When searching for product-market-fit, B2B SaaS startups rarely place much emphasis on their pricing models. This is typical of the first stage in a SaaS startup’s evolution: the pursuit of product-market fit. This pursuit does require the first attempt to discover the right price that the early set of customers will accept for the right product or service. At this point in the journey, though, the pricing model tends to be one-dimensional. The result is usually some kind of user-based pricing model that charges each client $x per user/seat per month. It’s simple, clear, and transparent. Most importantly, it removes any impediment to speedy customer adoption and revenue generation.
But the downside of this approach is that a basic user-based pricing model can attract customers that aren’t necessarily profitable or beneficial to a startup’s long-term success. It also may result in a startup discounting its product or service before giving the market a chance to price it fairly.
At Companyon Ventures, we invest in companies at the post-Seed/pre-Series A stage. This is when a startup has found product/market fit and is ready to grow sales. We tend to invest when a startup has reached at least $1million in revenue. It’s at this stage that companies are typically ready to revisit the pricing model.
As you read this, you might be thinking: “Well, hey now, this is a startup that has some solid revenue and just completed a funding round. Why fix it if it’s not broken?”
While having lots of customers and a growing customer base looks good in a slide deck, it doesn’t always translate into good long-term value. Consider that for every customer you have, there are likely fixed and variable costs associated with providing the product or solution to that customer. If that customer is not a long-term paying customer or would be interested in other future services, they may not actually be profitable to the company.
We think of it in terms of good customers and bad customers. Good customers are long-term multi-year customers who are advocates and buy more from you over time – in effect boosting your net positive churn. Bad customers want the lowest price, complain the most, and churn over time resulting in net negative churn.
When we begin working with our portfolio companies, they are emerging from the find-product-market-fit stage and are approaching what is starting to become known as the go-to-market-fit stage (hopefully someone will come up with a better name) – otherwise referred to as the expansion stage.
We find that nearly all of our companies are ready for the next stage of pricing maturity and evolution to attract the ideal customer.
This expansion stage involves pulling back the layers of your company and asking: Who is the ideal customer?
Most of the time, the ideal customer is a larger client or one with sharper needs and the potential to generate more revenue. After a startup figures out who the ideal customer is, it is time to determine the right pricing model. There are usually two solutions:
- Selling More Seats: In some cases, it may make sense to continue with user-based pricing if you can scale this model with larger customers. This is referred to as “selling more seats,” and it’s relatively straightforward. One of these larger customers could generate the same revenue as five smaller customers. It also may improve efficiency because you are still only servicing one customer even if it’s more work than your smaller customers.
- Usage-Based Pricing: The goal here is to vary the per-unit price in order to get more revenue from the same base unit (number of seats). As you might be able to guess, this model refers to charging based on utilization or consumption. The most basic example is pretty old school when you think back to cell phone companies charging customers based on how many minutes they used their phones. That could simply be raising the price per unit in user-based pricing because the startup feels they have proven out their concept or seen a very positive market reaction where demand drives up pricing. A more complex approach is to create a two-dimensional model, with the combination of unit and consumption based pricing (e.g. number of seats coupled with volume based consumption to get to tiers of unit pricing levels).
As we go through the expansion stage, we are finding that while selling more seats is easier to understand and more widely acceptable, usage-based pricing is gaining traction and starting to be looked at more favorably in the right scenario.
But this model has also now been applied in advanced ways to some pretty progressive companies. Remember Snowflake? The cloud-based data storage company went public at the end of 2020 and completed the largest software IPO ever. Their pricing model works by charging companies based on how much data they use.
The thing to understand about a usage-based pricing model is that it’s not for everyone, and several key components can make or break the model. Namely, the metric you base your pricing on – such as storage used or API calls made.
I know I’ve just thrown a lot at you, so I’m going to give you some time to digest it. In part 2 of our pricing series, we will investigate how pricing evolves in the expansion stage, the key questions to ask when developing your pricing model, and how to run an actual pricing model evolution discovery with customers and prospects.
Firas Raouf is a General Partner at Companyon Ventures Companyon Ventures invests in category-leading seed-funded B2B software startups that have found product-market fit and are ready to scale. The firm advances companies to an outsized Series A through an immersive expansion program resulting in repeatable and scalable go-to-market execution. Companyon’s expansion program employs playbooks and tools used by top-performing startups executed by a curated team of B2B SaaS practitioners who work for CEOs to deliver output and outcomes.