve the value of each plan, so they tend to put as much as possible in the higher plans. Since there is such a clear conflict of interest in the short term, it is necessary to discuss the ARR maximization in one to three years, the use cases and intentions of each plan, and the evaluation of functions from a medium- to long-term perspective.
The people who take the lead in pricing operations also differ from company to company. Sales, product marketing managers, and product managers are three examples. The sales manager is closest to the users and can strongly reflect feedback from the users. The product manager focuses on user value from a mid- to long-term perspective. The product marketing manager is a good combination of sales and product manager.
Summary
Pricing is one of the strengths of the SaaS offering. One of the most exciting aspects of SaaS is the ability to communicate with users by developing products that meet their changing needs and constantly changing banding and pricing. Pricing is a topic that needs to be reevaluated in the current downside market conditions, and it has the potential to break out of this situation. We hope this article will help you rethink pricing.
Reference
About the Author
Yoshitaka Miyata. After graduating from Kyoto University with a degree in law, he gained experience in a wide range of management consulting roles, including business strategy, marketing strategy, and new business development at Booz & Company (now PwC Strategy&) and Accenture Strategy. At DeNA and SmartNews, he was involved in various B2C content businesses, both through data analysis and as a product manager. Later, at freee, he launched new SaaS products and served as Executive Officer and VP of Product. Currently, he is the founder and CEO of Zen and Company, providing product advisory services from seed stage to enterprise-level. He also serves as a PM Advisor for ALL STAR SAAS FUND and as a Senior Advisor at Sony Corporation, primarily supporting diverse products in new business ventures. Additionally, he has been involved in the founding of the Japan CPO Association and now serves as its Executive Managing Director. He is a U.S. Certified Public Accountant and the author of "ALL for SaaS" (Shoei Publishing).
