Pricing
What is Value Based Pricing?
You’ve created a unique and valuable SaaS product that customers are sure to love.
But how do you know how to price it?
There are a couple of standard methods. One is to determine your price point by calculating the cost of supplies and labor and adding an additional cost on top — what's known as cost-plus pricing. Another is to base your prices on competitor pricing.
These methods work perfectly for some types of products, but they're not ideal for SaaS. They don't accurately reflect the value that your product brings to your customers.
Luckily, there’s a way to give your customers what they want for the price they’re willing to pay: value-based pricing.
This article introduces value-based pricing and shows you how to create a value-based pricing strategy.
What is Value-Based Pricing?
Value-based pricing , also known as value-added pricing or value pricing, is a method of setting prices based on your customers and how they perceive the value of your product. The more your audience thinks your product or service is worth, the more you can charge.
For example, a famous painting or a meal at a fine dining restaurant might come with a high price tag. This isn’t because the materials used to create the art or the food were costly — it’s because consumers believe the final product and experience attached to it to be worth a lot.
Value-based pricing is differentiated from other pricing strategies because it's exclusively focused on the benefits your product offers a customer. This sets it apart from cost-based pricing, which focuses on what your product costs to make, and competitor pricing, which focuses on the existing price points in the market.
Value-Based Pricing vs. Cost-Based Pricing
Cost-based pricing, also called cost-plus pricing, involves calculating the cost of producing a product and then setting the price of the product a bit higher than that.
Cost-based pricing has a few upsides. For one thing, it’s simple. It doesn’t involve as much research and analysis as value-based pricing — you just calculate your costs, tack on a “little extra” — typically at least 50% — and you’re good to go.
This method of pricing also guarantees, by definition, that you’re covering your cost and also adding a profit margin.
However, cost-based pricing has limitations, especially for SaaS companies.
The amount that customers are willing to pay has nothing to do with your cost of production. They’ll pay more for a product they value highly. That might be because it solves a certain problem in their business or a variety of other reasons.
Say it costs $20 to make a product. Using cost-based pricing, you mark that up to a price of $40 to cover some of your other operating costs as well. But what if customers think your product is worth $100? You’ll be losing money by choosing cost-plus.
Customers often value SaaS products well beyond what they cost to make. If an accounting SaaS app saves you $5,000 in payroll per month, you won’t scoff at a $300 monthly price point, even if the cost of running the app for you is only $20 or less.
Cost-based pricing may be easier to implement than value-based pricing, but it’s usually not as profitable for SaaS companies.
Value-Based Pricing vs. Competitor Pricing
The competitor pricing or competitive pricing strategy means that you set your prices based on what your competitors are charging for similar products. You can choose to set a higher, lower, or equivalent price, but in all cases, you’re setting your prices based on the competition.
Like cost-based pricing, competitor pricing is straightforward and doesn’t require all the research involved with value-based pricing. And if you follow the lead of a successful competitor, you’re likely to end up in the ballpark of what customers are willing to pay.
But is your product exactly like your competitor’s?
SaaS businesses usually work to find their own niche. Competing products are similar, but don’t have the exact same audience or value proposition. If you use competitor pricing, you’re basing your prices on your competitor’s target market and niche, not yours.
It could be that your customers are willing to pay more for the features that make your product unique.
What are the Advantages of Value-Based Pricing?
Value-based pricing is more complex than other options. So why should you bother with it.
Here are a few reasons why a value-based system is worth the trouble.
1. You Build a Better Product
With value-based pricing, your profits are higher when your customer values it more. That provides an incentive to build a quality product that provides more value to customers than your competitors do. In the end, everyone wins — customers get a better version of your product and you make more money.
2. Customer Service Improves
Value doesn’t just come from product features. Customer service is a huge driver of perceived value. Value-based pricing compels you to have best-in-class customer service, which again is a win-win situation for you and your customers.
3. Value-Based Pricing Inspires Loyalty
Value-based pricing is the only pricing method that focuses on the customer experience and customer needs rather than internal or market factors.
Naturally, that’s a business strategy customers like.
They learn that they can count on you to develop the features that they value most. And they don’t feel like they’re overpaying, because your prices are based on what the customer sees as fitting.
When your customers know you care about their needs and their budgets, it improves brand loyalty and trust.
A good example of this is Adobe Creative Cloud, with its $20.99 per month Photoshop plan.
Clocking in at over $200 per year, it’s much more expensive than many alternatives, but the perceived value of the product (that it’s just much better than everything else on the market) drives loyal customers regardless of the higher price tag.
When you sell a better product at a higher price point, people have to justify to themselves why they’re choosing your brand, so they’re open to noticing all the little differences that sets your product apart.
Think of how an iPhone user talks about how “clunky” the Android interface is (barely different, objectively), or how Rolex owners swear by their “high-quality” watch, acting like it has nothing to do with status.
Value-based pricing is a psychological tool you can use to build brand loyalty — but only if you have the product and service quality to back that price up.
4. You Make More Money
Another advantage of value-based pricing is that you can charge more for an identical product. If the perceived value of your product is higher than your current price, your profits have room to soar.
And you have some control over that perceived value. By changing your marketing messaging, building awareness of your company, or positioning your brand differently, you can cause customers to consider your product more valuable than they did before.
Value-based pricing lets you set your prices at the highest amount your customers are willing to pay. Customers feel good about what they’re paying because they perceive the price to be reasonable for what they get.
5. It Teaches You About Your Audience
Understanding your target market is valuable beyond creating your pricing model. It helps you learn which product features to develop to increase the value of your product.
The work you put into researching and analyzing your customers will also provide insights you can use for marketing, sales, customer support, and more.
How to Create a Value-Based Pricing Strategy in 6 Steps
Value-based pricing sounds perfect for your SaaS business, and you’re ready to maximize profits and build customer loyalty. Now how do you actually implement it?
The steps below take you through the process of setting value-based prices from start to finish.
1. Research and Analyze
You can’t adopt value-based pricing if you don’t know what your customers value. Before you can set any prices, you have to learn about your audience.
The best way to find out what your customers want is to ask them. Send out surveys or conduct customer interviews. Ask questions like:
What would you be willing to pay for this product?
How much have you paid for similar products in the past?
How much do you budget for this category of product?
Which features would cause you to pay more for the product?
What challenges does the product solve for you?
How do you decide between competing products?
Other research tactics include reading customer reviews and monitoring brand mentions on social media.
Although your primary focus is your customers, you can also look into competitor pricing and marketplace factors during the research phase. After all, these things can affect how your potential customers perceive you.
2. Build Customer Personas
As you learn about your audience, you’ll probably notice some clear patterns.
For example, say you’ve created a productivity app. Maybe a large percentage of your audience is students, while another significant group is mid-career professionals. These groups both like your product, but they have different interests and needs.
In the B2B world, SaaS companies often target individual contributors, small businesses, and enterprise customers differently.
The next step is to create buyer personas for your main two to five audience segments. A buyer persona (or customer persona or audience persona) is a detailed description of a person who represents a segment of your customers. The persona usually has a name and includes information about the fictional person, including:
Age
Location
Job
Interests
Habits
Pain points and challenges
Budget
3. Create Packages Based on Customer Segments
Look at the customer personas you’ve created. What does each of them want? What do they value?
Maybe your student persona wants the core benefit of your product, but they value a low price tag over fancy features. Meanwhile, the professional persona is willing to pay more for integrations with Google Calendar and Salesforce.
To address the needs, you need to create multiple tiers of your product — put together a package of features for each persona. You’re not setting prices yet — just determining which features will be most valuable to each audience segment.
Think about the biggest selling points for each package. It will be important to communicate these with your audience segments when you roll out the new plan.
4. Set Your Price Points
Now it’s time to set a price for each of the packages you’ve put together.
For example, let’s go back to our Slack example above. Slack probably researched the budgets and needs of businesses of different sizes. They found that small teams were willing to pay around $6 per month for a business communication platform with features like messaging and Office 36 integrations. But they didn’t need more than that and weren’t willing to pay more, so they set the pro tier to $6.67 per month.
Meanwhile, mid-sized businesses had larger budgets and also valued identity management features. So they offered a middle-tier plan offering identity management for $12.50 per month.
Value-based pricing isn’t an exact science. If you’ve done the research, you have the information you need to take a stab at choosing a price. But you may have to adjust later.
5. Communicate Your Plans to Customers
If you’re a brand new business, launching your value-based pricing tier plans isn’t complicated. Just feature them clearly on your website and emphasize the selling points of each package.
But if you’ve used a different pricing plan before, you have to roll out your new pricing in a way that doesn’t upset customers.
The key is to communicate the value of your new pricing plan to each audience segment separately. For example, let your individual and small business users know that there’s a new package that will save them money on your product, and let your enterprise customers know about the helpful integrations they can get if they upgrade to a higher tier plan.
This is an opportunity to collect more data on customer perceptions, so tell people how they can give you customer feedback on the new product packages.
6. Keep Optimizing
Unlike cost-based pricing, which is easy to calculate based on concrete factors like the costs of production, value-based pricing sometimes requires ongoing research.
After you’ve set your initial prices, continue to reach out to customers to get feedback. Find out whether they feel like they’re overpaying and which features they feel are missing.
Also, look for customers switching plans. If all of your enterprises are abandoning the higher tier package for the one you created for SMBs, that means your package isn’t providing enough value to that group.
As your business grows and the word spreads about your product, brand awareness and improved customer perception may allow you to raise your prices. You can also adjust your prices based on new features or add-ons you develop.
What Are the Challenges of Value-Based Pricing?
Value-based pricing has clear benefits, but it’s not the easiest pricing approach to master. Here are a few challenges of value-based pricing.
1. It Requires a Deep Understanding of Your Target Audience
With cost-based pricing, you only need to know how much your products cost to produce — information you already have. With competitor pricing, you just look up what your competitors charge.
But value-based pricing relies on understanding your potential customers’ values, thought processes, habits, and concerns. Gathering that data requires time and resources that not every company has, like having your support reps conduct customer interviews.
2. You Have to Target One Segment At a Time
Another challenge of value-based pricing is that you can only target a limited audience segment with each price point.
Value-based prices aren’t one-size-fits-all — they’re calculated based on the perceptions of one particular group of people. If you target more than one group, you have to put in the work to determine the best price for each group separately.
3. It’s Volatile
Finally, value-based pricing iseasily impacted by marketplace changes.People’s perception of the value of your product can change rapidly. When that happens, you need to update your prices to match the current customer sentiment. That can wreak havoc on your plans and projections.
Example of Value-Based Pricing
Value-based pricing lets companies price products at amounts beyond the sum of their parts. To understand what value-based pricing looks like in the SaaS world, let’s look at Slack.
Slack and value-based pricing
Slack’s 169k+ paid users come from organizations ranging from tiny businesses to Fortune 100 companies, and Slack’s pricing is based on providing value to each.
For example, the Pro plan, which is aimed at small teams, provides features like voice calls and integration with Google Drive. These features are valuable to businesses of any size.
The more expensive Enterprise Grid plan offers HIPAA compliance support, encryption key management, and a designated account management team.
The reason Slack can charge enterprises a lot more isn’t because the enterprise version of Slack is that much more expensive to produce but because enterprise customers value those features highly. Small business customers don’t value those features enough to pay for them, but they value Slack’s basic features enough to pay for the cheaper plan.
When Should You Use Value-Based Pricing?
There are examples of value-based pricing in a variety of industries, but it works best in niches that meet at least one of the following criteria:
You Have Limited Ongoing Production Costs
Software as a service is the perfect example here. You don’t have materials and manufacturing costs to account for every new SaaS subscriber. That makes cost-plus pricing a bad fit.
Instead, you can base your prices on how valuable your customers think your product is for solving problems or improving their quality of life.
Your Product Is Niche
If you and all of your competitors create very similar products, think toilet paper, they’re likely to have similar value to customers. In that case, it’s hard to avoid competitor-based pricing.
But a unique product can be much more valuable to customers. If it’s the only product to solve a particular problem, value-based pricing is a good choice. Your product may not be more expensive to produce, but if it can fill a need that no other product fills, consumers will be willing to pay more for it.
You Plan to Create Add-Ons and Upgrades
With a value-based pricing strategy, add-ons and new features are a great way to increase the perceived value of your product. When you learn what upgrades your customers want, you can create them and raise the price of your product accordingly.
Value-Based Pricing and the SaaS Industry
SaaS is particularly well-suited for value-based pricing, as your product often offers very concrete value (in the form of increased productivity or savings) to individuals or businesses.
Plus, developing upgrades and add-ons is a big part of most SaaS businesses. These improvements generate value in the eyes of your users — even if the cost of developing the upgrades wasn’t significant. Consequently, if you use cost-plus pricing for your SaaS product, you could be undervaluing it. Plus, it can be hard to conceptualize what the costs are in providing the service to each customer in the first place with high up-front R&D costs.
Creating new features and add-ons continually increases the perceived value of your product and, in turn, your profit margin.
Competitor pricing also isn’t the greatest fit for SaaS. SaaS products are often highly differentiated from their competitors — many companies appeal to a specific niche.
For example, LawRuler has a completely different target market from a more generic CRM like Salesforce, so it wouldn’t make sense to use the same pricing. Other SaaS products are brand new ideas and don’t have direct competitors.
When to Use Value-Based Pricing
Value-based pricing is a great strategy for many businesses, including the majority of SaaS companies. You should consider making the switch to value-based pricing if you can say the following:
Your product fills a unique need or has an emotional appeal to customers
You can continually add value to your product
You have the capacity to research and analyze customer data
You stand out from the competition
Conclusion
Traditional pricing strategies like cost-plus and competitor pricing are a good choice for many industries, but for SaaS companies, they could be causing you to undervalue your products.
If you’ve been using cost-based or competitor-based pricing, consider running some experiments with value-based pricing to see how it works for your product. You may find that it allows you to build a better product for your customers and raise your profit margin in the process.
