Pricing & packaging: how to create a recurring revenue model for SaaS?
Creating a recurring revenue model is the nerve of any business. Whether you sell quickly and well or have difficulty selling, whether you have a majority of customers on a basic offer or, on the contrary, a premium offer, there are certain warning signs to start thinking seriously about optimizing your revenue model.
The timing is perfect. We had the opportunity to talk with two strategy and pricing experts from Simon-Kucher, Alix Nepveux, Partner and French lead for software and Internet practice, and Karène Cousin, Director, during one of our workshops dedicated to our communities as part of our #Ring2Success program. Here are the key takeaways from our session!
1/ Objective: understand customer needs to define the right offer structure
When tackling your pricing strategy, understanding what your customers need and secondarily what they are willing to pay for is essential to define the right offer structure. But that’s not enough.
You also need to know what features and services you need to include in each type of offer to prioritize your product roadmap.
So, and you can see where we’re going with this, offer strategy and product strategy are tied together. Talking to your customers about products is fine, but if you have no idea what they are willing to pay for, there is very little point.
Whether you have an unlimited pricing model, 100% pay-per-use with per-user licenses or other more creative metrics, the goal is to define the right price point based on your customers’ readiness to pay for it.
2/ Recurring revenue strategy: what signals should alert you that something is wrong?
> acquisition is too difficult, you are never told yes (price strategy too high);
> acquisition is too easy, you are never told no (price strategy too low).
The repartition of your customers …
> all your customers are on the basic offer which seems to be generous enough for a low price that nobody has reason to move or that the step to the second offer is too difficult to pass;
> on the other hand, if all your customers are on the most expensive offer, which may mean that you have room to better monetize this premium offer;
> if you have customer typologies that are not at all homogeneous, it may also mean that your customers do not understand why they are there either;
> You are not able to move your customers upmarket.
You therefore have three major objectives to balance, which may seem contradictory at first:
- 1st objective: if you want to attract new customers, you may be tempted to provide a very generous offer at a lower cost that will keep you very competitive;
- 2nd objective: you also need to monetize and therefore also think about an upsell path or increase prices;
- The third objective is a retention topic about how you make sure your customers come in and pay but also stay to minimize churn.
To succeed in the challenge:
- We first think about packaging (at the intersection of monetization and acquisition). So, rather than having a single offer where you give everything to everyone, you need to think about having a differentiated and tiered offer structure.
- The second topic to think about is pricing strategy (at the crossroads of acquisition and retention but also monetization). The idea here is to ask yourself how you define the right level of engagement, especially for consumer and B2B models. Here also appears a crucial notion, the notion of risk sharing: “am I going to ask my customers to pay per use or on the contrary to be on a fixed basis whatever the use?”
- The third major topic is the price point. This is the cornerstone that holds the building together. However, if you’ve got your packaging and offering strategy and pricing model right, you have the right foundation and ingredients to have sustainable growth in your revenue model (discounts based on offerings, list prices based on verticals, customer seniority, etc.).
3/ Packaging structure: choosing the right approach that will allow you to structure your offer
Several types of structures exist on the market, from the least flexible but simple offer to the most flexible but complex one:
> All you can eat: this is a volume strategy, ultra simple to convert the maximum number of customers with a mantra: “I give access to all the features to my different customers”.
> Functional packages: this is the LinkedIn model. The use cases are clear, I know which package meets my needs. There is no upsell possible.
> Good, better, best: in this model, there is a differentiation of packages according to the needs of the customers with an unavoidable thought on which functionalities to put in the most basic offer, etc. but also which functionalities will create different types of values in the packages that will generate enough upsell.
> Platform + add-ons: you have a basic structure and you monetize several options.
> Build your own: the prime example is Microsoft. You have so many different use cases that you will have to customize. Your question will then be: what role will I assign to my different features to compose my different types of packages?
To understand the interest of this step, let’s take the example of the Big Mac menu at McDonalds:
- The Big Mac sandwich can be defined as the leading product, the one that customers come to McDonalds for in the first place. In your offer, you will have to identify this high value-added product that will generate either conversion or upsell.
- Fries and Coca Cola are defined as Filler features. In other words, customers would not have come specifically to consume a Coca and fries but they are nevertheless happy to have them on their menu. So that’s a serious plus.
- Coffee is defined as a Killer feature. Adding coffee to the menu seems to have a counterproductive effect: customers consider that they are paying for something they don’t like or don’t use and therefore don’t see the value. In the case of your offer, this product addition should rather be proposed as an option ;so as not to slow down the acquisition.
Identifying the Leaders features will let you feed your packages and serve as upsell. If you are on a Good Better Best structure, you absolutely must know the Leader features that will drive the upsell on a Better or a Best for example. This exercise also saves time in setting priorities in the product roadmap. Indeed, if certain features planned for development are finally identified as killer features, the roadmap can be reviewed.
Salesforce packaging, an example of Good Better Best +:
- 4 packages;
- a clear upsell path: from turnkey CRM to 100% customizable CRM;
- a smart fencing on the basic product: 25 euros/user for a maximum of 10 users;
- a rather expensive unlimited package allowing to fall back on another more advantageous price offer (enterprise offer).
Finally, when we structure our offer, we also think about the freemium offer. So, appropriate or not appropriate?
Several questions to find out:
> Are you able to have a low cost service to deliver a free offer?
> What is the potential of your service? Can it generate a form of virality?
> Do you have a clear and attractive upsell path to move users to a paid option?
4/ Pricing model: how to share the risks to define it well?
There are two main pricing models: fixed or variable (pay as you go).
Just to illustrate, here are two examples:
> Uber charges per ride, it is the pay as you go model;
> A gym membership: no matter how many times you go there, the price does not change. We are therefore in a fixed cost model.
Other pricing models have appeared in recent years:
> two-dimensional model: a subscription model is introduced to the pay as you go model, like what Amazon offers with Amazon Prime
> Adaptable fixed price: year after year, the price is adapted to the usage.
Once you have your formula, how do you choose the right price metric?
There are three main families of possible prices:
> service input metrics that reflect the size of the customer, number of employees and users, etc.
> service output metrics that reflect the customer’s activity and usage (how many tasks performed, storage volume, etc.)
> Business output metrics that reflect customer benefit (cost savings, increased customer satisfaction measured with NPS)
The main thing is to align the metrics with the value you deliver. For example, if I am a supply chain optimization software and I price according to the number of users and my solution will make the supply chain team of 5 people manage more and more flows which will stop recruitments and therefore generate less recruitments, I will lose revenue. If I choose a metric that is based on the flow of goods that I handle, I am more aligned with the value.
You can also optimize the pricing model by combining multiple metrics. If we take the example of a laboratory instrument management software, two metrics were chosen:
1/number of tests produced in the lab each day which allows to be aligned with the value delivered and the revenue of the lab
2/ number of laboratory instruments that have been equipped. This second metric allows to cover costs and secure part of the revenue for the software publisher.
Questions to ask:
> How consistent is the current pricing model with customer buying criteria? What are the budgetary obstacles?
> How are pricing metrics understood and perceived by customers?
> How scalable are the pricing metrics in relation to the value delivered by the company? Are there other metrics that can be explored?
Finally, how can willingness to pay be leveraged and price differentiated over time?
To measure willingness to pay for…
> segment customers according to their needs and associated willingness to pay ;
> understand the value of individual features;
> understand psychological price thresholds;
> define product and package prices.
The approaches can be direct or indirect:
> Fixed scenario testing: new pricing models are proposed to different stakeholders, hot and cold prospects, churners, customers, etc. to find the structure (Good Better Best) and price (lower, higher) that will impact conversion and retention.
> Gabor Granger’s method consists of looking at price elasticity and particularly at options to understand when the customer agrees to subscribe.
> Conjoint test: my offer has such features, users and different service levels. Different offers will be proposed with :
- a first offer with a very basic service level, few features, a very low price level;
- a second offer with other components, etc.
Based on the answers collected, the model is able to bring out segments defined according to price (those who are only interested in this criterion), service (some will systematically choose the quality of service), features, etc. and therefore offer structures optimized to meet the different expectations of the segments.
Questions to ask:
> What is the willingness to pay for the different customer segments? What is their limit of acceptability?
> What is the relative price positioning of the solution versus competitors? Is it in line with the value perceived by the customers?
> What is the current conversion rate? With what level of discount, via what sales process?
> How much flexibility is there for a price increase on current customers?
You now have the essential SaaS patterns to define the right pricing model. One last piece of advice, don’t try to duplicate, think about it!