Pricing strategy is essential for every company - small and big, startup and established - to remain competitive and profitable at the same time. It is more so for a software product company. Your new software product could excite the investors, management, and target customers, but you are struggling to decide the pricing that would attract customers and generate cash for you. You must keep the price sensitivity of a product in mind and set a balanced price acceptable to customers and profitable for the business.
So, let us discuss what could be the strategies to be adopted and the challenges you might face in pricing a software product.
Software pricing is about setting a price for your final product in the market. The pricing can vary for the same product based on the functionalities and features as well the delivery model. For instance, the price for a full-suite ERP will be different from the same ERP offered only with certain modules. Likewise, the pricing plan changes based on the delivery model - whether on-premise licensing model or SaaS subscription route.
In broader terms, the following factors need to be considered before finalizing the price for your software product:
The right price is crucial for businesses to remain profitable and growth-oriented. If the software product pricing is not done carefully, the fundamental economics of the business can go awry.
It is not just any single department in a company that is fully responsible for pricing as it touches every part of the business. Product pricing is not done in a silo but in a collaborative manner with inputs and insights from key functions, including product development, marketing, sales, finance, and management.
Let us take a look at how each function in an organization influences software product pricing:
To achieve growth and enhance profitability, businesses strive to improve their customer lifetime value (CTLV) and reduce their customer acquisition costs (CAC). Reduced customer acquisition costs and better customer retention rates, resulting from a good pricing strategy, lead to revenue growth and improved profitability.
You need to understand how CLTV and CAC impact unit economics to help you set the right price in the short term and long term:
The formula for calculating is the Total cost of sales and marketing / Number of customers acquired. We will consider a simple example to comprehend CAC more clearly.
Sales cost - $300k
Marketing cost - $500k
New Customers onboarded - $800
CAC - (300=500)/800 - $1000
Here’s an example:
CLTV - (700 * 100) / 50 = $1400
A CLTV/CAC ratio greater than 1 and your CLTV greater than CAC is vital for companies, particularly SaaS companies, profitability in the short-term profitability and growth in the long term.
Pricing is not a one-time exercise that is done at the time of the product launch. It is an ongoing process that helps the business achieve the best possible value from each sale. You should have a clear understanding of the popular pricing strategies and select the most appropriate one or a combination of them to get the pricing right. The common pricing strategies adopted by businesses include:
Using competitor or market pricing as the benchmark criterion to set software product prices is arguably the simplest strategy. The strategy has a drawback in that no two products can be exactly the same in terms of their functionalities and features. You must price your product based on the value it offers and the differentiating factors. In a nutshell, competitor price analysis can guide you in product pricing though not affect your pricing determination.
Price is calculated by working out the cost of developing your product and adding the required profit margin using this pricing mechanism. If the company has a good understanding of its costs which include the cost of development, overheads that should be allocated to the product, how overheads will be allocated, and the profit margin required, you can easily calculate your price. However, the costs keep changing or all costs may not be known upfront, as in the case of SaaS products, and this makes this approach a bit challenging.
This strategy looks for inputs from your customers, that can influence pricing. This is a more complex strategy that considers the willingness of your customers to pay a price for the current product and future value adds so that you can set a price that breaks even or makes a marginal profit in the beginning and later revise prices while you enhance the features of the product.
This strategy is more relevant in the SaaS model as you enhance the features and functionalities of your product in a progressive manner. This allows you to quickly revisit pricing strategies, and revise prices. A company that sells SaaS products needs to understand what price its customers consider as worth for its product. This will help you price products intelligently and retain customers while raising the price as you enhance the value of your product.
The viability and growth indicators of a SaaS product are driven by customer acquisition, customer retention, and monetization. Monetization has the maximum impact on a SaaS company’s bottom line. There are studies that found that monetization was the key to the growth of SaaS businesses more than customer retention or acquisition. The data derived from such studies have shown that knowing how to set a price for a product appropriately was 2x as impactful as retention and 4x as impactful as acquisition in improving a SaaS company’s bottom line.
Pricing and product development are correlated. They are both iterative, consistent, and dynamic. A data-driven approach using pricing software can be useful for you to determine product pricing on a continuous basis, in the short term and long term, to reap the benefits of a scientific pricing strategy. As a business, you must understand the variables that influence pricing and the best possible strategies and choose one that suits your kind of business, to come to a sweet spot that is beneficial for both you and your customers.