What is a pricing strategy?
A pricing strategy is a process that outlines how you establish the best price for your product or service to maximize value.
Many factors influence the development of a pricing strategy, such as customer demand, competition, cost of development, pricing objectives, and market conditions. A pricing strategy also includes decisions on discounts, timing of price changes, promotional pricing, and payment options.
Choosing the right pricing strategy is one of the most important decisions you will make for your SaaS business. It's a make-or-break decision. And while there are countless pricing strategies available, some work better than others for SaaS businesses. Here we explore seven different types of SaaS pricing strategies to choose from.
Top 7 SaaS Pricing Strategies
What is cost-plus pricing?
Cost-plus pricing is a pricing strategy that involves setting a price by adding a markup to your costs and then setting your profit margin accordingly.
Advantages of cost-plus pricing
There are several advantages to cost-plus pricing. It is straightforward and simple to implement. All you need is your costs plus your desired markup to get to your price. For example if you wish to make 50% and your costs are $10, your price should be $15.
Cost-plus pricing is also quick to implement as it doesn’t require any market or customer research, just a calculation. It allows you to achieve a predetermined profit margin, ensuring that your costs are covered and that you make a fair return on your investments.
Disadvantages of cost-plus pricing
Cost-plus pricing does lead to some disadvantages for SaaS businesses. It doesn’t engage with the outside market to ensure competitiveness. It also doesn’t include a customer lens to check the value that they get out of the product.
This may result in prices that are far from competitive in the market, too low or too high, and prices that don’t represent the value customers are willing to pay. It is also inflexible when any external factors change and is therefore not ideal for maximizing profit.
The final word on cost-plus pricing
Cost-plus pricing works best when you have high confidence in your costs and are able to easily predict expected demand for your product. It is more suitable for business that sell products, not SaaS businesses.
While necessary, cost-plus pricing is just one building block of successful pricing strategy. It’ll help you insure that your financials are validated internally. But ultimately it is not enough as standalone strategy for SaaS.
What is market-based pricing?
Market-based pricing is a strategy that uses competitor pricing as a benchmark to set your price.
Advantages of market-based pricing
Market-based pricing is a good strategy to use when starting out when extensive data on value, customers, and their willingness to pay, is not yet available. Unlike cost-plus pricing, it does take into consideration the external market demand factors.
It is also easy to calculate and understand. If you are looking to be a market leader with the lowest price on offer, all you need to do is identify your competitors and price below them.
Market-based pricing is also dynamic. As the market moves, so does your price. It is a low-risk strategy to use, especially for new entrants.
Disadvantages of market-based pricing
Market-based pricing does come with its challenges. It is limited by who you define as the market and doesn’t take your customers into account.
You might have features that customers are willing to pay more for but a pure market-based pricing strategy doesn’t account for that. This can result in money left on the table with pricing that is not profit maximizing.
The final word on market-based pricing
Like cost-plus pricing, market-based pricing should be viewed as a building block to a successful pricing strategy. It covers the external data needed to validate that the cost-plus pricing level makes sense when compared to the market.
However, purely market-based pricing misses the customer lens and results in money left on the table.
What is penetration pricing?
Penetration pricing is a pricing strategy that aims to gain market share by charging a low price at first and then increasing the price as time goes on. The hope is that customers will buy your product at a lower price than they would have paid if you had charged the higher price from the start, but most importantly, they'll become loyal customers of your brand.
Advantages of penetration pricing
In this way, penetration pricing can be used as an effective strategy when launching to quickly gain market share against established competitors who already have loyal customer bases.
It is also helpful in establishing a foothold in markets where customers are very price sensitive. The low prices are used to incentivize high initial sales volume and attract customers while building brand recognition.
Disadvantages of penetration pricing
The disadvantages of penetration pricing include lower profitability, potential price wars with competitors, and lack of customer loyalty.
The main tenet that penetration pricing relies on is the price increases in the future in order to grow your business or make it profitable.
The final word on penetration pricing
This strategy is in essence a version of market-based pricing and relies on building relationships with your customers quickly in order to start raising prices to recoup profitability. While it can be used to gain market share quickly, it is not the best strategy to use for SaaS businesses.
What is price skimming?
Pricing skimming is a strategy where initial prices are set very high and then lowered over time as demand lowers. The goal of skimming pricing is to capture the highest possible revenue from the most willing customers before competitors enter the market.
Advantages of price skimming
Price skimming can be effective when there are no competitors, or if you have the type of SaaS product that customers are willing to pay high prices for because they don't see any other options available.
It offers high revenues and return on investment and builds brand awareness through exclusivity. Price skimming also allows for easy customer segmentation based on at which price point they purchase.
Disadvantages of price skimming
Price skimming can appear unfair to customers that are price sensitive. For new entrants, the initial high price point may not attract customers if there is competition already in the market. This could inadvertently result in excess inventory.
The final word on price skimming
Price skimming works great if your SaaS product is so unique and powerful that creates a monopoly. It is harder to implement if there is competition already in your space. Apple has used it successfully for its iPhones for years.
What is premium pricing?
Premium pricing is a pricing strategy of charging higher prices for products or services that are perceived as high-quality or have unique features. The goal of premium pricing is to position the product as a luxury item and attract customers who are willing to pay more for the perceived value.
Advantages of premium pricing
The advantages of premium pricing are high margins, luxury brand image, and differentiation. Premium pricing works well for products that are full of unique features, not offered by the competition.
Disadvantages of premium pricing
Premium pricing does not appeal to price-sensitive customers. It is also challenging to maintain in a market with many competitors where customers could switch to cheaper alternatives.
Even with few competitors, premium pricing opens up the market to potential new entrants that could undercut on price to gain market share.
The final word on premium pricing
Premium pricing is another form of competitor-based pricing that looks at market and chooses to set prices above the market range to signal quality and luxury. It is a strategy that targets price insensitive customers that look at value, features, and quality, over price. It works best when a high investment in marketing is possible to build the premium perception.
What is high-low pricing?
High-low pricing is a strategy where the advertised price is set high and then promotions are used to give customers a lower price. The real sold price, however, is below the advertised price because of the discounts offered.
Advantages of high-low pricing
Discounts work as an incentive for purchase and can result in increased customer retention rates if they're offered at the right time. This can lead to increased sales and profits by encouraging customers to buy more than they normally would through offering discounts only above a certain spend etc.
Disadvantages of high-low pricing
The disadvantages of high-low pricing is an increased need in managing a continuous promotional calendar, lack of trust in the advertised price, and training customers to wait for discounts.
The final word on high-low pricing
High-low pricing is best used by businesses with highly price sensitive customers that respond to promotions. It is best for product businesses where customers are repeatedly incentivized by discounts to purchase. Therefore, it is not the best pricing strategy for SaaS businesses.
What is value-based pricing?
Value-based pricing is a strategy used to charge the customer based on the value they receive from your product. It's a pricing strategy that is based on the value of your product to the customer and not on a cost markup or what competitors are charging.
Advantages of value-based pricing
Value-based pricing is built through a series of pricing surveys directly with customers and is therefore a real indicator of their willingness to pay. This goes above and beyond cost or competitor comparisons.
Disadvantages of value-based pricing
Willingness to pay varies from customers to customer. Implementing value-based pricing also involves high investment in pricing research.
The final word of value-based pricing
The goal of value-based pricing is to ensure that you are charging as much as possible, while still ensuring that customers see enough value in your offering so they continue to pay for it. It is the best option for SaaS businesses. It can be seen as a third building block, after cost-plus, and market-based pricing to cover all three pricing lenses – profitability, competitors, and customers.
Choosing the right pricing strategy
When you're determining your SaaS pricing strategy, there are a few things to consider. First and foremost, who's your target customer? What are your business goals and targets? What pricing model do you have (link)?
Once you've figured that out, it's time to look at competitors. If there are similar companies in the market that have a similar offer and have been around for a while, then chances are their pricing structures create expectations for your customers as well. Is there an obvious market leader, a premium offer, where do you fit in?
Then it’s time to do your research. Do you have the time and money to invest in a value-based pricing strategy? Are you just starting out and want to test the waters by looking at competition only with a market-based pricing strategy? Are you looking to build market share fast and think penetration pricing may get you there the fastest? Or maybe your target customer loves discounts more than anything and would respond best to high-low?
Winning pricing strategy for SaaS
Ultimately, value-based pricing is the winner in pricing. Understanding your customers down to the features they prefer and how many dollars they’re willing to part with for your products has no better alternative.
If your customers are willing to pay, you can charge above your ideal cost-plus markup or above your market-based pricing level.
It gets away from the guess work and helps set you on the road to pricing success that is built around your customer.
Without the ability to invest in value-based pricing, the choice of the remaining six strategies rely on identifying your business goals, pricing model, and competitive landscape.
We hope you’ve learned something from these SaaS pricing strategies. SaaS businesses, like so many others, can benefit from a pricing strategy that best suits their business goals and customer objectives. Hopefully this has helped you to understand how to craft your ideal pricing strategy! Need help? Reach out!