Startup diary: Don't leave money on the table by having wrong price structure
This week I'm looking at the final term of the 'fundamental equation of SaaS': average revenue (per user).
The equation breaks down expected new revenue for a Software-as-a-Service business into three terms: acquisition (how many people visitor your site), conversion (how many sign up), and this week's term, average revenue (what each customer pays you, on average).
Multiply these together and you can estimate your new revenue.
The real value of the equation is that it gives you a driver for action.
For anything that you do in the business, you can always ask the question: does this improve acquisition, conversion, or average revenue.
In the last couple of weeks I covered the other terms, so let's now turn to average revenue.
When you think about averages, you need to think about them in the right way.
It is all too easy to interpret average revenue as the amount of money you get from each customer, 'on average'.
In practice you, have a wide distribution of revenue for each customer. Many will pay a little, and some will pay a lot.
The average is only useful to summarise overall sales and help measure your general effectiveness by predicting new revenue.
To actually find that average, you need to pay attention what customers on the ground are prepared to pay you.
In our case, where Voxgig is an event management platform, we can't expect small companies that run small conferences to be paying us thousands of euros each year.
But they will pay hundreds, and get great value.
Conversely, a Fortune 500 company that uses our system to manage all of their exhibition activity could easily generate six-figure revenue, and not even think about optimising the cost - we're still a rounding error in the overall scheme of things.
The biggest mistake you can make with pricing is to forget this dynamic and leave (lots) of money on the table.
In my first company, I started with a flat rate per user licence price of $50.
But my software generated very much more value for big companies than little ones.
That means that a five-person team in a big company was getting extraordinarily good value, and would have been happy to pay much more. I eventually learned my lesson, and created a pricing structure that meant big companies were paying my $5000 - that's a lot of money left on the table.
This lost money, which economists call 'consumer surplus', is the driving force in designing your customer segmentation for SaaS businesses.
That's why you nearly always see pricing schemes that offer basic, professional and enterprise tiers.
A small company won't be turned off by high enterprise pricing, and a big company won't really care, so long as it's within budget, and they can get 24/7 support. Pricing tiers are just the beginning, however.
You also need to think about your pricing axes. A pricing axis is the supposed rational basis on which you build your pricing. For example, you could charge a per-user per-month fee.
Many services do exactly that. In the events world, you could charge per-event, or take a percentage of the ticket price.
A pricing axis is just some way of measuring usage that lets you charge more when customers use more.
Sounds nice, but can you spot the money left on the table?
If you are starting a business, it's good to learn from the mistakes of others - they are far more valuable than the successes, which could just be dumb luck.
Mistakes and failure are definitive and real. In thinking about our own pricing (and we're still hard at it - thinking, that is.), I came across a great discussion by the venture capitalist David Skok, of the firm Matrix Partners.
David sat on the board of HubSpot. HubSpot is the mid-market alternative to Salesforce and provides customer relationship, inbound marketing and sales tools to mid-size companies. It's a great market that is not only very big, but much easier to sell into than very large companies. (For more from David, check out forentrepreneurs.com.)
When I say mid-market, I still mean very big.
HubSpot's original pricing (which was essentially flat rate), did not capture the large extra value they where creating for their larger customers.
The solution they came up with was to create multiple new pricing axes.
In particular, they started charging also on the number of sales leads - these would of course be many more in larger companies.
This new pricing axis, leads, measured they value they were providing more accurately, thus allowing them to increase Average Revenue per user.
They didn't stop there.
There are many potential pricing axes if you think about it. You can charge for extra functionality, more support, marketing promotions-there's no end to the ways you can segment customers.
Ideally, you end up charging each customer exactly what they can afford, which fully maximises revenue. In the real world, you'll never get close to this ideal, but you can walk a long way down that road. As I noted in a previous article, 'average' thinking is extremely dangerous.
You need to dig into your data to really understand what is going on- there's no substitute for understanding your customer - if you've ever had the pleasure of Michael O'Leary personally checking your Ryanair ticket at the airport gate, you'll know what I mean.
Marketing update: Our speaker's newsletter has 5513 subscribers, and open rate of 12pc.
The EventProfs newsletter is now at 206 subscribers and an open rate of 48pc (still just statistical noise), and the podcast is at 67 downloads.
As we are now running meetups for event professionals in both Dublin and London on a monthly basis, I'm going to start giving you the attendance numbers.
For the most recent events, both held in January (search meetup.com for 'eventprofs' to find upcoming events), we had 38 attendees in Dublin, and 21 in London.
Richard Rodger is the founder of Voxgig. He is a former co-founder of Nearform, a technology consultancy firm based in Waterford