Pricing is the most important lever for growing revenue. Profitwell data shows that a 1% improvement in monetization has ~8x the impact on revenue growth compared top the same increase in acquisition and ~2x the impact on revenue compared to the same increase in retention. But how do you improve monetization and pricing? Start with the fundamental building blocks. The three elements of pricing provide a framework for companies to consider when pricing and billing customers. Each component plays a critical role in determining how to price your software. Software businesses need to carefully consider each component to ensure they are not leaving value on the table.
The most important element of pricing by far is the price metric or the unit of measure for the price. Simply, the metric is what fills in the blank to this statement: "we charge per _________." For example, a product can be priced per user, per message, per hour, or per project. The metric you choose can have a significant impact on the final price, and businesses must choose a metric that accurately reflects the value of their product or service.
The most common price metric in SaaS is per seat billing. Back when software was predominantly on-premise or installed locally, the metric was per license. Usage-based billing may have become a hot topic in software pricing recently, but it's important to remember that software pricing has always been usage-based to some extent. The renewed focus on usage is simply about improving the price metric as new technologies have emerged in categories such as software infrastructure and artificial intelligence. The per seat value metric does not always closely align to value in these models. Usage of a core action or feature in the product is more often closely aligned.
The price structure refers to how you present your prices to customers. The structure includes decisions around pricing and packaging models such as traditional good-better-best, a la carte, and segment-based among many others. The structure you choose will depend on your business model and the goals of your pricing strategy. Within structure, there are commonly discussed choices around add-ons and bundling.
Add-ons are specific features or bundles of features that businesses can sell both as part of a bundle or separately for additional expense depending on the price structure. These features can add value to the product and provide additional revenue streams for businesses.
Bundles are a collection of two or more products sold together with additional benefits such as discounts, additional benefits and higher levels of support. This can be an effective way to sell multiple products together and increase the value of the overall purchase for customers.
The level is the element most people think of when the word price comes to mind. It's the actual currency amount or "sticker price" associated with your product. The price level is the most tangible aspect of pricing, but it is the least important element because it is a lagging indicator of value. The two most common questions about price level: "Are we charging enough or too much?" and "Should we offer discounts?"
Here at Stage, we believe in sparing our customers unnecessary pain. You should use only discounts as a last resort. Why? When you discount prices 20%, you decrease the customer lifetime value (LTV) by 20%. Decreasing LTV without more engagement or customer longevity results in onboarding less valuable customers who are less likely to renew. Discounts = the fastest way to onboard cheap customers who won't stick around. Assuming your fixed and variable costs remain about constant, you may shift what otherwise would be a profitable product or business into the territory of unprofitability. If anything, you should likely be charging more to focus on customers with the sharpest pain and highest willingness-to-pay.
The Bonus Element: Monetization Strategy
Your monetization strategy is tied to the context of your particular industry (ex: price regulations in healthcare) and your overall business strategy. Factors that can impact your monetization strategy include whether you are trying to penetrate a highly competitive market or attempting to attack different segments of a market. Other factors that can impact total monetization include branding, customer perception, and overall business strategy.
Each of these components plays a critical role in software pricing. When considering an adjustment to your pricing, you must always be sure to solve it in the order above: metric, structure, and then level. Too many software businesses start with the level without considering the metric or the structure. By carefully considering each component, businesses can price for growth by aligning their plans and segments with how their customers want to buy their product.