References and Pricing for SaaS Startups
Posted by Bob Warfield on April 5, 2010
Getting the pricing right is a pretty critical part of any startup’s early stages. And it’s hard. The first task when selling business software (I differentiate from the consumer software experience) is getting anyone to pay anything for it and then be willing to talk about it so you have references. Indeed, there is often some software that is essentially given away in the early days.
Give it away in order to get a list of referencible customers started. It’s very hard to sell business software without some references. Your first task is therefore to get references together. You will need at least 3 or 4 to have a credible start. The more impressive the three or four initial references are, the easier it will be for you to grow. But you’re not really done with three or four. In my experience, it isn’t until you have six to eight solid references that you’re starting to get beyond the point where you need to beg, borrow, or steal to get references. And in fact, if your business depends heavily on verticals, you may need three or four in each vertical before you can start to open up that vertical.
Okay, how do you line up your initial references? If you’re waiting on Marketing to produce those leads, it’s going to be a long lead. The initial references are going to come from networking. You already know them, or you know someone who does. Hopefully your salespeople have some of them in their contact lists (I almost said Rolodex then realized some may have no idea what that is). Your executives will have some. Your investors and Board will have some. This is no time to be shy, network like crazy. At Helpstream, I had every single person in the company sign up for LinkedIn and then made sure the sales people had everyone in their contact lists. This meant that whenever sales wanted to check up on a prospect, they could immediately see if anyone in the company had a contact that could help. The way LinkedIn works, they didn’t even have to ask, it would just come up on the searches.
Now get out there and talk to everyone you can. Wheel and deal like crazy. This isn’t about extracting revenue. This is about building credibility and learning something about the world’s reaction to you product. We would tell everyone we talked to at this stage that we were offering “friends and family” pricing specifically to get some referencing going and to get started. To give an idea, we would sell these early deals for 1/2 to 1/4 of what we’d sell for a year later. We’d give away the professional services to install the software too. And the CEO and VP of Engineering need to make double sure these customers know they’re going to get the extended red carpet treatment for a long time.
There’s really only a couple of things to be cautious of at this stage. First, you need prospects who really will be referencible. That’s the quid pro quo for the deal. They have to be willing, and they have to be decent references too. Think about whether the next tier of customers you get will be impressed with those references. Sure, they’re likely going to be venture companies just like yours, but are they larger? Do they have first tier VC’s? Are they getting buzz? Second critical thing is that they are real customers. They come from real markets you want to target. They will really use your software because they need it. And your software will give them a good experience they will want to talk about. This all matters.
Okay, you’ve established two or three referencible customers by almost giving away your software, working hard to make them happy, and jumping through whatever flaming hoops it took. What’s next?
An old friend and mentor once told me companies earn their way to their ultimate pricing. He was right. You earned your way to charge a little more for the next tranche of customers, but you’re still not likely to be at “full retail”, whatever that is. However, you have some tools at your disposal to think about. Are you publishing prices? Even if you’re not, you’re certainly quoting them. Set your price schedule up and get religion about it. You need to break your sales staff of the “Let’s make a deal” mentality before it becomes too thoroughly part and parcel of your culture. Insist they can discount no more than a certain amount off the schedules. Let the VP of Sales discount a bit more. The CEO has to approve the final discounts. Choose some list pricing that is not yet full retail, and use discounting to get the deals done. But don’t just give it up. The CEO needs to be the approver of deep discounts, and they need to start testing the waters to see what the market will bear.
Thus begins the stairstep process of setting prices, discounting until you sell, reducing the discounts, and then raising prices again when discounts are low enough. The deep discounts right after you raise prices provides transitional flexibility so that pricing moves up more smoothly. Initially your prices are not based on competition so much as they are based on your credibility. That’s what this stage is all about: building credibility. BTW, if you have not realized it yet, this means you have to get the early customers live as soon as possible and they need to be successful. It’s the number one priority for your engineering and other non-selling staff. The CEO and Executive Staff should be all over that process making sure it goes exceedingly well so the customer will be happy. Smother your customers with service.
Second thing to keep in mind–make sure your friends and family customers know they got a special deal and that they’re not to pass that along during a reference call. I would straight up tell them what you’re charging others. They will appreciate you all the more for the discount you’ve given them. They’ll also understand when the time comes for you to raise prices, because this is a SaaS deal after all, and they will eventually need to renew. So you will have telegraphed what’s happening and you can still cut them a little better deal at renewal time. We did well by trying to keep the discount rates constant for older referencible customers as we raised the list prices. That way, the early customers knew they were still “special” because they were getting the deepest discounts even though the pricing was going up.
Do you get a sense of how important it is that your pricing, even the discount rates be codified? These are stakes in the ground and progress must be visible and measurable, not random and all over the map. Everyone is not going to have perfect knowledge of it, nor should they. But customers know what they paid. They know what list was and what the discount to list was. They should have some sense of where you’re going with pricing as they renew. Some customers will want to sign on to longer terms. Get them to give up some discount in order to look in list for a longer period. Just as importantly, your Board will be monitoring this process carefully to understand what the market thinks your product is worth.
What about terms? SaaS is paid in advance, and you should be able to get a year in advance. Again, some customers will sign up for more to lock in what they feel is a good price. That’s fine. Prepayment is cash you can use to grow your business. Just make sure the pricing is on some rational path. Some customers will ask you for month to month. That’s nuts. I would not do that except under very special circumstances. Just the work to bill it is painful. Month to month plans should only be for customers that represent significant new milestones, and the month to month should end after some “pilot period” no longer than six months after go live. If they still can’t figure out whether they want you after that, they’re just taking advantage of the situation. Quarterly is a little better, but I like the same approach. Only do it for milestone customers and it has to end and go to annual some point after they’ve had a chance to learn to love the product.
As an aside, the bigger SaaS companies that no longer need as much capital to bootstrap with are now starting to push month to month deals. It’s a competitive advantage for them and it helps starve little companies of much-needed cash. Keep an eye on that in your space. They’re pushing a lot of rhetoric about how they’re doing it for customers, but we all know the reality of what that’s all about.
What can you expect to do in terms of raising prices? At Helpstream, our ASP’s (Average Selling Prices) went steadily upward. Within the first 2 years after launch, and really within 18 months, they had tripled. We cranked the pricing schedule every 6 months or so, and used renewals as a prime opportunity to increase prices. Frankly, we had customers telling us we needed to increase prices due to the value we created, so there was not much squawking when we did so.
How should pricing be done relative to competition? First, you need to understand how you are competing. Are you the price leader? If so, that’s a different thing. It will infuse everything you do. Are you the best product? That’s different. If you are the best product, you may also be the price leader at times, but that is never the point of your spear. Be clear with customers about this. Early on you will know if a prospect is looking for the cheapest solution. Your answer is that you are not the price leader, so-and-so is, so if that’s really all they care about, you’re probably not the right choice. However, while we are just getting started, yada, yada, we are both the best deal in town and the best product. At Helpstream we started out at about half the cost of the low-cost players. By the end of my tenure we were at half the cost of the highest cost players, and that by dint of discounts and much lower friction (more on lowering friction in a future post) in terms of professional services to install. Had we been given another couple of years, we would have been up there at the high-end of the pricing scale, but able to justify it by virtue of our ROI.
This post is dragging, so I just want to make a few of other points to finish up:
– If you want to lower friction in your sales cycle, make your pricing simple and transparent. Ours was by the seat, and towards the end, we only charged for customer service representative seats not for our customer’s customers. This was a competitive advantage because all of the other players wanted to charge for it all. Even though we had the same list price as a Salesforce seat ($1500 a year per agent), this left a substantial advantage. If we charged at Salesforce’s list price for customer’s customers and didn’t discount, we would’ve had a $50M a year business (theoretically, of course). Our pricing by agent seats was also much easier to understand. Most SaaS companies have way too complicated pricing. Most salespeople hate pricing schedules and simple pricing, though the smart ones realize the value. The others just look at it as interfering with their ability to play “Let’s make a deal” and with forcing them to say “no” instead of “yes.”
– Align pricing with value received. Our ROI proposition was around enabling agents to be vastly more efficient. It only made sense to charge by the agent in that case.
– Push negotiation on discounts higher in the org. Most sales people are about saying, “yes”, and negotiation is about saying, “no”. What’s hard is to get the customer ready to buy from you. Maximize the value of that difficult chore through the final negotiation.
– Think about pricing all along the demand curve so as not to leave an exposed flank at some price point. This borders more on packaging since it means low-end versus high-end modules, which I’ll be posting about at some point too, but it is an important long-term strategy piece.
My next post in this Learnings Series will be, “SaaS happens when the Business Shrugs.”
Dennis Moore has a couple of posts with very compatible views on how vendors arrive at pricing and cases where pricing less than customers will pay is helpful. Dennis doesn’t focus on the importance of references or the need to earn your way to higher prices as much as I’d like, but that is probably because he was thinking about a little different part of the startup lifecycle when he wrote those posts. The good news is that the model Dennis uses is sufficiently flexible to incorporate the two factors without change.