Pricing software takes more than just knowing your market. You also need to account for the difference when pricing two very different software delivery models: one-time sales and ongoing Software-as-a-Service (SaaS) subscriptions. While both approaches to software offer their own advantages for merchants, they also have distinct ways of interacting with and providing value to customers. As such, the approach to a one-time price is markedly different when compared to formulating a recurring one.
Despite the differences, there are some elements to pricing that remain the same regardless of the delivery model. For both, successfully pricing to maximize revenue is a balance. A product or service is worth as much as a customer is willing to pay but the perceived value of a product can vary drastically between different people. Therefore, both models face the challenge of figuring out the price point that can unlock the most revenue possible. You don’t want to overprice because you’ll dissuade too many from buying. But if you underprice, you risk losing revenue because customers generally would have been willing to pay more.
While SaaS is becoming increasingly popular, there are several advantages to having one-time software sales including a one-time cost to users, high net cash flow generation and little or no churn rate. This is the more ‘traditional’ approach modeled on how we price most physical consumer products.
In these cases, prices are usually guided by the costs of bringing a product to market, plus a built-in profit margin (AKA Cost-Plus Pricing). For software companies, this means fully researching, developing and marketing a product in the hope that the revenue generated afterwards will outstrip the overall cost to produce it. This one-time price is, therefore, usually higher than a recurring price as it must cover the entire unit cost plus a portion of overhead costs. The downside to relatively higher upfront costs to users is that it can depress demand.
In contrast, software subscriptions usually offer a lower upfront price by effectively mortgaging costs over time. While most SaaS companies don’t recover costs until 12 to 24 months into a customer’s lifecycle, they also have the potential to provide more value over time to customers. For customers, they get an evolving service that then continuously adds more features and functionality based on actual customer use.
Likewise, companies benefit from having continuous, predictable revenue streams as well as better information on how to best provide value to customers. So while one-time sales needs to increase first-time customer volume to maximize revenue, subscriptions can increase revenue by boosting both the number of new users and the amount of time they stay subscribed. The ongoing price should reflect the ongoing value being provided to users.
The most common way to price SaaS services includes charging customers according to the resources they use (Consumption-Based Pricing) or the number of users who access the service (Per-User Pricing). Initial recurring prices are usually based on the value perceived by potential customers, which can be derived using a number of different surveying methods like price laddering or the price sensitivity meter.
While finding the right price and a lower initial cash flow of SaaS can be challenging, many in the software space continue to be drawn by the promise of stable, ongoing cash flows. With this predictable income, companies have often found the freedom to further develop their service and deliver additional value to customers over time, which may allow higher recurring prices in the future.
With SaaS revenue growth of at least 20% expected in each of the next three years, it’s clear the software market is continuing its rapid shift towards the subscription-based model. With so many new to the world of subscriptions, it’s important to gain a solid understanding of the major differences you need to take into account when pricing SaaS as opposed to the traditional one-time sales model.