Slack has won a lot of attention over the past few months, mostly for its high valuation and rapid growth, but there is much more to the Slack story than this.
Slack is solving the internal communication problem through an elegant use of channels, search, tags and document sharing. But it is doing more than this. It is also rewriting the rules on pricing in a way that will impact everyone who has a subscription revenue model.
We use Slack at TeamFit for a variety of things and are planning to integrate, so we have had a paid subscription for quite a while. I administer the account. So I was delighted to get this e-mail from Slack.
Now, like most people, I have had trouble with companies that make it hard to change a subscription (‘a commitment is a commitment’ they tell me). So I was surprised and delighted to be working with a company that automatically gave me a credit for reduced use. It makes me more loyal to Slack, and more willing to commit to higher levels of subscription, as I trust they will be flexible and act in my best interests.
Is this an aberration? Something that other SaaS companies can ignore? Is it an end state? Or could it be a transition to something else? I believe it is the latter.
Evolution of Software Pricing Models
(Note: These are representative companies — of course Oracle now has many offers based on subscription models.)
Once upon a time people sold software by perpetual license and installed it on the customer’s hardware. This was great. The seller got a big lump of money upfront and the buyer got to capitalize the cost. The problem was that the seller had little insight into how much the software was being used. And this led to the transition to subscription models, which, combined with hosting software in the cloud, is now the new normal.
Today, leading SaaS companies are subscription-based, and companies like Zuora are building substantial businesses around the ‘subscription economy.’ Subscriptions are popular because they provide both predictability and a way to commit in well-defined increments. I can commit for a month or a year, and I am generally offered levels of subscription to choose from. As a buyer, I like this as subscriptions give me cost predictability. Most companies have budgets that they use to pay for subscriptions and budgets require predictability.
The vendors also like predictability, and so do their investors. The standard list of SaaS metrics, including MRR (Monthly Recurring Revenue) and LTV (Lifetime Value of a Customer) are measures of predictability. In an uncertain world we all want a little more certainty, and subscriptions give us this.
Adaptive Pricing or Bust: Slack’s Formula for Disruption
Hosted subscription models contain the seeds of their own disruption. Good SaaS companies generally have a well-developed API strategy and integrate with many other services. There is now a lot more data available to make two critical calculations:
- How much value does this service provide the customer?
- How predictable is usage?
If we know these two things we can change our pricing models.
*The Risk Discount
Willingness to pay goes down when a buyer is unsure of how much their company will will use an application or how much value they will get. Vendors try to address this through free trials and proofs of concept, and examples from other similar companies, but there is usually lingering doubt, especially among early adopters and early main-street markets.
When willingness to pay is low the vendors pricing power is low, and they address it through lower prices or discounts. This is why early-stage companies can often only charge for a very small part of the value they create for their customers.
If we know how much value we are providing we can develop a pricing model that tracks the value to the customer. This removes risk for both parties and will lead to higher profits (you may not know it, but your current subscription price has a ‘risk discount’ built in*).
And if we can predict use we can predict a) revenue (for the vendor); and b) cost (for the buyer). This predictability is needed for widespread adoption of value-based pricing.
I have been told that Slack has very good analytics to predict future use and that it uses these to adapt its pricing to optimize revenue and renewals. Is your SaaS company doing this? If not, you better get started. Because adaptive pricing models like Slack combine the best of predictability and adaptability. And I now expect all SaaS companies to offer me a credit for reduced use. (Thank you Slack.)
As a growth company, what do you need to do to prepare for and make sure you’re on the right side of this transition?
- Start giving users credits for lower levels of use (your users are going to demand this anyway, so get ahead of the game)
- Develop models for how you create economic value for your users, then see if your software can actually track them (and look for the integrations that help)
- Invest in predictive analytics to predict future use and future value to your customers
- Find a pricing metric that tracks your value metric (see my previous post “How to Disrupt Your Market with an Innovative Pricing Model”)
- Test your business model to see what adaptive pricing will do to your cashflow
The shift from perpetual licenses to subscriptions put a lot of pressure on incumbents and opened a huge space of opportunity for innovators. The shift to adaptive pricing and then to value-based pricing will do the same. Companies wedded to conventional subscription models will end up as roadkill.
More Pricing Tips from Steven Forth
- B2B Pricing Black Magic: Appealing to Economic AND Emotional Needs
Steven explains how to achieve a potent, irresistible B2B pricing formula by aligning economic and emotional value along the technology adoption lifecycle. Read more.
- How to Disrupt Your Market with an Innovative Pricing Model
Going up against an established competitor? A disruptive pricing model can be one of the most effective tools you use to differentiate yourself. Read more.
- Your 3 Pricing Strategy Choices: Penetrate, Skim, or Follow
The hardest part of startups is making choices. But choosing a pricing strategy? That is actually pretty simple. The hard thing is the discipline to stick to your choice. Read more.