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Ulf Johansson is the head of market research at Unity Technologies, where he leads the market and user research practice, building product development and go-to-market strategies for 30+ products. This article is an abridged summary of Ulf’s talk for the On Deck Chief of Staff program.
Pricing is probably the most important decision in a product's life.
But strangely, for most teams, pricing is often an afterthought. If you’re like most people in product or strategy leadership, you’ve considered your pricing strategy only after thinking about product-market fit, your potential competitors, and your go-to market.
There’s a ton of writing on the internet about SaaS pricing strategy as a whole, but little of it goes into the actual steps of how to practically implement it.
In this post, I’ll give you a blueprint for how to think about pricing, while providing tactical advice that will help you follow through and execute on your strategy.
How do you decide on a SaaS pricing strategy?
When trying to price a new product, you often initially have no idea what you're going to charge for it. This can feel a bit overwhelming because there are so many options. But actually, your decision space is constrained by three factors:
- The competition. How are they pricing? Is there a market consensus around pricing?
- The cost of product delivery. Understanding your fixed, variable and overhead costs provides another set of useful guardrails.
- Value metrics. How your customers will be paying you determines a lot of your key pricing options.
Let's go through each of these in greater depth.
1. Understand your competitors
In order to understand pricing in the market, you’ll need to get a birds eye view of your competition. Here’s how.
For your top 3-8 competitors, identify the following items:
- Their value metrics. How do each of them charge? Combining this with your knowledge of their products’ relative strengths and weaknesses helps you build a holistic view of the market.
- Their product pricing tiers. Put yourself in their shoes and think about why they’ve adopted the pricing model and tiering they have.
Now you can build out a market map with a 2x2 grid of value (or quality) and price. Where do the different competitors position themselves? Why do you think they have positioned themselves that way? You can then use this matrix to identify where you might fit in the competitive set.
9 times out of 10, this exercise reveals that critical pricing decisions have already been made for you. Your customers are going to expect you to fall into certain categories.
When there’s market consensus and buyer expectations around pricing, you don’t want to reinvent the wheel unless you have an extraordinarily good reason to do so.
2. Understand the cost of goods sold (COGS)
Understanding your COGS provides another set of useful guardrails that reduce your decision space to help you arrive at the right pricing strategy.
You can’t do this step alone. Work with your finance team and product team to build a high-fidelity picture of your cost of revenue. This includes you get the numbers for your:
- Fixed product costs. These are costs that don’t scale 1:1 with product growth like engineering, software/Hardware, brand marketing, go-to-market, etc.
- Variable product costs. These are costs that do scale with growth, such as the costs of delivering services, human services, sales commissions, performance marketing
- Overhead. These are the share of company-wide expenses allocated to your project e.g. shared resources (finance, legal, HR), facilities/rent, etc.
- Minimum margin. This is the minimum difference between sales price and COGS. For example, “All new products should have a gross margin of at least 40%”.
At this point, it’s useful to build a very deep, very granular spreadsheet built together with your finance team to organize all of this information.
3. Determine value metrics for your SaaS product
Value metrics are what your customer is paying you for. For example, Slack’s value metric is active users per month.
Your value metric can either be a single metric or multiple metrics. However, unless you are selling very expensive, complex products, I urge you to bias towards simplicity. The more value metrics you have, the more complex your sales and marketing efforts become.
Value metrics affect multiple teams: they’ll not only influence your sales cycles but also impact things like customer renewals and upgrades. Therefore, deciding on value metrics shouldn’t be done in a silo.
At Unity, we bring teams together for brainstorming. We’ll lead a session and encourage teams to come up with ideas beyond charging by seat. This gives us a wider palette of factors that customers might judge us on.
Starting with this big list, you can then start striking out options that are likely to be unappealing to customers. Some will be obvious. Reflecting on your team’s larger objectives also helps to cull options.
The goal is to create a shortlist of value metrics that are easy to understand and easy to enforce. For example, one mistake we made at Unity in the past was using “customer company revenue” as a value metric.
This was an easy metric to understand, but difficult to enforce. Unfortunately, there’s no central database that tells you which companies make more than $100,000 a year, so we ended up having to enforce this manually by scraping third-party sources. An unanticipated result was sometimes accusing our customers of being in the wrong product tier. In hindsight, it’s obvious that getting into adversarial relationships with our customers instead of a mutually beneficial relationship was a sign of a poor pricing strategy.
One final tip for value metrics: before implementing them, stress-test them by talking to customers. You’re looking for strong negative reactions, whether they can easily understand them, and how it would affect usage.
In addition to being easy to understand and easy to enforce, great value metrics encourage usage, scale with your customer, and work the way your customers work.
Once you’ve got a handful of potential value metrics that are both easy to understand and enforce, it’s time to bring the finance team back into the picture to build a model. You really want to understand the impact on revenue and your shortlist of value metrics on pricing, narrowing down your decision space further.
Designing a pricing model
Now that you have your market positioning, an understanding of your costs, and a target value metric, you can start designing your pricing model. There are three steps to this process:
1. Get live customer feedback to test your assumptions
Call up some of your customers or prospects and judge how they react to different pricing models and concepts.
"Hey, we're thinking about charging per gigabyte import." Then they might say, "Hmm, let me think. Okay. I find this to be a challenge, but that will work.". You might then propose different models: "How about per user?" And they're going to say something else.
It’s important not to talk about specific price points and stick to talking about models. When you talk about actual dollars and cents, you’ll get stonewalled: "Well, I don't really want to tell you how much I'm willing to pay you." So keep it at a conceptual level.
2. Start with simple tiers and packages
The next step is to then think about tiering. Most of the time, you're not going to have one tier and one package for every one of your customers. You’ll want to create packages and tiers for price discrimination purposes, offering prices that address the spectrum of your prospects’ willingness to pay.
For example, this was DocuSign’s pricing at some point. This is a classic SaaS price tiering. You have three tiers plus enterprise. And as you can see here, their value metric is on seat basis.
This is a base that most SaaS companies can use to iterate. But don’t get carried away: simple tends to be better. You may also start to feel different parts of your company asking for more tiers. Perhaps your performance marketing team wants to have different packages to sell to different personas. Next thing you know, you’ve got 16 pricing packages. Try to avoid that.
3. Make it easy for your customers to upgrade
Another thing to consider is an attractive, reasonable usage route so it feels natural to move up to the next tier. Think of this from the customer’s perspective. You have a lot of customers who really like a product and they want to increase usage, but they don't want to go back to their finance teams and say, "I need to increase my budget mid-cycle by 300% because I want to increase to the next subscription tier."
You’re forcing them to have a really hard internal conversation to have, and it’s difficult for you to win that battle. I can bet that 70% of SaaS companies are losing revenue because their usage ramp between tiers is poorly designed.
4. Get buy-in from customer-facing teams
Your pricing model will have a major impact on your marketing and sales teams. This is important to consider if the team leading the pricing strategy is Operations or Product. Very often, those teams will carry out pricing in tandem with the finance organization, but not much else, then all of a sudden, dump a pricing sheet on your revenue teams. "Go out and sell it."
Your SaaS pricing strategy has a major influence on their livelihood. They're going to be hired and fired, they're going to be compensated on these pricing decisions, so you really want them to buy into it because it has really negative downstream effects.
The marketing team will have a hard time generating demand. Your sales team is going to be demotivated. You are going to have challenges attracting or retaining talent.
Don’t create pricing in a silo; align with your marketing and sales teams early in the process and get their sign off before you ship your pricing strategy.
How to pick a price point for your Saas product
There are two broad categories when it comes to pricing. The first is bottom-up, cost-plus pricing where you think about how much it costs you and add a margin on top.
The second alternative is value-based pricing, where you think about capturing some of the value you create for your customers. This one is more complex. The thinking goes something like:
"I deliver $100,000 worth of value to my customers. And I should be able to grab some of that value for myself. If I deliver them $100,000, I know I can't charge them $100,000 because there is no value left for them. But I can probably charge more than $1,000 because then 99% of the value I deliver goes to the customer."
It's hard to do value-based pricing effectively in B2B. The key is to start with putting down thoughts on paper and begin triangulating. One of the ways you can do this is a mix of customer feedback and pricing research.
Validating your price points with customers and surveys
Qualitative customer feedback is really useful. However, when you talk to customers , don't trust their price point recommendations. Instead you’re trying to get a sense of whether a given price feels appropriate or not.
Quantitative customer feedback can give you robust data to back up your recommendations. You’ll have much better internal conversations when presenting to your pricing council or to your C-suite, or even going to marketing and sales.
Before we talk about quantitative price point research, I should caveat that it doesn’t work that well to give you specifics. What you’ll get out of it is an understanding that the price should be between A and B. You're not going to get a result that says the optimal price point is $79 a month.
A shortlist of common pricing methodologies are:
- Van Westendorp. Really simple: it's basically four questions. Easy to execute.
- Gabor Granger. A bit more complex, but you’ll get more granularity.
- Discrete Choice Modeling. The most complex of these three, but the benefit is that you’ll better understand trade-offs between price tiers and pricing models, and not just between price points.
As you get market feedback, recall that one of the key constraints is the competitive landscape. Your competitors, SaaS companies, and startups under-price so often. This is really unfortunate because despite your research and data, you’ll end up having to underprice your product, even though you should charge higher.
Common pricing mistakes
Pricing is both art and science, and it’s an area with a lot of potential pitfalls. Let’s cover some of the most common ones.
Reducing your prices to break into the market
If you’re a new entrant plotting out your go-to-market, you may consider artificially low prices in order to gain traction. There's only one problem: prices are sticky, and perceptions are hard to shape once they settle.
One way of getting around that is introductory prices. Temporary prices are your best friend. You can go to market and say, "We're $29.99 – but for a limited time, we're going to charge you $20."
Position this as a temporary price for early adopters, this way, you avoid adversarial conversations with customers when it expires. This allows you to raise prices, or perhaps stay at the lower price point if it turns out you’re not as valuable as you thought.
Freemium pricing models are harder than they look
Freemium can be really dangerous.
Unless you define the upgrade path effectively, you could end up shooting yourself in the foot as your best customers might get stuck on freemium. The delta between not charging and charging might be too high. Always picture them going to their finance team and asking for upgrades.
Free trials avoid a lot of the challenges of freemium without getting to the point where you have a direct paywall for new customers. And again, don't overthink free trials. You can do six months. That's fine. It doesn't need to be 30 days, especially for B2B where maybe adoption cycles are long. Err on the side of longer, but everyone knows if it's a free trial, they're going to have to pay. And it's built into their mental model, the way a freemium tier isn't.
Overreacting to feedback
When it comes to pricing, watch what people do, not what they say.
Your customers could be complaining, and this is really hard to ignore. Focus on their actions: do they keep using you? Do they keep upgrading? Did your pricing change significantly impact churn metrics?
Same thing with your sales team. They're always going to want to discount. They are always going to complain at happy hour about the cost of their product and how they can't sell. This is normal. The important thing is to look at their win-loss rates and whether they’re hitting their targets. That’s what’s actually going to impact their compensation and performance in the end.
Testing too many price points
A/B testing can be super powerful, but it can also very quickly accrue detritus of different customers on different price points, different tiers. And having been on that side of the fence at Unity, I’ve seen how this slows down your decision-making. You slow down your pricing iteration dramatically.
Instead of having six SKUs, you have 80, 100, 400 SKUs because you have different little groups of customers sitting around on different price points or different tiers.
My suggestion here is to aggressively transition legacy customers through the new tiers. Even if you have to pay them to move, it's worth it.
Pricing is one of your highest leverage variables
Many SaaS verticals are incredibly competitive, and you’re often looking for an edge over your competition. Companies often overlook pricing, or think of pricing as a “set it and forget it” exercise that doesn’t get touched for years.
With the ideas from this guide, you now have the tools to place pricing as a core part of your strategy, not as an afterthought.
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