SaaS Customer Retention is the key to Long-term Profitability

Profitability is one goal that most of the SaaS CEOs who ask me for help all share, and SaaS customer retention is the key to achieving that goal.

Though, while they’re all focused on achieving profitability, how that is measured varies from company to company, for the sake of this post we’ll consider profitability to be achieved once the Customer Acquisition Costs (CAC) have been paid back and the ongoing contribution margin is positive.

So the reality around Customer Churn is that for every customer you lose through attrition, cancellations, or non-renewals – you have to acquire one new customer just to break even… and that’s a tough way to grow!

[Read more…]

SaaS Churn kills Growth; Customer Retention is a Growth Accelerator

SaaS Churn Kills Growth, Profit, and ultimately your SaaS Business… together we can end Retention Deficit Disorder today!

Very often when I’m asked to help grow a Software-as-a-Service (SaaS) business, the CEO is often focused on Customer Acquisition strategies… the “how can we get more people into the top of the funnel?” issue.

But when I start to help a CEO get their SaaS company to profitable growth, I always dig a little deeper to see what’s REALLY going on… beyond what they THINK is happening.

Very often I find that – while ramping customer acquisition is most likely PART of the solution – the company isn’t hitting their proposed growth numbers because they aren’t keeping enough customers.

This means that a lot of their current Customer Acquisition effort (and spend) is being used to simply replace churned-out customers… making it VERY hard to grow at the rate they’d like.

Which is why I say that Customer Churn is the vile enemy of Growth while Customer Retention is a Growth Accelerator. [Read more…]

SaaS Customer Retention Requires Ongoing Realization of Value

Improve SaaS Customer Retention by helping your customers Continually Realize Value

When we buy something without trying it first, this is based on what I call “Perception of Value.”

When we buy something after trying it, this purchase is based on our “Realization of Value” during the trial.

Makes sense, right? But what about Customer Retention?

Well, as it turns out… real, long-term Customer Retention – the kind we’re looking for – is based on the CONTINUAL Realization of Value by your customer.
[Read more…]

SaaS Customer Retention: The Secret to Reducing your Churn Rate

When it comes to SaaS Customer Retention, I get questions like this frequently:

Hi Lincoln, I’d like to hear your perspective on minimizing churn, especially in an industry with steadily declining prices, Adding more value with a better customer experience and more product functionality to mitigate price erosion and churn helps. Better segmentation. What else?

Churn happens for many reasons, but especially when people think your product doesn’t do something they need it to do (especially if they thought it would), if it doesn’t do that thing as easy as it should, or if the experience is incongruent with the price paid.

SaaS Customer Retention: The Seeds of Churn Are Planted Early

Clearly these are just a few of the reasons for Churn… but in many ways, these are the basis for the things you might be more likely to hear or see, like Customer Service problems or post-sale price sensitivity.

So, up-front price sensitivity often results from directly comparing your product to a cheap competitor’s product… when 12 different products seem to be identical, price becomes the main differentiator and the lowest price “wins.” (Does anyone really win the race to the bottom?)

What is really interesting to me is that Increasing Retention (or Reducing Churn) and Converting Prospects into paying customers share many of the same requirements.

It starts with attracting the right crowd and managing expectations properly early in the process.

Improve SaaS Customer Retention by Adding Value Before the Sign-Up

It is easy to say “add value” so you can charge more, but what does that mean?

Where I’ve seen success in “adding value” is in what I call pre-sale or pre-signup Indoctrination.

How you position your product, the sales copy you use, the imagery and social proof, and even what you do to engage with your prospects before they sign-up (webinars, whitepapers, etc.) will all help in that Indoctrination process.

And it will help better prepare your prospects and customers for the post-signup experience, allowing them to become more Engaged – faster – thus leading to a deeper level of Investment and, of course Conversion.

So the goal of pre-sales lead nurturing / Indoctrination is to get them engaged, then get them invested in the product.

Customer Retention / Prospect Conversion are the same in that respect…

Get them and keep them engaged, then get and keep them invested in the product.

And never stop doing that.

You can also leverage some of my ideas and tactics from this other post on Churn Reduction / Customer Retention.

SaaS Customer Retention is a Process

So yes, a great User Experience, managing expectations, Engagement, Investment (time, energy, resources, etc.) are all part of the conversion – and the retention – process.

But the secret to both is having a plan for conversion and revenue expansion.

When someone enters your Free Trial or becomes a lead in any other way, you need to have a specific conversion path that they get on as soon as they sign-up (or hopefully before they sign-up).

Now everything you do should lead them down that path, never letting them fend for themselves or virtually wander around.

Well, the same thing should happen after they become a customer, too… you want to up-sell, move them to a more expensive version or incorporate add-ons into their current plan, etc.

To keep converting customers, expanding revenue, and growing Customer Lifetime Value (CLV) requires a clearly defined path and you should guide your customers down that path in everything you do.

And, of course, if you’re constantly moving them down that path, then you know you’re engaging them and they aren’t a churn threat.

Let’s Optimize your Free Trial Conversion Rate

There is only one of me, so I can only help a limited number of SaaS providers at any one time. But if you’re serious about finally turning your SaaS Free Trial into a customer-acquisition machine, email me with the details of your situation and I’ll get back to you to setup a meeting.

– Lincoln

What’s Your Biggest Challenge in 2012?

I believe in moving forward, not looking back.

So my question as we go into 2012 is this:

What’s Your Biggest Challenge as a SaaS or Web App Vendor in 2012?

Is it making your Free Trials more effective at creating customers? Coming up with the right Pricing? How to handle Competition? Whether to go Freemium? Overall Business Model issues? How to handle Accounting? How to Manage Recurring Revenue? How to keep Churn to a minimum? Or something else?

I’d love to hear from you – whatever the challenge – in the comments below.

Next week I’ll aggregate your comments, responses from those on my mailing list, and insights from Free Trial Dominator members to give you an idea of what your peers consider to be challenges in 2012.

Happy New Year!

– Lincoln
(972) 200-9317

PS: If your challenge in 2012 is how to turn your Free Trial into a Customer-Creating Machine, the solution is to become a Member in my Free Trial Dominator program.

That’s a Paypal link, by the way, but you only need a valid Credit Card to make it work.

And when you join the Free Trial Dominator, you’ll get access to all of this:

  • Core Free Trial Dominator modules
    – Rethinking the ‘Free Trial’
    – Attention Phase
    – Engagement Phase
    – Investment Phase
    – Conversion Phase
  • Free Trial Resources and Tools
  • My Super Ninja Free Trial Tactics
  • Pricing Page Success Formula videos (the full 5-hour series that was priced at $397 by itself!)
  • Master Class on Beta Testing & Pricing (60-minutes / $97 value)
  • Complete Group Coaching Call Archive
  • Private, Members-Only Discussion List where we talk about all-things SaaS & Web App Marketing

PLUS… you’ll get to join us for our Weekly Group Coaching Calls – every Wednesday @ Noon Eastern

Don’t wait… Join the Free Trial Dominator program today!

Freemium isn’t just for “Startups with Nothing to Lose”

A common misconception about Freemium is that it is just for startups with nothing to lose. This myth is perpetuated by many of the Freemium advocates whose backgrounds – and current experience – are limited to early-stage, venture-funded startups. Unfortunately, this misconception really misses the point.

Freemium is a marketing strategy – or quite often a tactic – and used most often to disrupt markets, competitors, etc. So, since when is disrupting markets relegated to startups? It is a bad idea to be focused only on the near-term and to miss the big, longer-term picture because of it.

NOTE: I originally published this paper in late 2010 exclusively for subscribers to my Mailing List. Below is the original paper, published in it’s entirety. I’ve provided updates to the numbers I cited at the bottom of this post.

While startups are often the first to market or the first to try new and risky things when it comes to marketing, if something works – or could be made to work by exploring lessons learned by failed startups – often the larger more established companies will come around. And when they do, that could be a big problem for the early-stage startups whose only real value proposition is that they are free.

No matter how you slice it, to really disrupt a market – the odd vendor that got lucky notwithstanding – requires significant capital regardless of whether Freemium is leveraged as the marketing strategy or not. But isn’t it interesting that for a startup to gain significant market penetration and traction using Freemium within the large markets required for the numbers game to work, it must raise significant capital for infrastructure and customer acquisition? Hmmm. It would seem Freemium is quite expensive for the vendor.

Here are some of the popular case studies in Freemium and how much equity capital they have raised to date (in late 2010):

Evernote $45M
YouSendIt $53M
Box.net $30M
Pandora $56M
Xobni $32M

So, who cares that you have to raise so much money to get a Freemium business to work? You should. The myth is that the built-in virality of the network effect enabled by Freemium is enough. Obviously it is not. Freemium is almost always associated with low Customer Acquisition Costs – CAC – through word of mouth, viral and game mechanics, social networking, etc. On top of that, with open source stacks and cloud infrastructure the cost – as you often hear – to support a free user is “near zero?” But support costs are just one expense usually not added to the actual CAC even though “near zero” support costs in aggregate at scale often result in something with “near many zeros.”

As was shown in the original “The Reality of Freemium in SaaS” the CAC metric must take into account all of the expenses required to land a paying customer. The true definition of CAC is the aggregate costs associated with discovering, reaching and getting the attention of a potential customer, getting them to your site or calling on them, converting them to a user, serving them (marketing, technology, human services) during the non-paying period, and then converting them to a paying customer.

In a Freemium scenario, you will have on average 97 free users for every 3 paying customers. If you have 10,000 users in the system, on average, 300 will be paying customers. That means, the aggregate CAC for each of those 300 is not what it costs only to attract and convert each of those 300, but what it also costs to attract and support the other 9,700 users while they wait to become customers. And of course, none of this is static so the 9,700 at a given time could include any number that churned out over time.

Some have argued that if you know 95% of your users will never convert then they aren’t customers and should not be figured into the CAC. Whatever it takes to justify your position, do what you will, but know that if you spent $100 on AdWords and got 100 people to come to the site, and converted 3, it was not a CAC of $3… it was a CAC of $100, or just about $33/customer. You have to get real.

If you are in a very small niche where you provide a significant amount of value to your business customers, Freemium should probably be the furthest thing from your mind. There are so many very targeted methods of reaching your customers in ways that add value and raise the value perception of your offering that you don’t need to worry about brand building or market making. Just tell people how you’ll solve their problems or help them take care of new opportunities, charge them for the privilege, and you will likely have a great deal of success.

In large, horizontal markets – especially in B2B – much of the cost associated with Freemium at a large scale is in market-making and brand building. That is, orchestrating the “organic” viral campaigns, greasing the palms of pundits, traditional PR… wait? What? None of that sounds like the Freemium we all know and love, right? The build it, make it free, and let the product sell itself. Yeah, that doesn’t work.

Even if the only costs associated with customer acquisition are the result of directly pulling in users and converting them to paying customers, few companies will look at the CAC correctly – at best forgetting to figure in “user acquisition,” too. But we know – as previously mentioned – the bulk of the expense is not in the highly-targed direct acquisition – a Google AdWords campaign – of Users or Customers.

No, for most, the cost is from the indirect acquisition methods (i.e brand building, PR, market making, etc.) and that is harder to keep in check. In fact, it is too often not calculated properly in the actual CAC and is relegated to other marketing, S&OP, etc. expenses.

How does the specific issue of Customer Acquisition Cost tie to whether Freemium is only for startups with nothing to lose or not? Well, its simple really. The problem with the way most companies leverage Freemium is that CAC goes UP simply because of the way they use it. They emphasize the FREE version rather than the PAID version in order to get “traction.” This simple marketing decision can be the death of a company or the point at which they thrive. No one ever said you MUST go through the free version to get to the paid version.

Yet, most startups are looking to get “traction” and are therefore pushing to get as many free users in the door as possible. Established companies used to generating revenue will be more likely to use Freemium as the marketing method it is but push heavily, from the moment the would-be customer lands on their website, the premium version. Free was what got you to the site, but the value of the premium product is what will get you to stay and pay.

SocialText – founded in 2002, $19M in VC funding over 6 rounds – hardly a startup – is an example of a company that has created a Free version of their service but is not putting all their eggs in the Freemium basket. For instance, they do not emphasize the Free version on their pricing page. In fact, it is not found on their pricing page at all but is instead a special program they have created to be leveraged in other ways.

SocialText can be considered Freemium, and will use that to get traffic to their site, but will de-emphasize the Free tier outside of those specific marketing campaigns. That is – if you come to the SocialText marketing website directly and not via a search for Free or Freemium or not through their carefully orchestrated campaign, Freemium landing pages, etc. then you will not be presented with that opportunity.

But is SocialText really benefitting from Freemium in the way that their competitor Yammer (founded 2008/$15M funding) is? Are they getting the press, the traction, etc. associated with Freemium in the way that Yammer is? It is hard to tell without any level of transparency, but the answer would seem to be no. So in SocialText’s de-emphasizing of Freemium, they are likely not seeing the same level of “traction” that Yammer is. The big question is then – is that a problem?

SocialText by all accounts has a thriving Premium offering and perhaps they are using Freemium to win over customers who bring up Yammer in sales calls. Perhaps it is something more. The interesting thing here is that they HAVE a Freemium offering and could be waiting to unleash it on the market. Yammer – who claims penetration in “80% of Fortune 100” companies as of October 2010 – has an interesting Freemium strategy that will be covered in a separate article.

So, while Freemium startups are out trying to make noise and get the market or industry to notice them, incumbents can leverage the same Freemium tactics of market penetration as the new kids on the block, but without the need to build a brand from scratch. Whereas Freemium startups think they’ll come in and disrupt the status quo with Free and knock the stodgy old-school monoliths off their pedestal, some are being beaten at their own game. Guess what? If Free is your only claim to fame, that is all you’ll get – fame – as you enter the deadpool.

Yes, large established companies are slower to pull the trigger on things like Freemium – many will never attempt it – but for others this “slow and steady wins the race” mentality is because they want to fully think it through. They need to fully understand what happens if it the strategy fails. How will it affect their market position, the brand value, etc. What happens if it is successful? How will it affect their market position, the brand value, etc. There is a very real issue around protecting their brand from the potential of “free = zero value.”

Wherever possible, established companies will look to existing products or services that they’ve already invested in the development or acquisition of but that are new or have yet to establish a strong market presence to experiment with Freemium. Due to the inherent risks of Freemium, this is a great way for a company to try Freemium without damaging an established product line, brand, etc. If you are a startup or are in a market where larger competitors have acquired smaller companies or if you know companies have invested in IP that directly competes with your Freemium offering but they have not yet begun to market it, that should be considered a direct threat.

There are many pitfalls that established vendors will want to overcome, but when they do figure it out, look out. If you see an established company leveraging Freemium, it is likely that they have figured out a specific opportunity to go after, a market segment adjacent to their current position that they want to penetrate, or they might just want to stop competitors in their tracks. And as established brands with a lot of money in the bank, they might just be able to do that.

Amazon Web Services (AWS) would hardly be considered a “startup with nothing to lose” but they recently “went Freemium.” This is a perfect example of a company that is very successful – not a startup – deciding to use “Free” to disrupt their competition and gain even more new market share. While the bulk of the noise in the industry was around their 1-year free trial for their core services – EC2, S3, EBS, ELB – the real news was around a real Freemium offering for their proprietary ancillary services like Queueing, Notifications, and Non-Relational Datastore.

Those services are unique to Amazon and once you are using them – which requires deep integration into your application – you are effectively locked-into AWS at some level. You can always move your app from EC2 to your own data center, you can move your objects from S3 to another file host, but the *services* that AWS provides in those ancillary offerings you cannot (easily) move. Brilliant and very disruptive to other “cloud computing” players.

Another great example of a successful and established company “going Freemium” is Mailchimp. It is true, many people think of Mailchimp as an overnight success since Freemium did its job – it got them noticed. However, the company has been around since 2001 and did not get into Freemium until they had been a successful company for nine years. Mailchimp was looking for a boost – a way to disrupt the status quo in the email marketing industry and knock the leaders down a peg or two. Freemium was the method they chose.

The key to the success of Mailchimp’s Freemium strategy was the fact that they had so much time in-market that they could anticipate and plan for the additional support burden – and system abuse – associated with a surge in free users of an email marketing system. Where they didn’t or couldn’t anticipate challenges, it was that time in-market and experience that allowed them to roll with the punches and make adjustments along the way to make Freemium work.

Startups should take note of that – the additional support and ABUSE that free users would bring was the major challenge with Freemium for Mailchimp. This is where existing companies will have an edge over startups in Freemium – they know what the early-stage companies don’t yet understand. For young companies hanging their hat on Freemium, they need to be very aware of this threat.

UPDATES

Since I published this in late 2010, some things have changed…

My suggestion to any SaaS or Web App company considering Freemium is simple: Make sure you’re targeting a large enough market that would actually want to use your product (B2B or B2C) and then seek out Venture Capital firms that have funded OTHER successful Freemium ventures.

Don’t try to do it on your own, bootstrapped. Freemium requires MASSIVE AMOUNTS OF MONEY and a large enough audience. Without both, Freemium is unlikely to work for you.

Classical Freemium Doesn’t Exist At Scale

“Classical Freemium” is the marketing tactic where a SaaS or Web App vendor offers a Free-in-Perpetuity version of a product or service, often feature- or usage-limited, as well as a version of the same product or service with less limitations to which the vendor will attempt to up-sell the user.

NOTE:  I originally published this paper in late 2010 exclusively for subscribers to my Mailing List. Below is the original paper, published in it’s entirety. I’ve provided updates to the numbers I cited at the bottom of this post.

This form of Freemium is actually on the decline as the primary go-to-market method for a number of valid reasons. Aside from the notion of the “Penny Gap” being a very real idea – the idea that trying to charge people *anything*, even a penny, for what they already get for free is a major hurdle – other realities are becoming apparent.

The concept of “near zero” support costs have been found to be “near untrue,” most find it difficult to justify and continue to support a 3-5% conversion rate, and most are realizing what Freemium really is – a marketing tactic and not a business model. Freemium is evolving, however, so there are other types of Freemium that are on the rise which will be covered in a separate article.

There is yet another reason Classical Freemium as the only method of customer acquisition is falling out of favor; many SaaS and Web App companies are realizing that the true motivation behind the Freemium companies they look up to has little to do with revenue generation by converting free users to paid subscribers and everything to do with building a user base as fast as possible without consideration for a sustainable monetization strategies. These companies are instead looking to make money through M&A or IPO activity. If they stumble into a way to make money along the way, great, but that is not the primary motivation. Twitter is a great example of this.

Twitter is a company that continues to raise money ($160M in disclosed VC funding through 5 rounds to date) and spend money to acquire more and more users but still lacks a fully defined monetization strategy. But they are changing the world so we can forgive that, right? The motivation is clearly not to generate revenue but to gain traction and grow the user base. Twitter continues to experiment with different ways to make money such as selling the tweet “firehouse” to Google, Bing, and through data aggregation providers like gnip, or promoted tweets which reportedly pull in $100k a pop, and the recently announced analytics which may or may not be a revenue source.

None of these, however, have emerged as the revenue model they’ll hang the future of the business on. Also of note; all of the revenue streams they have attempted to tap required the critical mass they had already achieved by having a 100% free service. Without the massive funding – and perfect timing and luck – required to get Twitter to the point it is in terms of “market penetration,” the monetization methods they are exploring would not be viable in the first place.

The founders of Twitter have likely already made millions of dollars through private stock sales and the company will likely be able to acquire several additional funding rounds as needed to ensure they stay around long enough to be acquired for billions. In other words, there is a very good chance the founders of Twitter will have built the company and made hundreds of millions for themselves and their investors all while having generated little actual revenue – let alone profit – along the way. Is this bad business? Certainly not. If you are building a business to generate revenue is it a model you will want to copy? Probably not. Twitter has used a risky strategy, to say the least and while it might seem counter intuitive, Twitter is successful probably because there was not a strategy there in the first place; you just couldn’t plan for what they’ve done.

Using Twitter as an example is a double-edged sword since it is an anomaly and difficult to categorize as B2B or B2C. But Twitter is such a pervasive technology service in today’s world that it is a great company to examine from the perspective of Freemium. But if you have a niche or vertical B2B SaaS or Web App, is Twitter really an appropriate analog? Obviously not. But it is a great example of a company being built around Free with little motivation to generate revenue or create profit. It is this piece of the puzzle that could be missing when companies look to Freemium as the go-to marketing method; they don’t fully understand the real motivations behind many of the companies employing Freemium. This is why it very important to know that Classical Freemium does not exist at scale!

You need to know that few companies are able to build a real, sustainable business off of the 3% conversions that most Freemium companies see. Evernote seems to be one of the few, but they are in a great position to play the numbers game required by Freemium. First, they aren’t B2B only; business customers can use the service, but so can anyone else. In fact, Evernote is one of the few companies to say – and mean – that anyone with an Internet-connected device is a potential user / customer. Most companies being honest with themselves cannot say that. So in the B2B world, building a sustainable business off of 3% conversions just doesn’t happen.

Freemium is a marketing method for getting users, for sure. But it is also a marketing method for getting a foot in the door, generating buzz or brand awareness, entering more price-sensitive market segments, or disrupting competitors. These are the scenarios where Freemium is going to flourish in the coming years for most business that leverage it. Few will be pure-play Classical Freemium and have any real success. To date, no B2B company has built and scaled a business through pure-play Classical Freemium – that is, one product line that has a free-in-perpetuity component and one or more premium versions of the same product for the same market segment.

All companies at some point must start generating revenue to remain viable. For many Freemium companies this occurs after they’ve reached some level of scale and either have new investors to answer to (especially post-IPO) or have otherwise reached a critical mass of adoption and now can begin to generate revenue. The thing to take note of is that many companies do not rely on converting free users to paying subscribers but instead rely on other revenue streams than premium versions of the free subscriptions to monetize.

You must have a clear path to monetization regardless of whether you will use Freemium or not and if you do choose it, you must do so on the applicability to your goals, your market, etc. and not because another company is doing it “successfully.” It is necessary to really and fully understand how so-called “Freemium companies” evolve over time.

If you are considering using Freemium as your go-to-market strategy, you must understand this before you choose to employ Freemium in your company. You cannot build your business based on what you see on the outside of these other “Freemium companies”. You don’t know what is going on behind closed doors. From first hand experience, anecdotal accounts, and publicly-disclosed accounts, it is clear that its not what you think!

Freemium seems to work best when the goal is simply to get people into the system and not as part of a monetization or sales strategy. If you create a free product for people to use and not as part of a sales process or what appears to be a free trial with no expiration – Freemium seems to work well. But what does it work well for? Getting users. Not generating revenue. However, if it is obvious that the free product is simply a free trial with no expiration or is limited in ways that ultimately makes it unusable without paying, it will fail to gain traction meaning it won’t even help you get users. People aren’t that stupid.

This is why the most successful and profitable methods of monetization right now in B2C revolve around an entirely free product with monetization through credits, virtual currency, product sales, or add-ons; think Facebook or Zynga. This is why over one-third of the top grossing iPhone apps are are Free, but offer in-app purchases for add-ons (additional levels, characters, chapters, etc.).

Back in the B2B world, we can look to a company like Helpstream, founded in 2004 and having raised just under $10M in VC funding as an example of a company where Classical Freemium failed and took the company with it in early 2010. While it is terrible that they failed, some transparency by the former CEO, Bob Warfield, helped shed some light on what happened. The main takeaway from Warfield’s post mortem was that Helpstream didn’t attract the right kind of users; the kind of users that would convert to paying customers. He said they were able to get 200 free users and convert 5 of those to paying customers; a conversion rate of 2.5% – just under the standard 3% conversion rate.

The biggest problem it would seem based on Warfield’s post is that they simply didn’t have enough traction to make the numbers game work. 200 users is simply not enough. Consider the numbers game here – they would have needed 100x the amount of free users they had to get just 500 paying customers if the conversion rate held. We don’t know what number of customers would have resulted in a sustainable business for the company, though.

The real tragedy with Helpstream seems to be that they didn’t make Warfield CEO earlier. His ideas about market segmentation, having the Freemium version be only for smaller businesses by putting upper limits on it (50 users in their case), and having only a free trial for larger businesses – those who are more likely to become customers anyway seem to be spot-on all things considered. Unfortunately this realization – the realization that basing their entire business on Classical Freemium was a recipe for failure – was just too little, too late; they had already ran out of money!

What is frightening interesting is that some companies are actually developing their pricing and building their business around a goal of 3-5% conversions. A fascinating post from Hootsuite – a builder of social networking tools for B2B marketers with just under $4M in VC funding – where they claim to want to build a business off of 5% conversions are hopefully putting up a smokescreen to the real revenue streams at scale. This quote is from a post clarifying their pricing after they initially released pricing that did not sit well with their customers:

“To determine the pricing levels, we analyzed data from active customers to ensure that 95% of current users would remain free based on current patterns”

Without deviating from the point of this article too much, only looking at usage data to determine pricing is not ideal. It speaks volumes when a company justifies its pricing decision based on data analysis to its users who are upset by the pricing announcement / change. Clearly, the company is not listening to what its users and customers want, but is instead looking at data that doesn’t tell the whole story to find the answers. In this case, they are using data to back into a Freemium Strategy and Pricing Model where 5% of their users will want or need to pay to use the service? Best of luck to them, but this seems like a very bad idea.

What Hootsuite seems to be failing to realize is that companies leveraging Freemium that have a 3-5% conversion rate from free to paid are not happy with that. They want higher conversions, it just seems to be that the nature of Free and the Penny Gap keep that from happening. Some do achieve higher than 3-5% and that should be the goal. Backing into a pricing strategy with a specific conversion rate in mind is a bad idea – and severely limiting. This is why pure-play Classical Freemium does not exist at scale in B2B SaaS; no B2B SaaS company actually sets out to build a system where 97% of the users of their system do not pay.

It would seem that Hootsuite might be falling into the trap of building a business around a marketing strategy employed by those that have no real interest in revenue generation on the product for which they’ve used Freemium. It must be noted Hootsuite has begun to use market segmentation within their marketing website and pricing and Freemium strategy by offering regular customer and Enterprise customers different options. Perhaps they quickly saw the err of their ways.

Here’s the dirty little secret about externally-funded Freemium companies and you must understand this. Most are not out to generate revenue – only grow the user base. Generating revenue and growing a free user base are two very different things and in many cases, doing both well is very difficult in B2B SaaS. For most companies using Free or Freemium, it is as a way to get a large number of users and build an audience. Many of these companies have no intention of getting money from those users – ever. This is so critical for bootstrapped companies or those with just a little external funding. Freemium is a Marketing Strategy used to get a lot of users fast – “hyper scale” as some people have put it. if you don’t have the money to support hyper scaling of a huge free user base, you should not attempt Freemium.

This is hard for the bootstrapped startups with a couple of founders simply looking to replace their corporate income with a SaaS or Web App to wrap their heads around. Why would you do something in your business that is not going to immediately result in revenue – even if it is only 5% of those people that pay? For the founders of companies employing a strategy that does not include revenue generation they will make money in other ways – ways that might even be counter to the longevity of the business as a stand-alone entity.

There is often a tipping point where you start to see products being more aligned with market segments, different versions being created specifically for revenue generation, you might see acquisitions of smaller-yet-profitable businesses, etc. Generating revenue is very different than acquiring users. Many of the entrepreneurs standing behind Freemium made their money not from revenue generated by the services they worked for but by the sale of those companies or the IPO. Is this a bad thing? No… its great and we should all be so lucky. But it speaks to the underlying fact that Freemium is not about revenue generation as much as interest generation by others – acquirers, investors, or an ecosystem.

Now the latter of those three – ecosystem – is very exciting and a very real, sustainable, viable and profitable business can be built around that – M&A or IPO be damned. But do not for one second forget that it takes a substantial amount of funding to get to this point. All of this comes down to the fact that Freemium is itself not just one thing. There are five types of Freemium in use today (covered in a separate article) and the type of Freemium to employ must be based on many factors, including the time-line to reach goals. Freemium strategies are either short- or long-term.

Short-term Freemium strategies are used for market disruption, to get a foot in the door, crush an upstart competitor, etc. and is often used on existing product lines or new alternative products (as detailed in the original “The Reality of Freemium in SaaS” under Alternative Product Strategies). Long-term Freemium strategies are employed by those businesses built from the ground-up to leverage this pervasive go-to-market strategy and is where the idea that Freemium is a “business model” comes from. These companies basically put all their eggs in the Freemium basket and if it doesn’t work, it often leads to complete failure.

For short-term strategies, monetization occurs through more traditional methods often using the free version as a foot in the door for a brand to up- or cross-sell to more established products to new customers, market segments, etc. Aside from M&A or IPO as the method of “making money”, long-term Freemium strategies are designed to monetize in ways only possible at scale by tapping into the network effect, ecosystem, or ancillary revenue streams made possible only after “critical mass” (which is relative) is achieved.

Consider companies that build an audience and monetize through ads – critical mass occurs when they have enough eyeballs to get the advertisers attention. For some companies, like Spiceworks (founded in 2006 with $29M in funding so far), they’ve been able to monetize not only the eyeballs of their 1.2 million users, but the activity of those users by selling network effect data to the advertisers.

Spiceworks has 1.2 million free users, but only around 200 customers – the advertisers – and is a perfect example of the notion “if you aren’t paying for the product, you aren’t a customer, you are the product.” Over time, Spiceworks – who is really in the advertising business not the IT management business – has used network effects generated by their 1.2 million users to add more value to the offering for advertisers. Spiceworks is technically Freemium since users can pay a monthly fee to turn off the ads, but this is not promoted as they see advertising – not subscriptions – as their primary and most scalable revenue stream. Again, Classical Freemium is not present in a company many consider to be one of the most successful B2B “Freemium companies” around.

Evernote is another example of a company building a big enough audience to get the attention of those that will pay to have access to that service in other ways. Evernote has been the poster-child for Freemium over the last few years and while they are not an analog for most B2B SaaS companies, it is definitely an interesting study in how to leverage engagement or “investment” in your product to produce conversions. We should all be thankful to CEO of Evernote Phil Libin’s frank and open discussions of Evernote’s growth and even revenue. Evernote, founded in 2005 and having raised $45.5 Million over 3 VC rounds, worked hard to build an immense user base. Libin has shared that many users and customers alike access the Evernote service from multiple devices, therefore as the service grows, makers of devices that could access Evernote are taking note.

As of May 2010, the poster-child for Freemium was making $500k per year – a not-insignificant amount – from licensing (the ecosystem revenue stream) by mobile carriers and device manufacturers to pre-load the Evernote app for their customers. Carriers and device manufacturers want to attract the attention of the vast – and dedicated – user and customer base of Evernote to sell more devices or network access.

If Evernote had charged for access to their service from day one, not only would they not have reached the scale they have and arguably the amount of subscription revenue due to the aforementioned engagement-based conversions, the reduced scale would not have attracted the attention of those that want to buy access to – in the form of licensing – that user base. Evernote clearly has a long-term Freemium strategy that employs Classical Freemium, but they are not pure-play Classical Freemium since they also employ other revenue streams. Also remember that it takes millions of dollars – $45.5 million so far – to get to this point.

The moral of this story is – for the companies that saw success from a revenue standpoint with Classical Freemium, that success was achieved by raising a lot of money and using that to build a large base of free users. Once they reached a certain level of scale, they had to branch out – or finally could branch out – to other, more lucrative revenue streams. When we can literally point to just a handful of “successful” Freemium companies with few of those employing pure-play Classical Freemium at scale or even in a very long time, it is at best difficult to consider Freemium a successful “Business Model.” For some heavily-funded narrowband horizontal SaaS companies, Freemium and Free have been the key to gaining critical mass before employing monetization strategies outside the scope of Classical Freemium.

UPDATES

Since I published this in late 2010, some things have changed…

The SECRET to $1M ARR in 6 Months is 9 Customers

It’s easier than you think to get to $1M in annual revenue with your SaaS app.

The Million Dollar Secret for SaaS and Web Apps

To have a $1,000,000 per year run rate, you need to bring in $2740 per day… roughly.

Pardon me if my math is off a bit… this is just one of those posts to get you thinking… your mileage will vary!

I prefer to plan from the bottom up most of the time, especially when looking to employ a short-term strategy and the tactics to execute on that strategy.

Bottom-up in this case simply means we figure out a goal for the business… let’s say $1M in annual recurring revenue… and figure out what it would take to get there.

Rather than the top-down approach of saying there are 12 Billion people in that country and if we could just get 1% of the market we’d have a $7 Trillion business.

So, for our goal today we’ll set it at $1M in Annual Recurring Revenue (ARR). I know… a Million isn’t as cool as a Billion anymore (thanks Hollywood’s version of Facebook) but its better than a slap in the face.

Even cooler than a slap in the face, is that getting to $1M ARR isn’t as daunting as it might seem initially.

First of all, the cool thing is you don’t have to sell $1,000,000 worth of subscriptions, only $83,000!

Yep, because it is monthly RECURRING – or continuity – revenue, you only need to get to $83,000 in monthly recurring revenue to equal $1M ARR!

Once you reach $83k/mo in recurring revenue, the next 12 months will equal $1M without making another sale!

And this is clearly without figuring in churn, expansion revenue, etc.

Okay, so $83k in sales is a lot less daunting than $1M, isn’t it?

So what would it take for your company to get to $83k in monthly recurring revenue (MRR)?

If you have $50 Average Revenue Per Customer (ARPC) then you need to get 1660 customers on board.

Hmmm… 1660 might seem like a lot of customers if you are just starting out and in a smaller B2B niche.

So this is where you ask yourself the very real and pointed question of “are there actually 1660 customers in my target market that I can land?”

If you want to build a $1M/year business, you need to have a market that will support you at the price you’ve chosen.

If that isn’t the case, find a bigger market (segment) or work to increase the perceived value of your offering so you can charge more.

But, if you set a goal to reach $83k in MRR in 6 months (180 days), then that would only be 9 new customers per day for the next 6 months.

WOW!

Seriously, only 9 new customers per day for the next 6 months will get you to $1M in annual sales!

Just 9…

That is pretty cool, and would seem to be totally realistic… that is of course with zero context about your business/market here.

These numbers are for illustrative purposes only, cool?

Now… here’s a secret that will speed things up for you if you use a Free Trial.

Convert customers faster and at a higher-price!

Uh, okay… but how? Well, here’s an example.

For the first 6 months, give everyone that signs-up for a Free Trial a crazy-awesome deal – call it an “introductory” offer or something and do it behind the scenes (not on your public Pricing Page).

But the catch is that the special isn’t a discount on the entry-level bundle or even the bundle they selected when they signed-up for the trial… it is for the next level up in price – or even an unadvertised bundle.

This way you aren’t lowering the price on the version that they were going to buy! This is main part of the secret.

So if we go with the example price of $50, and the next level up is the $99 plan, then you’d offer say a 40% off deal on the $99 plan, which would be $59/mo.

This would ONLY be a $9/mo bump from where they were GOING TO sign-up, but that is an extra $108/year for you.

Clearly the deal has to be presented properly with a clear value proposition… but you get the picture.

Now here’s the great part… while you’d need 1660 customers to reach $83k/mo at $50/mo ARPC, at $59/mo ARPC you’d only need 1407 customers… 253 LESS customers needed to reach your goal!

Instead of 9 customers per day, you’d only need 8.

That means you need less traffic to your site, which takes some of the burden off of your traffic-generating resources and reduces some of the customer acquisition expense.

OR…

You could get the same number of customers and simply get to $83k/MRR or $1M/ARR that much faster… in this example it would be nearly a month faster to get to a $1,000,000 ARR!

Of course not everyone will take you up on the offer, and a more realistic option might be to only offer the upgrade temporarily and/or to limit it to 6-months, but this exercise is simply meant to get you thinking.

But I hope you see why this is so important to consider!

Either way, 8 or 9 new customers, that is all you need each day for the next 6 months to get to $1,000,000 in Annual Recurring Revenue.

Pretty cool, huh?

Let’s Grow Your SaaS Business

For immediate consultation and advice on optimizing your growth strategy, schedule a 60-minute meeting with me via Clarity. If you feel a more involved engagement is required for me to help you, email me with the specifics of your situation (as much detail as you’re comfortable giving) and we’ll setup a meeting to work through the particulars.

– Lincoln

There are 7 Types of Freemium and Why That Matters…

There are 7 Types of Freemium and Why That MattersYou think you know Freemium in SaaS? Think again!

In 2009 I released the version of “The Reality of Freemium in SaaS” PDF and since then the “Freemium” landscape in SaaS has continued to evolve rapidly.

Freemium use in B2B technology / software / SaaS / Web Apps / Cloud (whatever) is evolving and I wanted to take note of where we are at today… where we’ll be tomorrow I can’t tell you, but I guarantee it will be different.

I wanted to also call attention to the fact that the use of “Classical Freemium” – the idea of a free version of a premium product – is losing popularity as the go-to method for adopting Freemium, with other types of Freemium coming into play.

This is with both pure-play startups and established companies moving to Freemium.

I’ve made a list of the 7 different types of Freemium below, but this isn’t meant to be an exhaustive list… if you have other ideas, please share them in the comments.

Further, few companies will tell you they conform to any of these, which is great… they shouldn’t be trying to conform to these “types” but instead do what is best for their market, users, customers and their company.

I even had a hard time deciding where to put certain companies – like Evernote and SolarWinds – because they don’t nicely fit in one “type”. But I don’t think that makes these “types” any less relevant.

In fact, many of these “types” of Freemium aren’t exclusive within a single company. The most successful models use a hybrid approach, for instance using the Freeware 2.0 & Ecosystem models together.

What I’ve tried to do here – more than anything – is indicate that there isn’t just one way of doing “Freemium” and maybe to a larger extent show the term “Freemium” is used even when there isn’t a clear Free > Premium path.

Pretty much, if there is a “free” component to a marketing strategy these days, it is called “Freemium.”

Where most companies go wrong is when they confuse “Free Trials” with “Freemium.” If you think Freemium is just an extended “try before you buy”… you’re in for a serious rude awakening.

There are MASSIVE psychological differences between “Free Trials” and “Freemium” that you need to understand. But for now, just understand what I am listing here are “Freemium” and not “Free Trials” and that confusing the two will cause massive issues and probably not give you the results you’re looking for.

The 7 Types of Freemium

1. Traditional/Classical Freemium

  • Free-forever feature-limited-but-usable version of a premium product
  • The one that started it all
  • The one that most people know
  • The one with the major penny-gap issues
  • Expectations that most users will never buy – by both the vendor AND user

Examples: OfficeDrop, Dropbox, LogMeIn
Notes: Read “Classical Freemium Doesn’t Exist at Scale” where I tell you why this type of Freemium rarely exists beyond early-stage (and heavily-funded) startups.

2. Land & Expand

  • The up-and-coming model
  • Free to acquire by users
  • Monetization at organization level
  • Adopters & Users are often kept out of buying process
  • Where the user & buyer are the same, the model uses a lock-in model to gain a foothold within an organization
  • Expectation by vendor is after x users in an org, they’ll pay

Examples: Yammer (Acquired by Microsoft in 2012 or $1.2B), Xobni, Amazon Web Services
Notes: Yammer is the most successful example of this model within pure-play Freemium organizations. Xobni uses this model to push their Enterprise-focused products. AWS uses this model a bit differently, offering their proprietary technologies as Freemium in an effort to get companies to invest in integration and thus make switching costs too high.

3. Unlimited “Free Trial”

  • Not really a “Free Trial” – the vendor likely doesn’t understand the true dynamics of Freemium (which will likely come back to haunt them)
  • Free-forever feature/usage/UX-crippled version of a premium product
  • Expectations by vendor are that they user will convert/upgrade
  • Expectations by user is continued-forever use for free
  • This seems like a risky type of Freemium to adopt since it is mixing the elements of a Free Trial with the psychological aspects of Freemium.

Examples: Echosign, Basecamp
Notes: WHAT? Basecamp is an Unlimited Free Trial? But they’re Freemium. Or maybe you said ” Yeah, they’re ‘Freemium’ but they hide their free plan.” Whatever… the idea is that their Free plan is so limited it just doesn’t make sense to even use it, and as Jason Fried has said many times, most of their paying customers STARTED as paying customers. Think about that for a second.

Now go back to the idea of why you would even have a FREE plan if you can just have a FREE TRIAL when you know MOST of your customers – those who pay – start out paying. I’m not even sure why they keep the free plan around except to appease those who would rip them to shreds on the interwebs if they ever got rid of it.

As for Echosign and others that have a very low usage-cap on their Freemium plan, this can work or it can cause work-arounds. You have to be very careful how you design your app and in-app marketing experience to draw users in and get them to use the product, selling them the whole way so when they hit that usage gap they’re ready to convert to paying today… rather than trying to game the system or put off some signatures for a few days to get into the next “billing cycle”…

4. Freeware 2.0

  • Free-forever, fully-functional product
  • This is their main product or a completely new stand-alone product line within a larger organization
  • No expectations of  conversion/cross-sell by MOST free users
  • Monetization is through add-ons for the free product created by the company itself

Examples: Evernote, Skype, AVG
Notes: I know someone will say Skype or Evernote are Freemium, not Freeware… and they are. All of these are examples of Freemium. I’m breaking down the different types of Freemium here. And why I say Evernote, for example, is Freeware 2.0 is that is 100% usable for free, forever, and the expectation – as noted by CEO Phil Libin – is that most people won’t pay.

Same goes for Skype.

When they do pay they are paying for extra storage and additional features/add-ons, but the base product is good-enough that few people percentage-wise will pay. Virus software, screen-sharing, video chat, etc. are also sectors made up of Freeware 2.0 plays.

5. Alternative Product Strategy

  • Similar to Freeware 2.0, but from a company with an existing premium product-line of which this is a discrete subset.
  • A Free-forever product with no direct up-sell path to “premium” version
  • Often used as a foot-in-the-door strategy
  • Goal is to cross-sell other offerings from the company

Examples: Autodesk’s SketchBook Pro for iPad, join.me (a product of LogMeIn), SolarWinds
Notes: This is actually where many SaaS / Web App vendors are turning to Mobile apps for a distribution channel to new customers. Make sure you watch my interview with Healy Jones from OfficeDrop about their experiences extending their Web App with Mobile apps and how they were basically forced to go Freemium. This can be awesome, but it can also have unexpected consequences.

I also wrote extensively about Alternative Product Strategy in my 2009 work “The Reality of Freemium in SaaS” (PDF) which you can download for free.

6. Ecosystem

  • Free-forever base product
  • Monetization occurs through revenue share with 3rd parties, like add-ons by 3rd party developers

Examples: iTunes, Google Apps, many commercial open source vendors leverage this plus professional services for monetization
Notes: I mentioned iTunes because the software is free creating the base-platform which you can use forever to manage your own music without ever giving Apple a dime. Monetization occurs via a marketplace rev-share with 3rd party content creators. I didn’t mention the Apple AppStore because the base product – an iOS or MacOS device – is not free. Make sense?
Google Apps has a premium version, but monetization around the free version occurs through its ecosystem play.

7. Network Effect

  • Monetize eyeballs, aggregate behavioral data, etc.
  • This is the idea – to whom I cannot find original attribution – that if you aren’t paying for the product, then you ARE the product. Or you’re creating the product through your use of the system.

Examples: Wave, Spiceworks, Google (advertising), Mint.com (revenue share from offers)
Notes: Spiceworks currently has 1.6M users, but only really has around 200 customers… those customers are the advertisers!

For immediate consultation and advice on leveraging Freemium in your SaaS business, schedule a 60-minute meeting with me via Clarity. If you feel a more involved engagement is required for me to help you, email me with the specifics of your situation (as much detail as you’re comfortable giving) and we’ll setup a meeting to work through the particulars.

– Lincoln

SaaS Business Model Resource Guide

I put together this list of my BEST SaaS Business Model & Architecture resources just for you. I hope it helps!

If you’re curious how I help SaaS and Web App vendors grow their businesses – and how I can help you grow yours – you can learn more and contact me here.

SaaS Pricing Model: Value Metrics Are Key

Your SaaS Pricing Model should be built around what the customer values, which probably means staying away from “commodity” metrics like storage.

I find most articles about “SaaS Pricing Model” to be less-than-helpful because they almost always fail to take into consideration the WIIFT of the customer – the What’s In It For Them.

Most articles usually talk about connecting pricing with the sales model rather than the value perception of the market – a potentially costly mistake. People who try to correlate specific price to distribution methods / sales models with few or no other inputs are making a big mistake.

Your SaaS Pricing Model Starts with the Customer

Price is always tied to the market’s willingness to pay, at all levels, commodity or luxury. Nobody cares what sales model you need to support internally, nobody cares what your costs are, all they care about is what is in it for them. In case you haven’t figure it out yet, this is what you should care about, too.

For SaaS, Web Apps or other information services with mostly front-loaded manufacturing costs, price is tied more than anything to how you market and position your product/service, since that will dictate value perception and willingness to pay.

This is in contrast to physical goods where supply and demand can affect the price or where manufacturing & distribution add significant cost to each order. I’m talking about SaaS here, not truck tires.

The key to pricing is simple: the better you understand your market the easier it will be to create an offering that they perceive to be high value, meaning more revenue and profit for you.

But understanding your market is hard, it takes work, effort, some thought, etc. So you might as well just pull a number out of thin air (or somewhere else), multiply x 3 (as they say, its easier to lower, than raise prices), and hope for the best, right? You’ll need a strong table to hold all that money you’re leaving on it!

The fact is, the price , or price ranges, for tiers / bundles is not often the issue when our clients come to us; well, not the first issue. For many, it is the pricing metrics that are used that is the real issue and once that problem is fixed, it usually renders the first problem irrelevant. Pricing metrics are those little things we base our prices on – and ultimately our entire business – all of us, even us consultant types.

The de facto standard pricing metric in SaaS is per user, per month. As the markets and vendors mature, this is changing and could be anything from packages shipped to number of transactions completed. These are the real keys to value pricing in SaaS and are not talked about as often; either because people don’t really understand this aspect of pricing or because it is too difficult; maybe both.

Unfortunately we see and hear from companies all the time that have built systems or leveraged metering/billing systems that are tied specifically to per user, per month or other legacy metrics. In SaaS, pricing is marketing, but it is also tightly coupled to the underlying technology.

You know that truck tire I mentioned earlier? You can change the price, the price metric, distribution for that truck tire – and legacy software – all day long and the tire (or software) stays the same.

With SaaS, not so much. Be careful that you listen to people that don’t just understand pricing, but the SaaS Business Architecture, too.

SaaS Pricing Model: WIIFT?

So, work with me here. If pricing is marketing, and pricing is where value perception (the market’s idea of WIIFT) and value proposition (what you think the WIIFT is) intersect, then the pricing metric is what ties all of that together. If you were to boil down the value perception to one element, it would be the pricing metrics. And yet few ever speak of these outside of pointing out what the typical metrics are.

Why is this so important? This is really a very large topic, but the idea is simple; if you base your pricing on something people find no value in, your value proposition will not be aligned with their value perception. If people don’t care about the number of users, for example, if you charge per-user you could run into the “shelfware perception.”

The idea behind shelfware comes from the old days when software came on a disk and in a box that you could actually put on your self. The saying comes from the fact that you bought too many copies of a piece of software and rather than using productively, it was “installed” on the shelf in the managers office.

So, if you have a situation where two users – Meg and Brian – are paying for the “lite” version (a bad name and a topic for another day) and want to add Glenn to the system, but to do so requires that they upgrade to the “pro” version which includes up to 10 users, they’ll be paying for 7 users that they don’t need – Shelfware 2.0? So, what’s the problem? Don’t we always want people at the low-end of the next tier up? Aren’t they the most profitable customers? Yes, but we need them to want to be there.

The idea in B2B SaaS that seems to apply almost across the board (your mileage may vary so please do your homework), is that scaling pricing based on the complexity of the companies that are using your product/service is a good idea. This ensures that your price is tied to value perceived at every tier. Which is why I hate this quote by Paul Graham: “You’ve found market price when buyers complain but still pay.” I don’t care who said it, its wrong.

That quote simply flies in the face of “value pricing,” customer-centricity, marketing, etc. and can hurt your Customer Lifetime Value (LTV). Complaining customers aren’t happy and it is hard to upgrade, up-sell, or cross-sell unhappy customers. If they are not happy, as soon as they find a suitable substitute, they will leave. And in the meantime, they’ll game the system, sharing users and logins, or they’ll stop using the system as much.

It is true, you can’t please everyone so some might complain about pricing, which is fine. At some level people will complain that they have to pay anything – this is especially true when you’ve been giving it away for free at first. You have to be able to figure out if the complaining is because of that, or if it is real push-back.

The better you understand your market, the easier that distinction will be to make. The goal should be to get those who do pay to do so happily so that we can get more money from them over their lifetime as a customer. Ideally, you’ve done the work necessary to focus your offering to those that will perceive value removing complainers from the equation.

But there is another aspect of pricing metrics besides keeping Shelfware perceptions at bay; its about aligning with value perceptions to grow LTV. As I’ve said a number of times before, one of the problems with Freemium – for example – is that people promote the free version over the premium versions, ensuring that all customers will go through being a user first; which is why conversions are so low and time to profitable revenue so long.

If they would promote the paid version from day one, give incentives to sign-up for the premium version, etc. they would get the money from their customers faster, meaning that an increased LTV. The same principal holds true in value pricing for SaaS vendors.

The SaaS Pricing Page is a perfect jumping off point for most discussions of pricing with SaaS vendors because it is generally where they start anyway. SaaS & Web App vendors who have opted for price transparency will quite often sit down to develop their pricing strategy by laying out a pricing page first.

Who cares if this is the right way to do it, it is the way its done. So we use the pricing page as the visual manifestation of a SaaS vendor’s pricing strategy and start from there. So when you lay out your pricing tiers or bundles, there is a good chance there will be three versions – small, medium, and large – and that it will be based on number of users. You need to ask yourself if that is the right metric.

Not only could “users” be a metric that has no value to the market, but by basing pricing on that metric, you’ve basically told your customers to start small, then move to medium, and then to large.

Have you provided any incentive – other than number of users – for someone to start with the large bundle out of the gate? What if they only have 3 users (rather than the 25+ in the large bundle) but would find value in some of the features of that bundle? Do they even know they could find value in those features or were you too busy pushing the fact that they the large bundle has 25+ users and 10GB storage?

Look, your pricing today affects the overall LTV – don’t worry about too high or too low – worry about aligning with value as the customer grows/changes. This is what I mean when I say once we figure out the right metrics, what you originally had price-wise is probably irrelevant.

When we figure out the right way to charge based on value-oriented metrics, the price might go up significantly. Or it might not, but the migration to higher-priced tiers early on means a greater LTV, more profit, and a business that is worth more in acquisition or IPO. Yeah, IPO – this stuff doesn’t just apply to startups and small Web App companies – this is a lesson for all SaaS companies of any size.

Let’s Fix Your SaaS Pricing Model

For immediate consultation and advice on effective growth strategies and tactics for your SaaS company, schedule a 60-minute meeting with me via Clarity. If you feel a more involved engagement is required for me to help you, email me with the specifics of your situation (as much detail as you’re comfortable giving) and we’ll setup a meeting to work through the particulars.

– Lincoln

Does Goldilocks Pricing Work for SaaS?

A Pricing Strategy for SaaS built for the sole purpose of nudging customers away from a decoy price to the middle version can work.

I was asked for my thoughts on this question someone posted on Quora: “Based on your real-world experiences, does Hal Varian’s ‘Goldilocks pricing’ result in most buyers choosing the middle option?” Essentially, this is the notion of having a low, medium, and high price to – theoretically – force people to the medium pricing tier / bundle. I decided to explore this from a value-based pricing perspective. Following is my response…

This is a great question / topic. I’m not sure anyone has data to support or dispute this at scale. Anecdotal and first hand experiences, though certainly not in aggregate, will be the best you can expect most likely and I will do my part to spread the word to get some of that input. My experience is also only in Software-as-a-Service (SaaS) and Web / Cloud Apps. While most of what I deal with could be extrapolated to include other industries, markets, etc. I just wanted to put that out there. If you’re selling brake pads, what I have to say might not work.

That all said I wanted to weigh in here with some guidance around “Goldilocks” pricing. My interpretation of Varian’s paper is that the differences between pricing tiers should be value-based, not just tiered without giving thought to the value perception at each level. This is certainly how we recommend our clients create their pricing strategy – if they go with tiers. “If” is key to that last statement.

The fact is most new SaaS and Web App companies assume they must have tiered pricing. For the most part this is due to following companies that are already in the market. They will assume since ABC SaaS app has 5 pricing levels that they should, too. What they fail to consider is that ABC has been in the market for 7 years and has the intelligence – market, behavioral, etc. – to be able to identify the proper value differentiators for each tier. Or maybe they don’t and even 7 years on they are still guessing. That is the problem with looking at other’s pricing pages – especially those not in direct competition with you – there is a serious lack of context!

So the key is that you should not do tiered pricing or bundles for the sake of having a “pricing grid” on your pricing page. For early-stage SaaS or web app companies it adds complexity, even if you leverage a light-weight subscription management solution like Recurly or Chargify. The reality is there is extra management overhead, expense, etc. and if you are brand new, right out of the gate you might not have the intel to know how to segment based on value yet. You could even turn away prospects or upset clients by using the wrong value differentiators in your pricing “bundles.”

We recommend that SaaS and Web App vendors work through a process to figure out what the value-based differentiators should be for their bundles. We put them through a value perception matrix to ensure their value proposition intercepts appropriately with what they know the market will want, but no matter how you do it, it should be done. This means, if you are considering “differentiating” bundles based on storage, for example, do your best to ensure that “storage” is a metric that is valuable enough to your customers that they want to move up to – or start out with – the next tier up. Otherwise you could cause them to feel like they are paying for something they aren’t using or alter behavior to keep from upgrading – while looking for an alternative product or service that understands them.

The other thing is, even with tiered pricing, regardless of whether you do the “Goldilocks” thing or simply have multiple tiers, it is generally unwise to attempt to have pricing that is all things to everybody if you cover a wide range of target markets or segments. Instead, you’ll need to employ market segmentation and then leverage tiered pricing within each segment. This is why you will see some SaaS apps with 7 or 9 pricing levels… everyone from tiny 1-person companies to Fortune 100 companies are represented on that one page. This is not advised.

This should make sense – what is valuable to one market segment will not be (or will not be the same as) for another and will require messaging around the pricing to convey the value to the segment. Healthcare users of your horizontal solution will speak a different language than Aerospace, just as small businesses will consume your messaging differently than Fortune 100 companies. The product might be the same (the great thing about SaaS and web apps), but how you convey the message – including pricing – is key.

But the point of “extremeness aversion” put forth by Varian is something legitimate to consider. But I would again look to that strategy in a value-oriented way. Why create a pricing tier that is your “hail mary” price (as I’ve seen some write about a high-priced version you “hope” someone chooses) if there is no real value? Do you create a high reference price so the “recommended” one looks like a bargain? Yes, but if the “high price” is not accompanied by some perception of value and appears to simply be a high price, it could throw off the entire value perception of your offering.

That is the danger of just pulling prices out of thin air (or somewhere else) and failing to work through a proper strategy. So yes, “Goldilocks” can and does work, but only when in the confines of true value-based pricing. Varian often refers to the “premium” product (tier) – premium doesn’t just mean more expensive, but more valuable. How it works, how often customers are “nudged” the middle tier, is hard to say in any conclusive way. In fact, you’ll note that most SaaS or Web Apps that have a “recommended” tier offer no reason for that, and it is quite often in the middle of 4 or more tiers, completely throwing off the “Goldilocks” nature of the experiment.

While the goal is always to get pricing as right as possible out of the gate, early stage companies are at a disadvantage due to lack of time in market. Understanding the true nature of value-based pricing, and that pricing IS marketing, can greatly improve the results of any pricing strategy. So, is “Goldilocks” a good base for your pricing strategy? It can be, but there is a lot more to it. I recommend going back to Varian’s paper (download the PDF here) and reading with with a focus on”value-based” pricing. Where he says “quality” substitute “value” and “What’s in it for them?”

If you’ve been in-market at least 6 months and are curious how we could Accelerate your Profitable Growth – perhaps by optimizing your Pricing Strategy – contact me and we’ll setup a time to discuss your options for improving and accelerating customer acquisition.

– Lincoln
(972) 200-9317