Patrick McKenzie often exhorts micro-ISVs and the like to "raise your prices. And he's right for many. I see technologists underprice themselves all over the place. Heck, I've been guilty of that too.
You're offering $20/user/month, but should it be $30? I say that merely increasing or multiplying the price is most often not the correct answer. The real problem is a disconnect between the value, the perceived source of that value, and the structure for fees.
The value is the first and most significant problem. We can think of it as two parts: what value am I receiving, and when does it make a difference?
The value I am receiving creates the ceiling for a willingness to pay. If I am getting $1,000 in value, I will not pay $2,000 for it. There is a further issue of risk. Most of the world is probabilistic, and the impact of services is not as straightforward as putting money in my bank account. If I am not confident that I am getting $1,000 in value, I discount it in my head. If I think there is a risk-discounted $500 in value for me, that sets a ceiling.
What does all that mean for pricing? First, communication that clarifies the connection between the service and the value one receives will reduce that discount rate, which increases the willingness to pay. This exercise may increase the actual value your client receives since uncertainty is itself a mental tax. Second, one can formulate a desired value capture level that feels fair as a fraction of the created value. In the previous example, perhaps if the risk-adjusted value is $500, I could take 10% or $50 and have the client happy with a 90% share. Much better than the $20 from the first paragraph!
The second part of the value is timing. If I see the benefit once initially, my willingness to pay will be on the early side. Clients may be slow to cancel the ongoing service, but the continuing subscription will drag on value rather than create it. I see this in prototyping and creative tools that charge per month. Entrepreneurs who need these tools early will sign up, use them, and - if they are wise - cancel. Not all do, but they become "zombie" customers, paying for value they are not receiving. They often feel toxic toward the vendor for taking their money. They may well take their business across the street when it is time to use this kind of service again. The flip question holds: if I am receiving considerable value now, why is the price now so low?
Subscriptions and financing overlap and confuse. In the bad old days, vendors sold software as an up-front expense. You could buy a CD-ROM from your local Egghead Software with an application on it and use it for as long as your Windows 95 machine lasted. At the business level, one could buy a support contract. These multi-year contracts usually ran 15%-20% of the initial purchase per year. They might include updates.
Many financial institutions offered financing to spread out the up-front costs over the years of the support contract. Such arrangements were de rigueur for hardware purchases, which went on a traditional depreciation schedule. The lender would put the depreciating asset on their balance sheet and give the customer an asset-backed term loan. The vendor got their money up-front, subject to a haircut for the financing fee. And so, a monthly recurring fee was born.
The initial software-as-a-service vendors brought this financing in-house. I hypothesize that falling interest rates around the turn of the century made this easier to afford. Some, starting with Salesforce, offered their goods on a term license that bundled the license with support and upgrades. Offering their software on what was then called an ASP model - hosted on their hardware - made all this easier to afford. So now they could offer software as an operational expense. Line of business professionals could write a check instead of getting capital budget committee approval.
Several software vendors thought this was the future but stumbled. Term licenses create a need for recurring value. Pushing product that does not get deployed or well-used would generate year one subscriptions but cancellations in the out years. Previously the customer was on the hook since they had paid a pile for the software. Now the vendor was at risk. And making sure benefit was recurring became important.
However, software in 2000 was very often about smoothing operational processes for human knowledge workers. Some offerings in 2021 are substitutes for tasks that one would have hired people to do. Rather than underlying a constant hum of internal human operations, the value delivery might be intermittent or one-time.
One hears advice about picking both significant and recurring problems in people's lives for a SaaS. I look at it a little differently. Many issues worth addressing respond to software and have a good deal of automaticity. But they are not good fits for blind per-month subscription pricing because they don't create their value evenly over time.
The idea of "software with a service" is, to my mind, an answer to this phenomenon. Offering a relatively inexpensive software subscription offering that is bumped up with the provision of more intensive services when needed (for example, for initial state change onboarding) can make a great deal of sense. The customer pays for value when they receive it.
I have met founders that push back on this idea. They offer free support to get more "MRR". The problem is that the MRR is financing a consulting arrangement up-front, with no guarantee or even probability of payoff over time, rather than being a high-margin ongoing operation. This ties into how many entrepreneurs under-value their time, a topic I have discussed elsewhere.
Many customers are knowledgeable about software economics. They have heard about spinning platter economics for 25 years. Why are they paying money when their business does not cost you?
I have found that a model that includes some visible variable costs helps build trust. One form of this is customer success. Clients hearing from a vendor about proactive initiatives to generate returns reminds them that they are receiving value that costs something. People cost something! The client should perceive a cost of continuous value delivery.
Finally, one should ask when the product makes a change for the customer. Subscription models for the likes of Canva become more puzzling. If I am likely to use it once, I would logically buy it today, use it, then cancel. Why make this hard? Why not make it an easy transaction for those likely to use it, and look for the recurring business later?
There is room in the market for pricing that matches the timing of value delivery. Rather than just hiking a per-user-per-month price structure, look at when you are making a difference. Charge reasonably for that, and separate the question of amortizing the cost (e.g., spreading a $10k charge over a year at $833/mo) from that of recurring value.
Pricing is part of the story of the product. Align with the customer's value and financing needs, and one can open up a great deal more business while separating from the competition. But all starts with knowledge of oneself and one's customer - the founder who has that market knowledge will be its best servant and succeed.
Photo by Estée Janssens on Unsplash