Pricing Strategy for SaaS: Why You Should Charge More

The Silent Killer of Great Businesses: Underpricing

Even the most sophisticated tech companies can fall into the trap of underpricing their products. Recently, Sam Altman, CEO of OpenAI (valued at $80 billion), admitted that they're losing money on their $200 per month ChatGPT Pro plan. If a company at the forefront of AI technology can underprice their product, chances are you might be doing the same - and it could be costing you more than you think.

The Power of Pricing in SaaS

Pricing is arguably the most significant lever in the Software as a Service (SaaS) industry. Getting it right can lead to a business that's two to five times more valuable and successful than if you don't nail your pricing strategy. On the flip side, getting it wrong can create a terrible business model that struggles to survive.

The Psychology of Undercharging

Understanding why founders often undercharge for their products is crucial. There are four core fears that typically keep founders from charging what their product is truly worth:

1. Fear of No Sales: The belief that nobody will buy the product if it's priced higher.
2. Product Insecurity: Feeling that the product isn't good enough to justify a higher price.
3. Competitor Comparison: Worrying that competitors charge less, so you should too.
4. Business Disruption: The fear that raising prices might wreck the business.

Let's examine each of these fears in detail and why they're often unfounded.

Fear of No Sales

Many founders worry that increasing prices will lead to a complete halt in sales. In reality, this fear is often baseless. Most of the time, products are underpriced, and there's room for an increase without significantly impacting sales volume. Competitors might be charging much more for similar products, but founders lack the confidence to raise their own prices.

Product Insecurity

This fear stems from a form of imposter syndrome applied to products. Founders might think, "When will everyone figure out that my product isn't good enough?" In most cases, this fear is unfounded. Across 22 B2B SaaS investments made by experienced investors, the vast majority were initially underpriced. When these companies raised their prices, their growth trajectories improved significantly.

Competitor Comparison

Worrying about competitors charging less is only valid if your product is a commodity. If customers can easily swap your product for another without any difference in quality or features, then price becomes the primary differentiator. However, the key is to avoid being a commodity. Differentiate your product through unique features, positioning, focus, or brand. Build a moat that prevents your product from being viewed as interchangeable with others in the market.

Business Disruption

The fear of wrecking the business by raising prices is often overblown. While it's true that price increases can potentially harm a business, the odds of this happening are extremely low. Experienced investors have observed hundreds, if not thousands, of SaaS companies raise their prices. Only in rare instances have companies had to roll back these increases, and there's only one known case where a business was severely damaged by raising prices - and even then, the real issue was the company's failure to react quickly to market changes and competitor price drops.

Why You Should Charge More

Now that we've addressed the common fears, let's explore the compelling reasons why you should consider charging more for your SaaS product.

First-Order Effects

The immediate impact of raising prices is an increase in Monthly Recurring Revenue (MRR) or Annual Recurring Revenue (ARR). This boost in revenue can lead to faster growth and improved financial health for your business. Real-world examples from TinySeed companies show significant increases in MRR growth rates after implementing price increases, transforming their businesses' trajectories.

Second-Order Effects

Beyond the immediate revenue boost, there are several secondary benefits to charging more:

1. Reduced Churn: Higher-paying customers tend to churn less frequently. An anonymous TinySeed company found that customers paying $29/month had a net revenue churn of over 11%, while those paying $99/month and up had a negative net revenue churn of -4%. This difference in churn rates can be the deciding factor between a $4 million annual revenue business and one struggling to reach $1.25 million.

2. Improved Customer Quality: Higher prices often attract more serious, committed customers who are likely to derive more value from your product and stay longer.

3. Enhanced Perception of Value: A higher price point can position your product as a premium offering, potentially attracting customers who associate price with quality.

4. Increased Resources for Improvement: With more revenue, you can invest in product development, customer support, and marketing, further enhancing the value you provide to customers.

Case Study: Gather

A TinySeed company called Gather provides an excellent example of the benefits of raising prices. Initially, they offered plans at $39 and $79 per month. At these price points, their business model wasn't viable - they couldn't afford to conduct the necessary sales calls to scale the business.

After raising their prices to $99 and $159 per month, they saw no difference in conversion rates. This price increase allowed them to invest more in sales and marketing, accelerating their growth. They've since further increased their pricing, with their mid-tier plan now at $199 per month.

The results of these price increases were transformative:

• Churn rates decreased
• They lost some price-sensitive customers but gained more valuable ones
• Overall growth accelerated significantly

This case study demonstrates that well-executed price increases can lead to improved business health and faster growth, even if it means losing some lower-value customers.

How to Raise Your Prices

If you're convinced that you need to raise your prices, here are some strategies and tips to help you do it effectively:

Quick Tips for Price Increases

1. Adjust Value Metrics: You can effectively raise prices by decreasing the value or thresholds on your value metric for a specific plan. For example, if you currently offer 3,000 contacts for $49, you could reduce it to 2,500 contacts for the same price.

2. Drop Your Lowest Plan: If you have multiple pricing tiers (e.g., $19, $49, and $99), consider eliminating the lowest tier. This is an easy way to experiment with higher pricing.

3. Avoid Split Testing: Split testing pricing is extremely difficult for most SaaS companies, especially bootstrapped ones. You likely won't have the volume to conduct statistically significant tests. Instead, you'll need to take a leap of faith and closely monitor your metrics.

Implementing Price Increases

When implementing a price increase, first decide whether it's an experiment or a certainty:

• If it's an experiment, treat it as such. Make it easily reversible and watch your numbers carefully.
• If it's a certainty, consider making it a marketable event. Email everyone in your trial funnel, non-customers, and existing customers. You can use this as an opportunity to drive annual conversions by offering to honor current pricing for a limited time before the increase.

New Customers vs. Existing Customers

It's important to distinguish between raising prices for new customers and for existing ones (grandfathering). You don't have to do both simultaneously:

1. Start by changing prices for new customers only.
2. Monitor the results for 1-3 months.
3. Once you're confident in your new pricing, decide whether to raise prices for existing customers.

Grandfathering Considerations

Grandfathering refers to maintaining existing prices for current customers while implementing higher prices for new customers. Here are some points to consider:

• Raising prices on existing customers will likely result in some churn and increased support requests.
• It could potentially damage your brand or reputation if not handled well.
• In most cases, raising prices for all customers is the right move, but it needs to be communicated effectively.
• Give at least 2 months' notice, but no more than 6 months.
• Rob's Rule of 15: If raising prices on existing customers won't grow your MRR by at least 15%, it might not be worth the effort.
• Never promise to grandfather for life, as you may want to raise prices again in the future.

Messaging Your Price Increase

Communicating your price increase effectively is crucial. Here's a structure for price increase messages:

1. Set the stage
2. Announce the pricing change
3. Provide a high-level justification
4. (Optional) Give more specifics about who it impacts and when
5. (Optional) Provide more detailed justification
6. Invite customers to reach out with questions

For a real-world example of effective price increase communication, look at the blog post CartHook used when they raised their prices.

Conclusion

Underpricing is a common issue in the SaaS industry, even affecting tech giants like OpenAI. By understanding the psychology behind undercharging and the benefits of charging more, you can make informed decisions about your pricing strategy.

Remember, pricing is the biggest lever in SaaS. Getting it right can dramatically increase your business's value and success. While raising prices may seem daunting, the potential benefits far outweigh the risks in most cases.

When implementing price increases, be strategic. Consider starting with new customers, communicate clearly with existing customers, and always be prepared to adjust based on the results you see.

By overcoming the fear of charging more and implementing a well-thought-out pricing strategy, you can unlock the true potential of your SaaS business. Don't let underpricing be the silent killer of your great business - take action today to ensure your pricing reflects the true value of your product.

Article created from: https://www.youtube.com/watch?v=isIvsXrk-ow