Startup Pricing

Pricing for Startups

“You’ve found market price when buyers complain but still pay” – Paul Graham

Pricing is a crucial component of any successful business. Most companies, especially startups tend to under-price fearing losing out on an account resulting in leaving significant money on the table when they finally come away with a customer win. Offering free products, free trials, fremium etc are different strategies startups employ in winning customers and they all work for some and don’t work for the rest. In fact, there is no clear cut, ready-made, cut-out pricing strategies for any company to emulate or follow. Startups work in a highly dynamic environment with constantly changing market dynamics.

An Ideal Pricing is an art that results from a series of experimentation and also in knowing and understanding the true value and positioning of your product. Startups must, hence, use a framework to chalk out the best pricing scenarios and also analyse the feedback/ response from the market to tweak it. The broad framework for startups to work on their pricing should consider the following factors:

Positioning:

Brand positioning is one of the most important factors that influence pricing strategies for any product. In fact, both goes hand in hand. Pricing strategy does reflect on the brand as well. Imagine buying a Ferrari for the price of a Toyota or buying an iPhone for the price of an entry-level Android phone. Same goes for technology products as well – In the FSM (Field Service Management Software) segment, a product like Servicemax might be able to charge a premium while the SMB focussed mHelpdesk might not be able to charge that premium. Same goes for the other software categories as well. In the CRM space, a Salesforce commands a premium which a Zoho or a Nimble will not be able to get.

The message should be clear across all touchpoints – website, collateral, ads, PR, Sales pitch and every other channel the brand gets visibility. The pricing strategy reinforces the brand positioning be it Premium, Mid-market or low cost alternative.

Sales Team Structure:

Pricing defines the structure of the Sales team. Higher price points are very attractive from a revenue perspective but they also require a larger sales cycle, a much more sophisticated sales rep, increased chances of opportunities lost and volatility.

Nimble CRM for eg. has a pricing of $15/user/month and mostly sells into the SMB market. With a deal size of $3k-$5k, typically an inside sales person should be able to close 3-5 accounts a month. This is a much predictable model with a steady revenue coming in every month through these closures. However, for, a higher priced product like a Siebel CRM system, an inside Sales team will not be the right fit. They would be multi-million dollar contracts and would require specialised field sales person who would charge anywhere from $250k or above.

The Market at Large for your product:

It’s important for organizations to scope the market at large for them. The value of any organization is broadly the NPV of its earning (profits) for the next 5 years. Reducing price points might enable you to sell more, increase the closure rate, however in the longer run you need your product to be profitable as well. Any product will have churn, so the net revenue that you make out of a customer should be at bare minimum equal to the cost of acquisition. Also, the market size for your product is the price point multiplied by the number of potential customers. If the no. of potential customers is not a very big number and your product’s price point is relatively low, then the max market you can address might be very less for investors to have any interest in your company.

Pricing Model:

Pricing models can be different for different organizations. One could have a one-time license based pricing structure to subscription based pricing. Even with subscription based pricing – you could have a monthly or quarterly, bi-annual or an annual plan. For subscription based pricing model, I had in my previous post discussed the benefits of having an annual subscription model not just from a cash flow perspective, but also from a revenue predictability perspective and in reducing the overall churn numbers.

Like any function in a startup, pricing is also a constantly evolving function that changes with time. The best way for any startup is to broadly identify each of the parameters discussed above and create a framework which they can rely upon in revisiting pricing few times a year.

The SaaS Customer Acquisition Conundrum

Building a successful SaaS startup and putting it on a growth trajectory involves a great amount of effort and a thorough understanding of the market dynamics. To begin with one would need to build a product and achieve product market fit. Once you have a product market fit, you know there is a target segment that you can sell into. The question then becomes – How do I reach out to my target audience and start converting them as paying users?

An easy answer some would say with the amount of options a SaaS company has to interact with its customers in today’s digital world. But is it so? To understand SaaS customer acquisition and business viability one would first need to understand a few basic metrics that become extremely crucial to understand the health of a SaaS business:

  • LTV – Lifetime Value of a Customer
  • CAC – Cost to Acquire a Customer
  • Sales Velocity – Number of days required to acquire a customer from the first point of interaction
  • Payback – Time taken to recover the CAC
  • Churn(monthly) – % of customers you lose in a month

A well balanced business model will always have a LTV value greater than the CAC. If it’s not so for your SaaS business, then it might be a good option to reconsider the business model you are building.

One in a million SaaS startup would be able to depend upon the inherent virality of the product to scale up. But even in case of these startups there is an initial threshold value for the customer count that they need to hit for the virality to kick in. Rest of them, well they have to use of mix of SEO, SEM, Social Media, Direct Sales, Channel Sales, PR etc to hit their audience. Let me tell you, the CAC for majority of the SaaS companies have shot up so much that it becomes really difficult during the initial days of its incubation to rely on the Paid channels to acquire customers.

So, when does Paid Channels Work for a SaaS Startup?

Paid Acqusition works only when LTV > CAC

To elaborate, let’s assume a startup which relies on Google Adwords for eg to generate leads and works with the following numbers:

Scenario-1Scenario – 2
Total Traffic80008000
Cost Per Click$1$4
Conversion to Trials10%10%
Conversion to Paid Customer5%5%
Number of Trials800800
Number of Paid Customers4040
Cost of Converted Trial$10$40
CAC$200$800
No. of Sales & Marketing Resource710
Cost per Employee per Month1000010000
Total Cost Incurred Per Month( Without salary)800032000
Total Cost Incurred Per Month( With salary)78000132000

 

As you can see the CAC is a function of CPC, Conversion % at each stage, Sales & Marketing Overheads, Churn and the Sales velocity. You would want to have a high velocity and a churn percentage close to zero to reduce the CAC. Similarly, with more human touchpoints, your CAC value goes higher. Touchpoints could be any of email followups, sales calls or demos the inside sales team does. The CAC value goes even higher with direct Sales team involved, however in such cases your Average Contract value will also be much higher. In short it’s important for any company to keep their CAC < LTV to sustain.

While you do your math and try and figure out the CAC number during the early stages of your business, another important metric to track is the payback period. Let’s assume in the above example your avg. revenue per customer is $400/ year.

Scenario 1: Payback Period = 200/400 = 0.5 years

Scenario 2: Payback Period = 800/400 = 2 Years

 

Implies, in Scenario 1, you would take 6 months to recover the amount of money you had invested in acquiring the customer, while in Scenario 2, you will take almost 2 years to recover the money you spend on getting your customers. For a Startup at an early stage having limited access to capital the second Scenario is a sureshot bankruptcy contender, so while you analyse your business keep in mind the payback period and the amount of capital you would need to sustain your business. A simple workaround in Scenario 2 would be to collect the payment upfront – For more, refer Pricing Strategy makes or breaks a SaaS startup.

Always be asking yourself the following questions before you decide to spend on acquiring customers through Paid Channels:

  • Has my product already achieved Product/ market fit?
  • What’s my CAC for a paid channel?
  • How much Capital do I have?
  • What’s my runway with the Capital I have?
  • What Pricing Strategy can enable me to sustain the business if I am relying upon my cash reserve to acquire customer.
  • Do I plan to raise more money or am I planning to run the business through the revenue generated? If you are planning to raise funds, burning money to show momentum might be a good idea. You may want to read this article The Incremental Customer

Find answers to these questions to have a clear understanding on why and when to use paid channels for customer acquisition. Remember you will have a sustainable business only when:

  • CAC < LTV (general rule of thumb is that LTV should be 3 times your CAC)
  • Payback period < 1 year
SaaS Pricing Strategy - Payment Collection

How Pricing Strategy Can Make or Break a SaaS Startup?

I’m sure if you have ever been part of a startup, you would understand the importance of managing cash flow at an early stage and how it can make or break your startup. It becomes even more important for a SaaS company which depends on the recurring revenue to sustain itself.

Cash is the lifeblood of any startup. It let’s the management invest in the business not just in terms of growth but also with regards to beefing up the intellectual capacity of the team. It helps the startup take a faster trajectory to achieving its milestones – It’s virtually a no brainer that any startup should focus on improving its cash flow at an early stage.

Let’s analyse the pricing & payment collection strategies a SaaS startup could adopt to improve its cash reserves. Assume a hypothetical startup generating a MRR of $60k in the first month, growing 10% YoY and with a burn rate of $250k per month. Startup has an existing cash reserve of $3 Million from series A.

SaaS Pricing Strategy - Payment Collection

I have put down 5 pricing strategies ( payment collection) options :

1) Monthly – Customers pay at the end of each month

2) Quarterly – Customers pay at the end of each quarter

3) Bi Annual – Customers pay at the end of each 6 month period

4) Annual Pre Payment – Customers pay for one full year at the beginning of the year

5) Annual Post Payment – Customers pay at the end of one year

See how in the case of Bi Annual and Annual Post Payment systems, the startup runs out of cash and is on the verge of bankruptcy. It’s a a situation you wouldn’t want to address as a startup founder. While the Annual Pre Payment system infuses a ton of cash into your reserves which will help you pump in more money into your business to grow. Remember, this is an effectively zero interest capital that your consumers have provided you access to that you can leverage for rapid business expansion.

So how are you collecting payments from your customers? It might make complete sense for a startup to shift their pricing strategy to a annual pre-payment option provided you don’t see an increased reduction in conversion because of a change in the pricing strategy. Certain segments and markets do react differently to annual pre-payment pricing strategy especially the SMB segment where the owners of these business themselves would in all probability be in a cash crunch situation to run their businesses.

Do your math and run the experiment!

Fundraising for Startups

Fundraising for Startups

Fundraising is difficult and that’s me being very polite. How many times have you heard a VC tell you – “Your product is really nice and very useful as well. I love it. I just need to see a bit of traction now to convince myself to invest”? If you are a early stage company looking for someone to invest, then I will bet my house on you having heard this from one of the VCs.

A couple of years back there was no shortage of VC money, they were making bets on anything and everything they could find and in doing so many of them have burnt their hands. When I say, burnt their hand, I mean they had literally drowned all of that money down the drain for crazily stupid ideas that would have never made it big, let alone India, anywhere else in the world. That’s changed the investment scenario for the better. The heavily discounted models which a few of these startups were running were extremely difficult to sustain. These models weren’t inherently changing consumer behavior or making consumers loyal to any brand/ product. What they were doing was just delaying the inevitable, that’s running out of money and not finding a backer who will invest at a higher valuation.

With funds drying up the investment firms, including the early stage ones have changed the way they approach investing. These days, Seed stage investing is more or less like the Series-A/ B a couple of years ago. The investors look for genuine traction – Revenues and focus more on profitability rather than GMVs. Gone are the days, when all it took for a startup to raise money was to have a few thousand free users sign up on the platform.

In an ideal world, bootstrapped, cash-flow positive startups would be the rockstars. But there are times when a startup needs fund to survive and grow, the cost of running a startup is often not understood well enough by founders. From my experience, the investors look for the following in a startup:

 

  1. Ability to generate revenue (an existing portfolio of a few paying customers). This is also a confirmation on product/market fit.
  2. Ability to scale – Addressable market
  3. Identified a Channel to Acquire customers – A process that is repeatable
  4. The Team – A balanced set of skillset
  5. Ability to hustle

 

If you feel your product or startup fits the bill and is in need for funding, then go for it. Remember, fundraising is a painfully long process that will drain you out. So ensure you have a support system in place to continue running the business while the founder focuses on raising money. If your startup does not tick off the 5 criteria listed above, then put your foot down and get cracking on these 5 items.

Re-thinking your organization structure to maximize customer value

We all have come across customer acquisition funnels and conversions at each stage of the funnel is something most organizations measure to understand how individual teams are functioning. While I was heading customer acquisition at FieldEZ, I was obsessed with conversions across each stage of the acquisition funnel during the initial days.

While we tried to improve the numbers, one thing that we focused on was optimizing conversion for each of these stages. There was a lot of thought put into understand blockers within each stage and options to rectify them. We did succeed in optimizing conversions – for eg: our success rate with being able to just reach the customer on his phone after they sign up on the website initially was about 18%. This was for customers who browse the website and signs up either for a “Free Trial” or “Requests a Demo”. What we also knew was these leads typically spent upwards of 12 mins on the website and would have on an avg. browsed 7 pages on the website. Considering the amount of time invested by them in understanding the solution and then signing up, this number was pretty bad. We did something really simple to improve this – we made it mandatory for our inside sales to reach the prospect within 5 mins of him signing up and that resulted in an increase of 200% in being able to reach these prospects on their phone after they sign up on the website.

While these hacks and improvements for the individual stages did improve the overall conversion, what we did realize during the course of this journey was to look at customer acquisition more holistically – across all these stages rather than looking at them in silos because the customer journey from the top of the funnel to the bottom of the funnel is never linear. Customers did not necessarily sign up on the website, then speak to our inside sales who do a demo and then gets the prospect to sign a $10000 contract. There were leads that went from being hot to cold and then hot again.

This meant re-aligning the way the organization functioned. Instead of having marketing report to a CMO, Sales and Account Management report to the Sales head, which in our case was the CEO, a better approach was for these cross-functional teams to report into a single person. This ensured one thing – the broader team had a goal to maximize revenue than look at individual conversion metrics and the team had more freedom to experiment across the funnel. And for me SaaS organizations should re-think the way they are structured – the single most important factor for a SaaS business is to maximize customer lifetime value – the focus should be on that. If it makes sense to have all your individual teams having a touchpoint with the customer across the top, middle and bottom of the funnel report into one single person, then do so.