This post is by Kyle Poyar from Openview Labs
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Editor’s Note: This article was first published on August 23, 2016. Segment CEO and Co-founder Peter Reinhardt was recently reflecting on what were his top lessons learned from changing packages and pricing. Without batting an eye, the unicorn founder said, “The first is to raise prices and that we discovered we could raise prices by probably ten thousand times from what we were initially charging and people were happy to pay for that.” While Segment may be an extreme case, the business is far from unique in learning that it was leaving money on the table due to its pricing. Successful price increases drive a far higher profit improvement than any other initiative. Across a study of Fortune 500 companies, for instance, Andreas Hinterhuber found that a 5% price increase leads to a 22% improvement in operating profits. Compare that to a 5% improvement in SG&A expenses, which
moves the bottom line by 5%. A successful price increase helps you acquire better customers, who are more serious about using your product and less likely to churn. It dramatically improves the lifetime value of a customer, which in turn boosts the LTV: CAC ratio. Plus, it allows startups to build a more sustainable business model, and hence be more in control of their own destiny. Take StatusPage, the leading hosted status page provider acquired by Atlassian. As Co-Founder Steve Klein describes in detail, StatusPage started out with two price points – free and $49/month. Over time, they removed the free tier and managed to raise prices by up to 8x with minimal impact to conversion or churn. This was a key lynchpin in their efforts to grow average revenue per user (ARPU) by 2.4x and reach a $2.5M annual revenue run rate over the course of only two years.
Pricing Is Your Best Shot at Growing 25% FasterEach year, OpenView collects benchmark data from hundreds of companies on important metrics such as growth rates, cash burn and unit economics. The 2018 study also asked questions about pricing. We found that among companies that changed pricing, 98% of the time the pricing change had either a neutral or positive impact on the revenue growth of the business. In two-out-of-five cases, pricing changes led to a 25% or greater improvement in ARR. The experience of Deputy, a Sydney-based workforce management software company (and an OpenView portfolio company), helps reinforce the insight. Deputy had provided additional value to its customers year after year, which could be seen in their NPS scores, yet had been reluctant to adjust its pricing. The company ran a comprehensive market research study to gauge customers’ perceptions of their affordability and value. Armed with these insights, Deputy decided to raise the price of their monthly plans by between 25% and 33%. By all accounts, the price increase was an overwhelming success. Deputy didn’t see any dip in trial volume or conversion through the funnel. The higher prices fueled an acceleration in revenue growth, which the company could then use to further invest in the product and customer experience. Not long after, Deputy pulled in an $81M Series B (the largest in Australian history).
BigPanda and Pricing for Fair Value ExchangeI recently had a chance to connect with Dan Turchin, the VP of Growth Strategy at BigPanda, about their recent pricing increase and how he approaches software pricing. BigPanda, which in May 2016 announced a Series B funding round closing at $21M, centralizes and automates IT incident management. Looking at BigPanda’s 2016 pricing page compared to what it looked like a year before, they implemented a significant change to both packaging and pricing. Turchin has two fundamental philosophies when it comes to pricing: it should be as transparent as possible and it should align with value. He explains, “The goal behind any pricing model is to achieve a fair value exchange…What’s driving our process is not revenue maximization per se, it genuinely is a spirit of partnership and trying to figure out what is the right balance and what features are unlocking the right value.” In other words, when you invest in creating new features and driving more usage of your product, it creates an opportunity to extract some of that added value in the form of higher prices. What struck me about Turchin’s approach is how rooted it is in truly understanding BigPanda’s customers and what they value. This type of deep voice-of-customer research is regularly talked about, but rarely done at most startups. As Turchin puts it, “We’re trying to have enough conversations with customers to get feedback on how they associate value with BigPanda and how to translate that into the most simple, transparent, logical way to consume the value.” After the pricing change, Turchin and his team made sure to closely monitor the response and make adjustments as needed. “We measure sentiment on pricing mostly by the adoption cycle – how quickly a customer gets into production and how quickly the deployment grows. We’re definitely seeing onboarding times and time to incremental purchase go down,” he notes. Seeing those metrics trend in the right direction gave the team confidence that their pricing change did not have a negative impact on customer success, and was a smart course of action.
Room to Raise PricesIn my current role and past life consulting companies on their pricing strategies, I’ve picked up on six signs that a SaaS company is due for a price increase. They all hark back to Turchin’s notion of fair value exchange, and being able to extract more money only when you are delivering sufficient value to your customers.
- Sign 1: Prospects don’t push back on pricing. Does your sales team have the authority to discount, but rarely uses it? When you send a proposal to a prospect, do they comment on everything except for the price? For better or worse, software buyers have been conditioned to negotiate, especially when procurement gets involved. If they don’t negotiate with you, you’re probably leaving money on the table.
- Sign 2: Customers tell you how cheap you are. Have customers ever told you that they are surprised you are able to make money with your current pricing? Do they (favorably) compare you to other solutions in their tech stack, mentioning how they prefer you but pay 2x, 5x, 10x the price for another piece of technology? Or, my personal favorite, are customers satisfied even if they only implement a portion of your software because they see the investment as a ‘drop in the bucket’? In general, when customers are consistently happy with your pricing, they will not balk at paying more.
- Sign 3: You create a very high ROI. Does your software demonstrably save time, reduce waste or increase your customers’ revenue? Are you capturing enough of that value creation? As a rule of thumb, software companies can safely capture 10-20% of their economic value.
- Sign 4: You have not touched pricing for years. Did you set prices a while ago and have not given them another look since? Or, worse, have you not changed pricing since you launched? Do you have a strong point person in charge of evaluating and managing your pricing strategy? Many SaaS companies put a 5-7% annual price escalator in their contracts, and so 3 years without raising prices could mean you fell 20% or more behind competition.
- Sign 5: You added new features without monetizing them. Have you invested in extending your product capabilities, but gave those new features away for free to create goodwill with customers? Do you continually do that? Customers are more open to price increases when you can show a track record of using that extra money to invest in improving the product.
- Sign 6: Your customers mostly buy your most expensive package. Even if prospects aren’t raving about your affordability, they may be telling what they think about your pricing based on what they choose to buy. In an ideal world, your most popular package will be your middle one (the ‘Better’ in your ‘Good-Better-Best’ lineup).
Don’t Shortchange ImplementationWith pricing, it pays to sweat the details. Too often a pricing strategy gets rigorously analyzed and debated by an executive team, but then nobody pays attention to the nitty-gritty details of successfully implementing it. I don’t need to repeat the cautionary tales of Netflix (2011) and Zendesk (2010). Nailing implementation and minimizing backlash requires telling a good story about your pricing change, and giving customers a choice about what to do. As Turchin comments, it’s best to err on the side of transparency and view it “as an opportunity to engage with the customer; here’s what we’re doing, here’s why.” Specifically you should:
- Validate your course of action: First, confirm whether an across the board price increase is the best strategy. Could you add a new edition instead, or change the pricing metric to one with more upside?
- Communicate why you’re raising prices: Talk about how you have not raised prices for a while, how since the last price increase you’ve invested in new features and services or what you plan to invest in going forward. If possible, add metrics that point to the impact of what you’ve invested in – for instance, the amount of time spent on the platform, the % uptime you’ve delivered or how quickly you’ve been able to respond to help desk requests.
- Use the pricing change as a marketing tactic: By pre-announcing a price increase, you can create urgency with customers and prospects about why they should lock-in their rates now before their old prices expire.
- Give customers a choice: Nobody wants to feel strong-armed in a negotiation, and too hardline of an approach is likely to upset your customer base. A better approach is to provide a bounded set of options for customers to choose from. For instance, they could stay at their current plan at a higher rate, or choose to downgrade plans and keep the rate they’re paying today, or if they commit within 30 days they could get 10% off a better plan than they have now. This takes some of the sting off and puts the customer in the driver’s seat.
- Have a plan for existing loyal customers: Depending on the size of the price increase, it could be difficult to swallow for long-time customers who signed up at a steep discount to the current rate. The first thing to consider is whether grandfathering makes sense. If you are rapidly scaling and doubling your customer base year-on-year, the revenue opportunity from migrating existing customers may not be worth the effort. If you decide that it is, you should still proactively identify customers who will see especially steep increases and have an account-by-account plan to retain them. Typically if they’ll see a price increase beyond 50%, a best practice is to stair-step them so they gradually move up to the new rates rather than swallowing it all at once.
- Make peace with not convincing 100%: If you’ve done the math on a price increase, you know exactly how many customers you can lose in the process and still break-even. Set a realistic target for how many customers you think will leave as a result, and recognize the team for a job well done if that target is achieved. Keep in mind that some of those ‘lost’ customers will eventually boomerang once they try an alternative and realize the grass wasn’t actually greener.