Even if people haven’t heard of software as a service (SaaS), chances are they’ve used one. That’s what makes SaaS such a dynamo in the world of digital assets.
The SaaS business model relies on ongoing subscriptions for its revenue. Subscribers usually pay to lease software that’s hosted in the cloud. This means there aren’t any physical copies or license agreements, which makes it extremely convenient for customers to access your service.
When done right, investors love the SaaS business model. The ongoing revenue stream makes this business model a potential goldmine and is the primary reason why SaaS businesses tend to get a higher valuation than most other online businesses.
The valuation of a SaaS business is more challenging because there are several moving parts. In our guide on SaaS company valuation models, we’ll provide a comprehensive overview of the valuation method that should be used. We’ll narrow down the focus to pricing models and discuss why they deserve special consideration.
Reasons Why Pricing Models Affect The Valuation of SaaS Business
When you have a product that people need to use, it creates the opening for endless opportunities. Whether that’s business to business (B2B) or business to customer (B2C), the SaaS business model can do it all.
No matter who your customer is, there’s always one thing on the top of their mind: Price.
Justifying the price of the software is often the main pinch point that prevents users from subscribing. This is especially true if your offering is new to the market and you haven’t fully established your brand yet.
That’s where a good SaaS pricing model can help you.
Pricing Can Be a Persuasive Factor
One of the most powerful persuasion tactics is to make it as easy as possible for users to see value in the service you’re offering. Some SaaS businesses provide a “freemium” level to their pricing which allows a restricted level of free use.
Freemium, a portmanteau of the words “free” and “premium”, is a pricing strategy by which a product or service is provided free of charge, but a premium is charged for extra features, services, or online/offline goods that increase the functionality of the free version of the software.
Everybody likes something for free, right? Getting these customers in through the door then makes it easier to upsell them. That’s just one of the many tactics that SaaS companies usually implement to get new users.
Can you see now how pricing is one of the most critical SaaS valuation metrics?
Pricing Affects CAC & CLTV
The combination of good software and effective marketing will start to increase your profit. And, higher net profit is the best way to boost a SaaS business valuation. However, there’s also more to choosing the correct pricing model. Customers like to see that SaaS businesses are operating sustainably.
The pricing model directly contributes to the customer acquisition cost (CAC) and the customer lifetime value (CLTV). Both of these metrics are tremendously important in determining whether your company is prosperous.
CAC is the cost of convincing a potential customer to buy a product or service, while CLTV is a prediction of the net profit attributed to the entire future relationship with a customer.
How To Choose The Right Pricing Model For Your SaaS Business
Keep in mind that price is always tied to the market’s willingness to pay, at all levels – commodity or luxury. Nobody really cares what sales model you need to support in-house or what your costs are, all they care about is what is in it for them. In case you haven’t figured it out yet, this is what you should care about, too.
While it’s possible to change the pricing model after your business starts operating, it’s a lot easier to get it right the first time. Completely changing the pricing model risks alienating the users you already have. The ideal situation is a lower CAC and a higher CLTV. You not only need this to be successful, but it also values your SaaS business at a higher price. These two metrics often go hand in hand.
Even if you aren’t thinking about selling your SaaS company just yet, getting operating procedures implemented as if you were will help you to succeed.
To get through the startup and into the hyper-growth phase, you need users to sign up to become your paid customers. It’s important to get the correct pricing structure in place early on to ensure as many users do that as possible.
No matter what pricing model you choose, you need to find the right balance between value and revenue. That’s because your ability to help users and be fairly compensated for that help will make or break your SaaS business.
If you undercharge, you’ll incapacitate your company with uncompensated development and delivery expenses. Likewise, if you overcharge, you’ll obstruct your growth and repel thousands of potential customers.
Common SaaS Pricing Models
To help you get the most from your SaaS business, let’s take a look at some of the major SaaS pricing models.
1. Per-User Pricing
2. Tiered User Pricing
The numbers of permitted users increase in bands rather than single digits. For example, Confluence offers tier user pricing packages.
3. Usage Tier Pricing
Cloud storage companies often use tiered pricing based on the amount of storage people need. Dropbox is a popular example of this pricing model.
4. Feature-Based Pricing
You differentiate prices in tiers based on the services and upgrades available to customers. For instance, PandaDoc follows this pricing structure.
5. Pay As You Go
You charge customers based on their usage of the service. An example is Amazon Cloud Server’s pricing.
Let’s Fix Your SaaS Pricing Model
Whether you’re tied up in tiered pricing or frustrated by freemium, the pricing models covered in this guide should help you identify the optimum way to market, sell, and grow your SaaS business.
For immediate consultation and advice on effective growth strategies and tactics for your SaaS company, get in touch with Upward Exits. You can also check out our blog on 8 Proven Techniques to Grow SaaS Business.