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Estd 4.22.2023
Introduction
Pricing is perhaps the most critical yet underappreciated lever for SaaS business success. According to Price Intelligently, pricing optimization can have up to a 4x greater impact on your bottom line than acquisition improvements. Yet research from OpenView Partners reveals that the average SaaS company spends just 6 hours on their pricing strategy—total. Not per month or quarter—but over their entire company lifetime.
For founders navigating the complex world of SaaS pricing, understanding the terminology is the first step toward building an effective monetization strategy. This glossary covers the essential pricing terms and concepts that can make the difference between mediocre margins and exceptional profit potential.
Core Pricing Models
Subscription Pricing
A recurring payment model where customers pay at regular intervals (monthly, annually) for continued access to your software. According to Zuora's Subscription Economy Index, subscription businesses grow revenues 5-8x faster than traditional companies.
Freemium
A business model offering basic services for free while charging for premium features. Dropbox, Slack, and Spotify have used this model effectively to drive massive user adoption before conversion. However, Profitwell data shows the median freemium-to-paid conversion rate is just 3.75%, making it critical to balance acquisition benefits against monetization challenges.
Tiered Pricing
Offering different packages with varying features and price points to target different customer segments. Typically structured as "Good, Better, Best" options to appeal to different willingness-to-pay thresholds.
Usage-Based Pricing
Charging based on actual consumption of resources or service (e.g., API calls, storage, data processed). According to OpenView's 2022 SaaS Benchmarks, companies with usage-based models grew at a 29% higher rate than those with purely subscription-based models.
Seat-Based Pricing
Charging per user or "seat" with access to your software. Simple to understand but can disincentivize adoption across an organization if poorly implemented.
Value-Based Pricing
Setting prices based on the perceived value your product delivers to customers rather than cost-plus or competitor benchmarking. This approach tends to produce the highest margins but requires deep understanding of customer value perception.
Key Pricing Metrics
Annual Contract Value (ACV)
The average annualized revenue per customer contract, excluding one-time fees. Particularly important for enterprise SaaS businesses to track.
Average Revenue Per User/Account (ARPU/ARPA)
Total revenue divided by the number of users or accounts, typically calculated monthly. Critical for understanding monetization efficiency across customer segments.
Customer Acquisition Cost (CAC)
The total cost of acquiring a new customer, including marketing and sales expenses. According to Profitwell, the median CAC for SaaS businesses has increased by over 55% in the past five years, making efficient monetization increasingly important.
Lifetime Value (LTV)
The predicted total revenue a customer will generate before churning. The LTV:CAC ratio is a vital health metric, with 3:1 generally considered healthy for SaaS businesses.
Net Revenue Retention (NRR)
The percentage of revenue retained from existing customers after accounting for upgrades, downgrades, and churn. Elite SaaS companies maintain NRR above 120%, meaning they grow revenue from existing customers even without new sales.
Price Elasticity
A measure of how sensitive customer demand is to price changes. Low elasticity indicates customers are less sensitive to price increases, suggesting potential for upward price adjustments.
Pricing Psychology Terms
Price Anchoring
The practice of establishing a reference point (anchor) that influences perception of subsequent prices. Often implemented by showing a higher-priced tier first or displaying "original" prices alongside discounted rates.
Decoy Effect
Adding a strategically priced third option to make one of your primary options look more attractive. Netflix and many SaaS companies use this approach with their three-tier pricing to drive customers toward a preferred middle option.
Value Metric
The unit of value by which you charge customers (users, storage, features, etc.). According to Price Intelligently, companies with proper value metrics grow 30-40% faster than those without.
Willingness to Pay (WTP)
The maximum amount a customer would pay for your product or service. Varies significantly across segments, making customer segmentation critical for optimal pricing.
Price Fencing
Creating boundaries that determine which customers qualify for specific price points, preventing revenue leakage. Examples include enterprise discounts only for companies above certain employee count thresholds.
Monetization Strategy Concepts
Price Localization
Adapting pricing to different geographic markets based on local purchasing power and market conditions. Critical for global SaaS businesses, though requires careful legal and operational considerations.
Grandfather Clause
Allowing existing customers to retain previous pricing when implementing price increases for new customers. Reduces churn risk during price changes but can create revenue complexity over time.
Price Skimming
Starting with high prices to capture early adopters with high willingness to pay, then gradually lowering prices to capture more price-sensitive segments. Common for innovative products with limited initial competition.
Penetration Pricing
Setting initially low prices to capture market share quickly, then potentially raising prices after establishing a large customer base. Requires significant funding and works best in winner-take-all markets.
Expansion Revenue
Income generated from existing customers through upsells, cross-sells, and usage increases. According to Profitwell, companies focusing on expansion revenue grow 34% faster than those focusing primarily on acquisition.
Implementation/Onboarding Fees
One-time charges for setup, implementation, or customer onboarding. These fees can improve cash flow, qualify prospects, and recover costs associated with complex deployments.
Conclusion
Pricing is the most powerful lever SaaS founders have to influence their company's growth trajectory and profitability. A strategic approach to pricing—informed by these key concepts—can dramatically outperform even the most effective improvements in customer acquisition or retention.
The most successful SaaS companies revisit their pricing strategy quarterly, conduct regular price sensitivity testing, and align their monetization model with their core value metric. By mastering these pricing fundamentals, founders can build more resilient businesses with healthier unit economics and stronger competitive positioning.
As Patrick Campbell, founder of Price Intelligently (acquired by Paddle), often says: "Pricing isn't just about charging more. It's about charging right." With this glossary as your foundation, you're better equipped to do exactly that.