They say you can’t teach an old dog new tricks, but what about teaching a new dog new tricks? SaaS companies have become the darlings of innovation, embracing the latest technology platforms, new business models and modern marketing strategies – then why are these “new dogs” adopting outdated pricing practices that their traditional industry peers have outgrown 10+ years ago? Competitive-based pricing, drastic price discounting and lack of pricing discipline have led to price wars and eroded margins in B2B high-tech, manufacturing and distribution industries for decades. It’s time for SaaS to ditch the old practices and adopt data-driven, value-based pricing that has been the gold-standard for B2B for the last decade.
First the good news: SaaS as an industry has woken up to pricing. I’ve met with over a dozen B2B SaaS companies and PE firms specializing in this space in the last 60 days alone, and the self-awareness is there: SaaS pricing is in its infancy and needs to grow up before margins are wiped out. SaaS companies are taking the right first steps by embedding a dedicated pricing function within Product Marketing, building Pricing Councils and Committees and hiring for senior pricing executives to lead the transformation.
Now the bad: The transformation is partial – many SaaS companies are approaching pricing with a paranoia regarding competitive offerings and an obsession with market share over profitability. In plain-speak, this is leading to a self-inflicted price war. SaaS companies need to see beyond competitive-based pricing the full way down the pricing spectrum to value-based pricing as their B2B industry peers have already done. Sympathetically, this shift to pricing best practice is a uniquely difficult challenge in SaaS.
First of all, with marginal costs near zero and virtually non-existent capacity constraints, there is no natural cost barrier or “price floor” to SaaS pricing. This is most apparent by excessive price discounting, which reaches epic levels during the frenzied end-of-quarter push. Sophisticated buyers are trained to expect this, delight in pitting competitors against each other and achieve heroic procurement-led discounts. In theory, SaaS CFOs aim to control pricing based on the Price to Acquire Customer (PAC) to Customer Lifetime Value (CLTV) ratio. However, in a B2B setting, PAC and CLTV are nebulous estimations at best that fail to allow for the full CLTV potential of a rapidly evolving SaaS portfolio. The net of it is that the race to the bottom is on! SaaS CFOs and Product Marketing leaders would be wise to learn from the consolidated rental car market in 2012-14; the insatiable desire to capture market share through aggressive price matching caused profitability to take an irreversible hammering, and the industry is still rehabilitating its price levels nearly five years later.
Secondly, there are many more degrees of freedom in determining a pricing architecture in SaaS than in other B2B physical goods or services businesses. The seemingly limitless number of permutations to bundle and unbundle features, differentiate by delivery mechanisms and product packing options can be daunting. This makes SaaS pricing decisions more intimidating and ripe for hasty and inconsistent changes. For an industry characterized by rapid change and “pivoting”, SaaS organizations require an uncharacteristic degree of discipline to see through their pricing strategies and avoid over-tinkering and granting unwarranted exceptions.
Lastly, the temptation of network effects and the winner-takes-all game theory scenario entice many SaaS companies to live in the long-term. Most SaaS companies pursue a land-and-expand strategy, often at the expense of near term cash-flow. While the dilemma of creating value tomorrow versus capturing value today is not new, the low thresholds for switching costs in SaaS (perceived or real) erodes pricing and total profitability, even at high market share.
But – it’s not too late. The SaaS industry can apply its characteristic attitude toward embracing innovation to embracing pricing best practice. Instead of painfully applying the same failed pricing tactics of other industries, it can leapfrog to value-based best practice, unencumbered by decades of historical poor practice. More on that in the next post, and as a sneak-preview:build pricing and packaging based on data and customers, not competitors and features.