On The Connected Enterprise podcast, Dan Balcauski from Product Tranquility discussed helping B2B SaaS businesses define product pricing and packaging.
Great to be here, Carl. I've spent my entire 20-year career in software. I’m a founder of a consultancy in Austin, Texas, called Product Tranquility. We help high-volume B2B SaaS CEOs define pricing and packaging for their products.
But I started more on the value creation side of software versus the value capture side I'm on today. First, as a software engineer writing code, I did low-level driver development. I have blue-screened more Windows machines than I can count. Then I went into engineering management and ultimately became fascinated by how our products created customer value and turned into dollars for the business.
That led me to pursue my MBA. I didn't realize it, but I was lucky. My program was widely recognized for its excellence in marketing, but I didn't discover until recently that few MBA programs have courses and prices. I received my theoretical grounding there. During my internship, I worked for a successful Silicon Valley startup with a problem on the CEO's desk.
Basically, it was deciding if they should do a freemium approach. I looked at it in depth, and it’s generally a terrible idea. That threw me into the real world of pricing. After grad school was product management/strategy, but the company I worked for acquired a bunch of other smaller companies and tucked them into our portfolio.
I usually managed three to four products, so I saw the mistakes early-stage companies made in their product management strategy, pricing, and packaging. Now I help founders, CEOs, and their teams build sustainable businesses and get their products to as many customers as possible.
I’d never met a pricing specialist before I met you.
There aren’t many of us.
I wouldn't think so, but maybe there's a need for it. Tell us about your ‘3 Cs of pricing,’ please.
I can’t take credit for the 3 Cs of pricing, but they stand for cost-based, competition-based, and customer value-based. It’s often called value-based pricing, but we can’t change it because we'd drop the C, which would be no fun for marketers, who love acronyms.
These are what we call pricing orientation, and pricing orientation is “How is pricing done around here? What things do we look at when we're trying to determine pricing and packaging?” I look at the cost-based, competition-based, and customer value-based pricing as a ladder. You can't jump to the end of customer value-based pricing without taking the other rungs on the way.
We're trying to look at different inputs that would influence how we create the pricing and packaging we set for our product. Most folks start with a cost-based pricing example. Very simple and clear cut. The data you need is generally within the firm. And even if you're doing a value-based pricing approach at the end of this, the data can help you set a price floor below which your pricing is unprofitable. But it has a bunch of drawbacks.
Your customers don't care about your costs—they only care about their problems. It seems very quantitative, and the finance accounting types like it because you get a spreadsheet with the cost of goods sold and markup, and it looks very scientific.
But it’s qualitative because although the output is a quantity, your markup for a cost-based approach is qualitative. Adam Smith, economic God, didn’t go to your CFO and say you deserve an 80% gross margin or 30% or whatever. You've made that up. So it seems quantitative, but it’s qualitative.
Ultimately, there's no consideration of customers’ willingness to pay, or your products’ perceived value, or your competition. So those have drawbacks, but it’s a fine place to start because if you’re pricing below your costs, you can’t sustain your business without unlimited venture capital or private equity funding. You can't lose money on every sale and then make it up on volume—you must eventually turn a profit.
Then we graduate to competition-based pricing. Like cost-based pricing, it’s a relatively simple concept. We're immersing ourselves into a market dynamic of, “What’s available to our customers as they're considering a purchase?”
It opens up aperture data. It’s not as readily available as in cost-based pricing, but it’s usually straightforward to collect. There may be different markets that are more transparent or opaque that make it more difficult, but you can get the data. There are drawbacks to a competition-based approach, though it generally outsources your pricing department’s work to your competition.
I don't know any CEO who would happily give their competitive CEOs the driving controls of their product or acquisition strategy or marketing collateral. But if you rely on your competition—only you're fundamentally giving that power to your competition to help drive—it assumes your competitors have done their homework. I learned early in my career not to get caught up in your competitors' announcements of new features.
Because that assumes the product managers have done their homework. You don't know if the new feature was a bright idea the CEO had on a golf course, a chat with his buddy, or an unresearched machination of some product leader. So, if we outsource our competitors, out-pricing our competitors doesn't help us that much. It has the same drawbacks as cost-based pricing. It doesn't consider customers’ willingness to pay. That could be challenging if we're in an opaque market where competitive data isn't easy to get.
And finally, we get to value-based pricing. I want to stress that you can't get all the way to value-based pricing without going through the other two because you need to understand your costs and competition to do value-based pricing.
But what we're layering on in the value-based approach is a customer focus. We're trying to align our company's profitability with the value our customers receive from our product. Most research supports this as a superior way to price products. It's a north star to shoot for—never to be attained because it’s difficult. And the most recent studies show that only about 20% of companies do true value-based pricing. Because it's difficult. You need a mature understanding of your market.
Again, there are cons. It requires an internal organizational reorientation of your pricing philosophy. You could think of it as a go-to-market model. You can't have your pricing team go into a back room somewhere and then spring out on the rest of the company and your market, “This is what we realized our customers would get.” It needs to be supported by an entire value philosophy throughout the organization. You need value-based selling, messaging, and customer success for it to succeed. And it demands a deep understanding of the market customer segments you serve via research, which can be more costly in terms of time and money. That’s why it's maybe less adopted.
It's interesting. But how do you discover what the value is? Who's going to tell you that? And it’s a moving target, right? In SaaS, as we started doing things in the cloud, people would try to do ROI evaluations of if it’s cheaper/more cost-effective to do it on-premises versus the cloud. That didn't always work. Now I think they're looking at, “What's the value of the cloud?” And that’s still a moving target because it hasn't been that long. We don't have all the knowledge yet. So, how do you get at what the value is?
There’s a joke about three umpires. The manager says to them, “I don't understand how you call balls and strikes. It's a mystery.” The first umpire says, "It's easy. I call them as I see them." The second umpire says, "I call them as they are." And the third says, "They ain't nothing till I call them."
So, we can think about value through these views. The first umpire is taking the perspective that values exist. It's like the temperature outside or your heart rate; people perceive them and report them as best they can, but maybe with some bias. The second umpire has taken the perspective that people know their values and preferences directly like they know 2+2=4. The third umpire believes values are preferences constructed in the process of elicitation.
We see this in our lives, maybe not explicitly, but it’s a whole keeping-up-with-the-Joneses phenomenon. Your neighbor pulls up in his new car, and even though you didn't think he needed a new car, suddenly, you need a new car. So the elicitation is indirect/implicit, but suddenly, our wants—our values— are getting drawn out of us because of our external environment. We see this a lot in terms of whether you have more of an enterprise-type sales motion. And I deal with this a lot in consulting.
They haven't thought through the implications of why. So what this comes from is understanding that value comes from our process, which is asking customers about their businesses. The trick is to drive the discussion to a dollar sign and get an answer to financial value. I generally focus on B2B, so that’s more possibility. If you're in a B2C market, you might deal with more intangible values like a brand or emotional and social outcomes that might be more difficult to get to.
But in B2B, we can probe for understanding: What are the most pressing problems and issues around the product or service they're exploring? What are the solutions they're using to address those needs now? How do their current solutions cost them in time, money, or opportunity? What’s the estimated magnitude if we could address those cost savings? How might they save additional time or money or realize additional monetary gains? It comes from deep conversations with customers to get out of them where and how they create value for their customers. What does their process look like?
I've done that work with clients in the consulting business, but it's the unusual sales professional who can have deeper conversations with customers about value. I think that's why the value-based approach is more uncommon. It takes so much work, and you have to somehow take that and filter it back. It must make that full circle for those deciding on pricing to factor that in. So, if you had 60 salespeople and two or three doing it, those two or three need to get that information back to the leadership for input.
Ultimately, it depends on the product or service you're engaging in for consulting offer. It might be too customized to be copy-paste. But what you might do instead, if you’re the product companies I service, is have your product team, pricing team, or product marketing team doing in-depth investigations with customers in your market. It could be prospects or people in your ideal customer profile that might not be customers yet, but you want deep elicitation conversations.
One of the fundamental pillars on which I base a lot of my pricing and packaging work is customer segmentation. The idea would be this expeditionary force is going ahead, having in-depth conversations, and synthesizing that into personas that represent the different customer segments that help the rest of the team grasp at a high level. Here are the value drivers, here's what these customers care about, here's why their context dictates the value our product can help them achieve.
That can turn into other sales enablement collateral, whether that's demo scripts or qualification questions, to determine what kind of customer you’re dealing with. This isn’t an easy skill. It takes a lot of practice, and it's not something everybody can do. If you have it in that scenario, you can have some of that early work enable the rest of the company.
I've found that even the customers don't always know how to answer the questions. They just know it hurts. They don't know how to value that in terms of that cost internally. Do you think the concept of pricing gets enough attention in companies?
Absolutely not. Some statistics say that even among Fortune 500 companies, 75% don’t have a dedicated pricing organization. And something like a third have no pricing titles. I was working with a SaaS CEO recently. We're discussing an engagement, and in the proposal process, they had a three-day exec strategy meeting offsite. The week after, I met with them and said, “Based on those three days, what’s changed regarding this pricing project we're discussing?” He said, "We didn't discuss pricing." Can you imagine three full days of strategic planning with your entire executive C-suite, with 0% of that time devoted to pricing?
There are three ways to grow your SaaS business: acquisition, monetization, and retention. Way too often, companies put all their focus on acquisition. We may see that shift with some of the macro changes out there. Retention is becoming dear to folks. Acquisition has been harder to come by, and monetization is growing as a growth lever, but that's been a downfall or a lack of taking the appropriate measures for that large growth opportunity.
For sure. Who is typically responsible versus who should be responsible for pricing decisions in most companies?
One fundamental problem is an entire lack of pricing process or governance. It's nobody's problem directly, even though everyone's affected by it. Even if someone recognizes an issue, there's usually no systematized process to address it. But absolutely somebody should own it. What are the checkpoints? At the early stage of a company, the founders own pricing because there's no one else to do it. They're writing the code, making the sales, writing the marketing copy—they're doing everything.
As those companies evolve, they need more engineers to write more code, more salespeople to make deals, more marketing people to do the marketing, support people to help customers, etc. But as you imagine that as a role scale, at no point is there a, “Let's bring a pricing person in.” My rule of thumb is that $200M in revenue and multi-product is time for a full-time pricing person.
So the founders handled pricing, but then they got busy with everything else, and now no one’s explicitly responsible for it. I recommend that EMM own pricing and establish a pricing committee or council. They’re best positioned to hold the strategic aspects of the company in mind. What are the long-term goals? PMM is usually responsible for the ownership and caretaking of positioning. And pricing is a function of your positioning, so it makes sense to have those as a shared home. They usually have a good sense of what the value is because they’re responsible for the positioning and, therefore, the messaging, and they can have some of the insightful conversations we discussed earlier.
How does the company tell if they need to fix or optimize their pricing? When is it time? It gets ignored a lot, but eventually, there are discussions about raising prices. “Is it time? Can our customers stand those prices?” Do you have a basic rule of thumb?
There's no magic number to say how often. Some of the high-level strategic questions I might ask are, “Are you meeting your goals? Is pricing getting away in the way of those goals? If you recently implemented a pricing change or increase, did it succeed? Are you losing deals? Is price playing an outsized role compared to other factors?” Tactical questions I might ask would be, “Are too many customers buying and staying in your entry-level plan? Are too few customers upgrading or expanding? Is sales regularly selling something that’s customized for each deal?” There are many strategic questions. Even, “Is pricing creating internal friction between different aspects of the company or different operating units?”
Is there a magic number or magic time to change your pricing? Generally, no, but I don't think companies do it often enough. It makes sense to revisit it at least once per year. But companies are constantly improving their products. And if we think about pricing, one of its fundamental relationships is to value. Your value is constantly changing because you’re constantly improving your product. You're shipping new releases, adding new features, etc.—and so are your competitors. Your differentiated value is changing. I can’t say, “You should do it at this time, like clockwork,” because it will depend on so many things. Did inflation just spike to historical numbers that haven’t been seen in 50 years? Has your competitor massively changed how they go to market? And you might have more structural issues to address in real-time. But generally, I’ve found that companies that revisit their pricing capacity more often grow a lot faster.
You work with companies creating new SaaS software. With a new product, it seems like it's critical to get it right out of the box. But what I've seen with existing products is they could have a 10-year shelf life already, and they've added a thousand new features. But the license price hasn't changed from day one to 10 years later. It's still the same basic cost to the user. Is it more difficult for people to raise prices on an existing product? Do they get fixed in a spot?
When pricing new products, the level of rigor I see most companies apply needs improvement. But there’s also a big fear around pricing and packaging. Such as that it must be perfect or we can't do anything to it. It has this reputation of being more magical voodoo than it is. There's art and science, but it's more science than art. Several things happen. One is that pricing is, in many ways, opportunity cost—and opportunity cost doesn't show up on your P&L.
Every month the COO sits down with the VP of engineering or CTO, saying, “Look at these AWS costs. What are your engineers doing? We have to improve this because these bills are spiking, and that's a direct cost that person gets on their desk, and they're probably incentivized.” Part of their bonus is how they help control costs. Whereas if the company is selling—for example—at $10/user and they could sell at $100/user, nobody sees that. There’s no invoice on the president and CEO's desk that says, “We're losing 90% of our revenue to what we should do with our pricing.” That’s a major issue where it's out of sight, out of mind combined with it looks like black magic. People are afraid to touch it.
I think it's difficult for people to increase prices, but sometimes you have to. Things can't be the same forever in terms of value, right? Or maybe prices need to go down—maybe something doesn't have as much value as it used to have. When you raise a price, how do you communicate that with customers and execute that throughout the company?
You have to look at signals to determine if it's a good idea. Then I can talk about how to execute some of those. And your prospects should push back on pricing; you should see some healthy pushback and deals lost to pricing. Hopefully, you're tracking win-loss codes and win-loss systems as they're maintained by sales in your CRM. I’d never view them as the God's honest truth—anything maintained by the person who lost the deal will have some bias. Plus, they won’t have full information because of their relationship with the lost prospect.
A healthy rule of thumb would be that you lose about a third of your deals to price. And if you look in your win-loss codes and see none are getting lost to price, you probably have a good signal to raise your prices. Other signals are if customers tell you how cheap you are or how crazy of an ROI you create for them, if you haven't touched your pricing for years, and if you've improved the product dramatically without additional monetization. I see it a lot.
One thing that's happened has been that as the economy was expanding and going gangbusters over the last couple of years, we had a seat-based pricing model. Like Salesforce. Every sales rep who has access to the CRM is charged a user license.
So as people are adding headcount, that's a beautiful tailwind for the companies with that business model. But macro conditions change, and those tailwinds turn into headwinds. Companies start to reduce in many sectors, which becomes a challenge. And these companies have realized that in a massive bid for market share, we were just “add value, add value, add value,” without monetizing it. So they added automation capabilities, and we see a lot of discussion of AI, and companies are thinking, “Wow, not only can we make do with fewer people, it's even better than we thought—our current people are way more efficient.” Companies have sowed the seeds in their own demise because they bid to add more value without monetizing it, and they're reaping what they've sown by not monetizing effectively.
Those are signs I’d look at. When you think about changing prices, one thing I’d apply to almost any business decision is thinking about customer segments. The easy one to think of in terms of a price change is new business versus current customers. There could be an interesting philosophical argument that if you change your new list prices, say, on your website for people who aren't customers, did you really change prices? As a pricing nerd, I sometimes track people's prices because it's interesting and useful for my job, but most people aren’t doing that. Price changes for non-existing customers are less worrisome to most leaders than changing prices on existing customers.
Our plans can be different for both of those. For existing customers, I want to think through potential announcements and timelines for changes way in advance. There’s one thing we run into in B2B cases that we rarely run into in B2C cases, like Netflix. I bet the price per account for Netflix looks like a uniform distribution—most everyone's paying $10 a month, but there's a little bump in variation for different packages. In B2B cases, probably 20% of your accounts make up 80% of your revenue.
There, we probably want to consider the 80% of accounts that are 20% of our revenue as test rollout cohorts of our price change messaging. Then, by the time we get to our very sensitive enterprise accounts, we have a good playbook. We know what objections we’ll potentially run into. We have give-gets we've armed the sales team with. We have our messaging down pat with multiple negotiation plays available. We're not just a poor sales guy on the phone with our largest account at JP Morgan, and he's having a conversation for the first time. That’s not a recipe for success.
There's a lot of debate about grandfathering. Grandfathering is if you make a price change, the change should leave existing customers on the old plan. There’s no one-size-fits-all answer. You must weigh the positives and negatives, but ultimately, there’s a cost to maintaining customers on legacy pricing, like complexity in invoicing and revenue systems. But there are many ways to approach this, and if you’re strategic in terms of segmenting those customers upfront, you can create more nuanced plans that help you grow the revenue you hope to gain by your price change.
Dan, this has been great information for companies dealing with customers and product pricing. We appreciate your time today. Thanks for sharing with us on The Connected Enterprise.
Thank you for having me, Carl.
You're welcome. And to everyone else out there, till we meet again—stay connected.