There are a number of ways to determine when you’ve hit the right pricing tiers or product cost. Customers won’t complain too much about the cost, you’ll have a steady stream of orders, your conversion rate will be above 1% and the sun will seem warmer on cold spring days.
It can take a lot to get to that place though. In fact, it can be one of the more difficult aspects of running a business. In some cases, this will be relatively straightforward like if you’re running a retail or e-commerce business.
A common formula for retail products just asks what amount of profit you’d like to make from the product:
Retail Price = [(Cost of item) ÷ (100 - desired profit)] x 100
But even that simple formula adds complexity. While the cost of item is fixed, desired profit is not. If you shoot for the moon and slap an extra zero on that baby, your product will probably be too expensive for the market and fail.
Price the product too low and suddenly you’re not making any money.
The situation becomes further complicated when you try to price SaaS products. The “Cost of item” becomes closer to COGS (Cost Of Goods Sold) which includes labor costs for your engineers.
But it you look up pricing SaaS products online, no one is mentioning COGS.
Ok, so what do we do?
We need an ideal place to test pricing with high-intent users who are actively trying to purchase similar products.
That’s where Google Ads comes in.
Say you’re selling a CRM for small businesses. Let’s run a quick google search...
There are your competitors. Well, there are two of them - Zendesk and Salesforce. The other two are basically affiliate spam.
Ok, so let’s dig a deeper.
First, we’ll dig into Google’s free Keyword Planner.
Whew. Those are some expensive clicks. Breaking it down, we see a low bid for top of page ads coming in at $13 and the high range is a staggering $57. Now, this referring to Cost Per Clicks, which means any time a user clicks your ad, your account will charged something in that range.
That might seem staggering in cost to you, and in reality it kind of is, but it’s also a positive signal. We have two affiliate marketers also paying those prices and they’re only getting a small portion of the sale when a user signs up for the actual CRM.
That means there’s enough “meat on the bone” for a middleman to bid on these terms and still find a place to make a profit. Awesome.
Based on that alone, we know that this is a high-intent search. Users are ready to sign up after clicking on one of these ads. That’s a great place to spend your ad money.
So, we have a high-intent search, middlemen that think they can insert themselves into the equation and take a cut and high CPC’s.
You can take whatever price you may have had in your head and double it now.
Here’s Salesforce’s pricing:
And here’s Zendesk’s pricing:
Right away, you know you should be offering two things to directly compete:
- Per user pricing
- Annual plans
Now you see why the bids are so high. Let’s assume that most customers are going to choose annual and start with a single user for a year. That’s $300 in revenue for Salesforce in Year 1 and $228 for Zendesk.
Based on my experience, a high intent keyword usually converts to a paying user between 7% and 20%.
Let’s assume that the CPC is somewhere in the middle of the range Google provided (13, 57) at around $35.
At the low end (7%) of the conversion rate:
- 100 users click through at $35 = $3,500 ad cost
- 7 users convert at the annual price point for a single user = $2,100
$3,500 ad spend - $2,100 revenue = 1,400 negative return on ad spend in Year 1
You may be thinking: “that calculation looks terrible, they’re losing money!”. But you forget that we’re talking SaaS. Many of these customers are going to last 5 years and one or two may even last 7 to 10, especially with a CRM which is an infrastructure level tool.
So let’s assume we lose half of those users after year one, but the remaining 3 stay on for 5 years and 1 stays on for 7. Let’s also assume they add no new users, pricing doesn’t change, and they’re not up sold on any other services, which is borderline impossible for any good SaaS product.
Year 1 (7 users): $2,100
Year 2 (3 users): $900
Year 3 (3 users): $900
Year 4 (3 users): $900
Year 5 (3 users): $900
Year 6 (1 users): $300
Year 7 (1 users): $300
Total Revenue = $6,300
$3,500 ad spend - $6,300 total revenue = $2,800 positive return on ad spend
And remember, that’s at the low end of the conversion rate. You can go ahead double or triple those numbers once you have a tightly refined funnel.
In summary, a few things to keep in mind while pricing your SaaS offering:
- Revenue recurs, don’t price for year 1
- High intent users convert at a higher rate, which means you can afford to pay more for them
- Competitors can serve as a marker to price against, but you can always forge your own path based on some industry standard tools like Google Keyword Planner
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