How to think about pricing in SaaS Part I: Understanding your customer base
Updated: Jan 25
Pricing is a nuanced part of SaaS - it can often make or great several key metrics - LTV (lifetime value), earnings, revenue, and more. However, most SaaS startups spend a mere 6 hours deciding pricing - which is astonishingly short considering how a company’s sales channels, market fit, and product are all affected by pricing.
We think a good place to start with pricing is understanding who your customers are, and how many of them there are. We took at a peak at an article written by Brian Balfour, a former VP of growth at Hubspot, who created a simple framework for how to think about pricing for company success - the framework he used to help push Hubspot to $100M ARR and beyond. Once Hubspot had figured out a good product-market fit, they had to find a good pricing model and channels to complement their product, which they did using the average revenue per user to customer acquisition cost framework, or the ARPU-CAC framework.
In the graph below, you can distinguish different customer groups by how much they’ll pay for your product - average revenue per user (ARPU) - and the number of customers out there (another way of expressing CAC). The basic principle of the ARPU-CAC spectrum is that the higher revenue you generate per customer, the more effort and money you can spend on customer acquisition. Elephant companies selling large, expansive products to high-paying businesses, rely on high prices to support direct to enterprise sales, and very rarely offer a freemium product. On the other hand, a mouse company that sells a small product into the enterprise, can sell a moderately priced product to a modestly large customer group using freemium/self-serve pricing models in conjunction with traditional sales.
Hubspot identified themselves initially as a mouse company, one that targeted a broad set of lower ARPU customers - small businesses and business owners. Leading with freemium, self-serve pricing, they grew well in that customer segment. However, they eventually realized that their marketing was more focused on larger, mid-market customers. They shifted away from being a mouse company, and towards being a moose, removing lower-tier pricing options and doubling down on the middle market. Pricing is a vital part of your company’s “fit”, one that also interacts with your market, product, and channel fits.
A great example of an elephant company is Palantir, the data analytics company that serves the NSA, FBI, and other large organizations, has an ARPU of $4.3 million per year. In fact, they only have 125 customers, despite being a $45 billion company by market cap. These large contracts mean that selling Palantir services isn’t transactional - it’s a big decision that likely requires bespoke pricing, feature sets, and heavy effort on the sales side. Moreso, reliance on inbound channels is less likely - far more customers will sign themselves up for Hubspot or Shopify before Palantir’s next client decides to sign a $4.3 million contract for Palantir’s products on their own. Elephant companies like Palantir can’t rely on self-serve models for growth, rather deliberate effort from field salespeople, and dedicated account representatives.
Conversely, a mouse company with low ARPU, low CAC products is Atlassian, the project management software company. When they went public in 2015, ARPU was $5594/year, putting it in the bottom quartile of SaaS companies - with 48,000 customers at this point, they famously only spent around 20% of revenue on sales. This was unprecedented at the time, with Atlassian operating on a primarily self-serve model. Atlassian was able to get away with having a small sales team because of their modest ARPU - their product could land small footholds in teams with their free or low-cost products, and then expand further into the enterprise from there. If they were selling million dollar contracts, self-serve wouldn’t work, precisely because you need salespeople to land expensive, high-revenue clients. Moreso, having cheap, tiered pricing allows a gradual expansion of the product without a sales team intervening.
Deciding how to price a product in SaaS means understanding what you are truly selling to your customers. When you’re selling expensive solutions to consumers you're forced to focus on a smaller, more valuable set of users. On the other hand, if your product is a smaller, self-sufficient product with a large user base, you likely don’t have the luxury of charging higher prices. Rather, cheaply priced plans for many users works best - it’s a reflection of how transactional your product is.
Identifying the right spot on the spectrum for the target market is the first step to designing the right pricing models, sales strategy, inbound channels, and business structure that fits the market, the product, and your business.
We would like to thank Jordan McBride, Danny Chrichton, Brian Balfour, and Tomasz Tunguz for their inspiration.
This article is a collaboration between Archit Bhise and Alex Li.