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Pricing models never made headlines until freemium came along.
Praised as the fuel for rapid growth of companies such as Dropbox, Spotify, and Evernote, and lambasted as the reason smaller companies went bankrupt, freemium has piqued the interest of developers and CEOs who hope to get as many people possible hooked on their products as possible.
Freemium is free + premium: a good or service that can be offered for free, but ramps up to include premium features that cost money. The concept is basic and widespread: entice enough curious people, accept some early losses, and win over a few remunerative customers for life. An ice cream truck offers free samples; some people stop by to try a flavor, some just take a bite and leave, and others buy large cones for the whole family every summer for generations. Ad for Ben & Jerry's annual free cone day. [source]
Often the path to buying software is not as direct as ordering soft-serve. We want to clear the air about freemium and its place in the SaaS landscape. We'll look at why it works, what happens when it breaks down, how profitable companies have made it fit into their longterm goals, and what the future holds.
This is our Freemium Manifesto—what we consider the right way to do freemium. Consider this guide the final word on how to make freemium work in SaaS from the people that have seen inside more SaaS companies than anyone else. Freemium does have its pitfalls, but done right it can work beautifully to get users into your ecosystem and on the path to upsell.
To start us off in this first chapter we want to see where it all started. Let's look at why companies started offering products and services for free.
Freemium in its infancy: 1982-2000
The freemium model as we know it now can be traced back to the early eighties, gaming culture, and a few press-savvy developers.
Freeware and Shareware
In 1982, an editor at PC Magazine, Andrew Fluegelman, wrote a communications program called PC-Talk. It was a great little program. PC Magazine, perhaps unsurprisingly given its editor, said PC-Talk "is elegantly written and performs beautifully. It is easy to use and has all the features I would expect from a communications program."
But the interesting thing about PC-Talk wasn't the software, but the way it was sold. Or rather, the way it wasn't sold. Fluegelman distributed the program via a service called Freeware. Anyone who sent him a disk in the mail would receive the program in return, and could copy the disk for friends. If they liked it, they could mail Fluegelman $25.
Though slightly different to the model we see today, freeware incorporated the fundamental tenet of freemium: only pay when you get value. If you never liked PC-Talk, you were free to have it for free (minus shipping and handling).
Around the same time, IBM developer Jim Knopf created a program he named PC-File, and followed the same model. He observed, “Here was a radical new marketing idea, and the computer magazines were hungry for such things to write about," he explained. The result: "much free publicity for PC-File."
Fluegelman and Knopf had uncovered the essential nature of freemium: it's a marketing strategy first and foremost.
Where utilities went, games followed. Freeware's model was embraced by gamers who were eager for others to try out their creations. Indie developers mailed floppy disks of games called shareware for other enthusiasts to try out. These disks were later aggregated into catalogues and larger disks for distribution.
Shareware fit into the gaming culture of good will, knowledge-building, and collaboration that was in tandem with the growing open-source development movement (though it's important to note that both freeware and shareware do not make source code available). It's doubtful that software would be as advanced as it is today without those who made their products free. Screens from Blox and Crux, shareware games created for MS-DOS [source]
These DOS games and applications allowed anyone to try them for free. More than that, they had perpetual value. In this sense, they were truer to the real idea of freemium than a lot that came afterwards. PC-Talk, PC-File, Blox, and Crux gave you access to free software and games forever.
Unfortunately for their inventors, they hadn't really figured out the upsell.
The rise of the internet
In 1995, journalist Esther Dyson asked an important question about the burgeoning web: What new kinds of content-based value can be created on the net?
Dyson observed that as the web becomes populated with all kinds of content including executable software, business data, and entertainment, games, and news, intellectual property will depreciate in value.
“The likely best defense for content providers,” she argues, is “to distribute intellectual property free in order to sell services and relationships.”
Boom! In that one sentence Dyson created the most prolific business model of the next two decades: freemium. Distribute some IP for free to get people to pay for something else.
But even by 1995, one company was already making significant headway with this idea. Give a little away in the short term to get a lot back later: AOL. Anyone over a certain age will remember opening their mailbox one morning in the mid 1990s to find an unsolicited disk. It's free, it's easy, it's fun—it's America Online.
The USPS dropped millions of AOL disks in mailboxes around the country, as other postal services did worldwide. Each disk contained a few hours of free time online for users to spend emailing, chatting, and reading the news. Just long enough for you to get hooked on the world wide web. AOL's stunt was so memorable and prolific that the disks are now on display in the Smithsonian. Then came the upsell.
After your 15 hours were up (in the early days, as they transitioned to CDs, you got 1,000 hours free for 45 days!), you had to start paying at about $14/month for continued access. But it worked. From 1992 until 2002, the number of AOL subscribers grew 125X, from 200,000 to 25,000,000.
It worked because AOL had the unit economics done. Though they spent over $300M on disks and CDs, their LTV:CAC ratio was 10:1.
AOL employed the shareware method to bring its suite of services to the mass market in the early days of internet growth. Unlike shareware, however, the disks contained an expiration date, and were not copyable. This isn't yet freemium. Now there is the upsell, but no perpetual value. This model would also become common in SaaS—the free trial.
Boom and bust: 2006-2017
Fast forward to the mid-aughts. Dyson's projections prove accurate, and the web is saturated with free content. Bundled service providers like AOL have phased out and cloud-based subscription services are enjoying their time in the sun.
Enter software-as-a-service. The smartest SaaS providers realized early on that it's not enough to build a product that is novel or useful; the most valuable products need to have compounding value over time, built-in network effects, and a high-performing infrastructure. Even so, people still expect all kinds of online content, including services, to be free. At least, at first.
Venture capitalist Fred Wilson notices a trend among fast-growing SaaS companies and extols the method on his blog:
“Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc, then offer premium priced value added services or an enhanced version of your service to your customer base.”
Wilson calls it his favorite business model, and points to examples such as Skype, Flickr, Trillian, Newsgator, Box, and Webroot as paradigms. At the end of the post, Wilson says:
I would like to have a name for this business model. We’ve got words like subscription, ad supported, license, and ASP, that are well understood. Do we have a word for this business model? If so, I don’t know it.
Thirty-three comments and much debate later and Jared Lukin, then of Alacra, wins with his term for this business model: freemium.
At the time, these companies all had seen explosive growth at one point or another. And in pre-recession Silicon Valley, growth-at-all-costs was trendy. Wilson, like other VCs at the time, was impressed by large usage numbers and less concerned with monetization. Profits would follow, they assumed, once developers and marketers got everyone and their friends using their products.
Skype: basic in network voice is free, out of network calling is a premium service. Acquired by Microsoft in 2011, Skype basically still operates on the same freemium model. You can make Skype-to-Skype calls for free, but have to pay to call regular phones. Skype for business is $5/user/month.
Flickr: a handful of pictures a month is free, heavy users convert to Pro. Again, the same model for the most part.
Trillian: the basic service is free, but there is a paid version that is full featured. There appears to still be a free version of Trillian for personal use, but the company doesn't want you to know about it. If you go to the Trillian pricing page, it defaults to business pricing with the lowest price for business users being $2 per user per month.
Newsgator: the web reader is free. If you want to sync with outlook and your mobile phone, that’s a paid service. Newsgator is gone. What was an RSS aggregator in 2006 is now an internal messaging app for your company in 2017, called Sitrion. Either way, freemium is gone along with all self-serve pricing on the page. Now you have to contact the sales team to even see the product.
Box: you get 1gb of virtual storage for free, but you have to pay for more than that. You can still get storage for free as an individual with Box, and they've kept with the times upping the limit to 10GB. There is no freemium for the business version, only a 2-week free trial for your team.
Webroot: you can get a free spyware scan, but for full protection you need to pay. Freemium has gone for both home and business use. The smallest plan is now $29.99 for one device for one year.
From those six companies:
2 look the same, with freemium option intact (Skype, Flickr)
2 have freemium, but are hiding it (Trillian, Box)
2 have removed the freemium option altogether (Newsgator, Webroot)
Over time, while many of these companies successfully expanded their network effects, others have obviously struggled to find a freemium structure that's sustainable. Two companies that were the doyen of the freemium movement, Flickr and Evernote, typify the struggles that this model can elicit.
Flickr's pricing trip
Flickr's pricing now looks the same as 2006, but their pricing structure has changed time and again over the last decade to find a happy medium between revenue growth and user growth.
As other photo services have gained traction. Acquired by Yahoo! in 2005, Flickr was the first social platform based around photos, Flickr has struggled to add value to its core product. It started as a free product with an option to upgrade if users wanted to upload more than 1GB per month. While still in beta, they switched the pro plan to $24.95 annually and added another GB for uploads, which stayed more or less the same for several years. Flickr upgrade page in 2006.[source]
Over time, Flickr experimented with allowing free users to only upload photos that were up to 10 MB in size, or up to 20MB. They limited the number of photostream items to 200. In May 2013, Flickr moved almost completely to an ad-supported model. Most pro features were made available in the free plan. Legacy pro users could keep their accounts, and there were still upgrades, but they were vastly more expensive and largely unnecessary, even for power users. Flickr in 2013. [source]
These changes were unpopular with users, and a new pro plan was reinstated in 2015. The Flickr upgrade page now looks like this: [source]
The new pricing page shows a clear difference between the plans, with notable value-adds for power users, and prices that are simple and gimmick-free. However, it may be too little, too late, for fed-up customers.
One of the problems with Flickr's pricing changes is the way they took away previously available features. This led to users getting annoyed by paying for things they expected to be free. In some cases, when users stopped paying, Flickr would hold photos “hostage,” until the pro fee was paid.
In 2015 Flickr released the Auto Uploadr, a tool that allowed users to upload batches of photos, among other things. By 2016, the tool was restricted to paid users. Wired said the move felt “a bit like ransomware.”
By that time, Flickr was no longer the best and only photo-sharing site, and competitors such as Google Photos, 500px, and Instagram offered the same functions for free, with no threat of removing them.
Evernote's lack of focus
Evernote was another product that spread like wildfire in the mid-2000s. When it launched as the first cloud-based notes app during the recession in 2008, its founders didn't raise much venture capital. Instead they relied on word of mouth referrals, the opening of the App Store, and freemium to grow to 75 million users and a valuation of $1 billion by 2013. In a 2011 talk, former CEO Phil Libin called his customers his marketing team and said, "The easiest way to get a million people to pay for nonscarcity product may be to make 100 million people fall in love with it." In 2014, they surpassed that 100 million mark. Evernote has a beautifully laid out pricing page, but most users don't even look at it. [source]
However, as Libin proudly noted, they have pursued a conversion rate that hovers around 1%. They continue to put enormous effort into their products, and yet millions of people don't see a need to upgrade. A 2015 Business Insider article shows why:
"Instead of focusing on its core note-taking product and on converting users to the paid service, Evernote spent more time releasing a bunch of new products and features that only helped it grab news headlines."
Despite 150 million users at the time, Evernote had to lay off 18% of the workforce and close 10 offices. While the management team focused on partnerships with Post-it Notes and Moleskine, the actual product became secondary.
Ironically, the Evernote team was pursuing a strategy that can work beautifully. Upsell other products adjacent to your core product. This way, Evernote can increase revenue not just from their 1% conversions, but also from free users who want a nice leather-bound notebook for their written notes.
But in doing so, they forgot two things:
Continuing to offer the core value through the app to dedicated users
To understand their customers and what really drives them to use Evernote
Users didn't want a nice notebook, they wanted a working note app. They also didn't need to be sold on minor improvements. Rather, Evernote needed to emphasize what kept them ahead of all other cloud-based note-taking apps, and what value they offered to loyal customers. For instance, could they use machine learning to predict what you might want to write as you continued to jot things down over the years? Had Evernote made the core product more valuable to paying customers, they might not have struggled with revenue.
The Future of Freemium
It seems that freemium, like freeware, is still an experiment in economics. Just like freeware and its descendants dovetailed, freemium and free trials are now becoming distinct models. Free trials are more like advertisements — they offer a test-drive to those who need an interactive experience to be convinced. Freemium is about creating value from the start via personalized pricing tiers for specific user profiles.
And when done right, freemium allows a company to monetize properly. By gaining a greater understanding of its position within an industry, a freemium company can maximize its longterm value while reducing customer acquisition costs.
As an understanding of the freemium model has evolved, the SaaS sector has realized what doing freemium right means: getting to know your customers first and continuing to offer perpetual value whichever plan they are on.
MailChimp: free, but still valuable
MailChimp took a measured approach to freemium, working for years with customer data to ensure that the products they built matched what every user wanted and needed.
MailChimp CEO Ben Chestnut made a point of saying that the company was not a startup when it launched a free plan, 8 years after its founding. In those 8 years, they tried out freemium variations such as pay-as-you go vs. monthly subscriptions, and free trial vs. free forever. By the time they went freemium in 2009, the core email product was both affordable and profitable. They had recently saved on server costs by switching to the cloud.
They named their first free plan “Forever free,” and the exact wording is still on their pricing page today. It's used by new businesses, non-profits, and small organizations. And if you're not sending a large volume of email, it's an excellent service. MailChimp pricing page in late 2009 [source]. MailChimp pricing page today. [source]
A year after launching Forever Free, Chestnut wrote another blog post with the following data (h/t Drift):
MailChimp had grown its user base 5x, from 85,000 in September of 2009 to 450,000 in September 2010.
They were adding more than 30,000 new free users and 4,000 new paying customers each month.
Profit had grown 650% (!)
CAC had decreased 8% in just the last quarter to under $100 (main reason for profit growth).
MailChimp had not only created more value for more people, but they had increased their profits in the meantime. And more MailChimp emails were out in the world than ever before, meaning that people were sending better email, regardless of cost.
ProfitWell: perpetual value
One of the constraints most freemium models above impose on user is a value metric limit. Whether it is the storage limits of Flickr and Box, or the subscriber or email limits of MailChimp—at some point the product becomes unusable for these users without the upgrade.
This is, of course, part of the point. At these limits it is assumed that users are getting enough value that they will want to pay for the service for continued use. But the low conversion rates on all freemium show that this isn't always the case. That is why we advocate for perpetual value in freemium.
The core value should be free for whoever you are—a single user or a 1,000+ team. This is slightly akin to Skype's freemium model, at least for individuals. If you download Skype you can use the core value, calling other Skypers forever, for free.
This is the model we want to build and that we want others to build. In ProfitWell, we want a product that is useful for any size of SaaS company, whether you have one customer or 1M, and can be used by you alone or a 1,000 member team. There is no value metric limit. The upsell comes from adjacent products to the core value. The core value of ProfitWell is understanding your analytics. The premium part of our freemium comes from helping you do something with that information. For instance:
Retain recovers delinquent churn (that you identified through ProfitWell) using in-app messaging and email reminders to customers
Recognize allows you to convert your subscription revenue (which you manage through ProfitWell) into GAAP recognized revenue.
If you don't need to recover churn or don't need to recognize revenue, then no worries. ProfitWell will continue to be entirely free for you. But if you are using ProfitWell properly and getting value from the product, you will need these things. You'll understand your churn and want to stop it. You'll grow your..
We live in a wonderful time in history where with enough time and money, we can build essentially anything. The flip side of this, though, is that you can fall victim to death by a thousand paper cuts. Different groups of customers have competing priorities and want or need different features, and there are always some outliers that have such specific requests you'd need to build a separate product just for them. It can become overwhelming, and quickly derail even the most well-thought-out product strategy.
This is something Matthew Bellows of Yesware has faced multiple times over his years of building and running several companies. He's put together a team that shares his laser focus, most importantly among them: sales and product. They're aligned on Yesware's mission and vision, and apply that framework to their strategy, setting them up for seamless success.
You probably have some kind of sales cycle for your product that every new customer goes through.
A process with well-defined stages, aimed at turning prospects into leads, leads into opportunities, and opportunities into customers.
Having a process in place is a great start—but if your company is like the hundreds of other SaaS companies we’ve seen, your customers don’t follow that process.
They don’t care about what they need to do to become a sales qualified lead. Instead, they act according to their own set of challenges, decisions, and budgets. They follow their own buying process, like the yin to your sales teams’ yang. The peanut butter to their jelly. You get the idea.
Understanding how your customers buy and lining up your marketing efforts, pricing, and sales process to mirror their buying process can help you increase conversions, boost retention, and decrease your cost of sales.
Failing to align your processes is also one of the most common mistakes we see most SaaS companies run into.
Let’s take a look at how you can optimize your sales process to match your customers’ buying cycle, starting with a straightforward definition of the buying cycle.
What is a buying cycle?
The buying cycle (also known as a purchase cycle) is the process a customer goes through when purchasing a product or service. Customers move through a series of purchasing stages in the cycle as they educate themselves and move closer to making a final purchasing decision.
The five buying-cycle stages
While the exact buying cycle looks a little different for every product and service, every customer goes through some process of
realizing they have a problem;
considering their options;
making a decision; and
purchasing a solution (or renewing, in the case of subscription products).
Each stage requires a different set of strategies to compel customers to move to the next stage because they expect different interactions with you depending on which stage they’re in. The goal at each stage isn’t to make the sale. Instead, your focus should be on simply moving each customer to the next stage.
And, as much as we’d like to believe we have control over which stage customers are in at any one time, they're the ones in the driver's seat. All we can do is align our strategies and sales process to match where each customer is in the purchasing cycle.
Let’s take a more detailed look at each stage in the cycle.
Awareness is the first stage of the buying process. Potential customers understand they have a problem that needs solving and begin to search for solutions. It’s also the stage where companies tend to put the most effort into their marketing, since the potential for reaching new customers is only limited by the size of the market.
As soon as potential customers become aware of your product or service and how it can solve their problem, they move to the next stage in the journey: consideration.
The consideration stage is where your work as the salesperson can start to make a difference. Your customer is out there searching for solutions, and your product is (hopefully) in the mix. Your job in this stage is to provide detailed information explaining how your product or service can solve their problem better than the competition and what benefits they’ll experience after solving the problem.
Once customers are convinced they need to purchase a solution for their problems—whether that means your product or your competitors’—they progress to the next stage: intent.
In this stage, decision-makers pit the various alternatives against each other—and whichever makes the most logical, emotional, or financial sense will be the one they end up choosing. Your sales team’s job now is to convince customers that, out of the potential solutions they might be considering, yours is the product or service they should choose.
Eventually, each customer will be ready to pull the purchase trigger and then progress to the fourth stage: purchasing.
The customer has decided on the product they want to buy, and they buy it. (Hopefully, it's yours; if not, time to improve a bit!)
Even at this stage, your job isn’t done. It’s crucial to develop an ongoing relationship with customers and to support them in their problem-solving journey. Staying in close contact can also create opportunities to persuade customers to purchase again or renew their subscription—the trigger for the next stage.
5. Repurchase/Continuous Purchase
This stage can look a little different, depending on what you’re selling.
If the product you sell is perishable, like food, or consumable, like diapers, your customer will most likely be back soon for a reorder. Likewise, if you’re a subscription company, your continuous purchase point will be when a customer's billing cycle is up and they’re charged again. This stage can (and ideally will) repeat indefinitely, so it's where companies frequently find the biggest opportunities for increasing revenue.
Why buying cycles matter
Even the most successful businesses only ever convert a tiny percentage of their potential customers. The rest are still at some other stage in the buying cycle—maybe someday they’ll make it to the purchasing stage, or maybe they won’t.
Without a strong understanding of your target customers’ mind-set when buying a product, you’ll end up spinning your wheels with sales and marketing, and you’ll never capture that customer. On the flip side, seeing your products through your customers’ eyes and understanding what draws customers through each stage of the buying cycle is the path to a thriving business.
Here’s why purchase cycles should matter for your company.
Optimize your marketing efforts
View your marketing efforts through your customers’ eyes to see which aspects are working well and where your efforts will have the biggest impact.
Maybe you're getting tons of qualified traffic, but those leads aren't purchasing, indicating a problem in the consideration or intent stage. Or perhaps you discover that you’re converting nearly every lead you get, but you need to capture more leads—you should invest more time building awareness.
Either way, it’s helpful to see where your marketing efforts will have the biggest impact.
Convert more customers
When they're still trying to understand the problem they're experiencing, customers don’t like pushy salespeople. Nor do they need basic education about a solution once they're ready to make a purchase.
Understanding what customers need at each stage and then matching your sales approach to that stage directly improves your conversion rate—and keeps you from annoying customers who might not be ready to buy.
Capture a higher market share
Beyond increasing conversions with new customers, optimizing your purchase cycle can keep existing customers choosing your product or service over your competitors’, letting you capture a greater share of those customers over time.
Investing in retention pays high dividends—in fact, increasing it by just 5% can grow profits by 25% to 95%. While focusing more on the later stages of the buying cycle might mean delayed results, the increase in renewals and customer lifetime value is well worth the work and the wait.
Enough about benefits—let’s talk tactics.
Optimizing for every stage of the buying cycle
If you spend all of your time at only one end of the customer purchasing cycle—closing the sale, for example, or educating customers about their problems—you’ll fail to capture all the potential customers who are still at the other end of the cycle.
You can’t shortcut the buying process. Instead, optimize your sales and marketing efforts for every stage of the purchasing cycle.
Let’s look at what you should be doing at each stage to move customers along their buyer journey.
Awareness: marketing moves
Your marketing team has to be on this from day one. It’s incredibly important that
your customers know that your product exists; and
your product will solve almost all of the problem they’re facing.
Building awareness around your product requires a strong understanding of the specific struggles your potential customers are encountering and how your product or service eases those struggles. Start by creating targeted content that helps them begin solve those problems. Then, share your content where they’ll see it, such as on social media—anywhere your future customers are already spending time.
For example, check out this article we wrote recently on revenue growth that teaches founders how to calculate their revenue growth and shares tactics for growing their revenue.
The article is aimed at companies that know they have a revenue problem but don’t yet know how to solve it. Beyond just education, though, it gives readers a subtle nudge toward ProfitWell’s newsletter, where they can find more information for growing their revenue and optimizing their pricing.
Once potential customers engage with your content and (hopefully) sign up for your newsletter, you can use marketing automation tools to nurture them until they’re ready to progress to the consideration stage.
Consideration: tiers and options
Customers in this stage are searching for the best solutions to meet their needs, and there’s a good chance you’re not the only option available. Your first choice should once again be content—articles, case studies, and videos all educate customers about your solution and highlight reasons to choose your product rather than your competitors’.
There’s another strategy your competitors might be overlooking, though, and that’s offering multiple pricing tiers and product options. Tailor each tier to specific customer personas or budget levels. That way, every customer can find a tier that meets their needs as closely as possible. It also distinguishes your product from those of competitors who have just a single offering.
Our own pricing structure is a great example. We offer multiple products and product tiers across different price points with ProfitWell, ranging from ProfitWell Metrics (free) to Price Intelligently (where we offer two different tiers for customer needs).
We’ve found new customers often start by signing up for our free metrics service before progressing to more robust offerings. But many customers continue to use our free offering indefinitely.
Your potential customer understands what they need, knows how your product will solve their problem, and is ready to buy a solution. Let’s look at some tactics to help close the deal.
Intent: product descriptions, reviews, and branding
Customers who reach the intent stage are ready to buy a solution. Your job now is to persuade them to buy your solution.
Success here depends more on earning trust with potential customers than educating them. Let your product speak for itself—customer reviews, case studies, and benefits lists can help sway customers to give you, rather than someone else, their credit card number. Make sure you have highlighted what your product can do that’s better than the rest, why your other customers absolutely love it, and why your brand is a sign of quality.
Subscription analytics is one of the most valuable features we offer at ProfitWell, so it's something we highlight for potential customers. Each subscription-management provider gets a dedicated landing page, like this page for Zuora.
On the landing page, we explain how customers can integrate our analytics software with their existing system, and the benefits they'll experience by doing so. We also include social proof, like testimonials and logos from existing customers, to boost trust even further. Finally, the page has a clear CTA to sign up for a free trial, making it easy for potential customers to move to the next step: purchasing.
Purchase: optimize pricing
Your customer is ready to commit to your solution. The last thing you need is for them to change their mind at the last minute.
Make sure your pricing is accurate. Finding out at this late stage that your pricing is above (or, in some cases, far below) what they’re expecting to pay is frequently the last thing standing in the way of the sale.
For SaaS companies, the only viable option is to base pricing on value. By finding out how much customers are willing to pay for your product before they reach a purchasing decision, you’ll increase not only your conversion rate but your profitability as well. Always opt for value based-pricing to maximize your revenue.
The show doesn’t end with the purchasing decision, though—you can also improve your retention or repurchase rate with a few extra tactics.
Repurchase and renewal: customer care over everything
Whether you’re selling subscriptions or one-time purchases, growing your lifetime revenue depends much more on retaining existing customers and increasing your repurchase rate than on the number of customers who click the buy button.
Customer churn can obliterate your business when left unchecked, but shifting your focus away from marketing in the final stage in favor of customer care and product advocacy can help keep renewal rates high. Make sure customers are happy—and that they’re staying happy—by touching base regularly. As your happy customers become more experienced with your product, ask them for testimonials or case studies, or ask them to refer you to other potential customers.
You can’t shortcut the process
I see far too many founders spending all of their energy trying to close the sale—but they’re often targeting people who aren’t yet ready to make a purchase.
Trying to shortcut the buying cycle will only end in frustration and lost revenue. Instead, understanding how customers purchase your products—and how to optimize the purchasing cycle—will help you convert more customers with less effort.
Getting your pricing right can be complicated, and it depends on a lot of factors. This week's question from Leo Campos at Chartbeat gets to the heart of it. He wants to know: Which tactics will increase willingness to pay?
To answer this question, we looked at the data from just over one million different subscription consumers and just under two thousand companies. Here’s what we found.
Your price is the exchange rate on the value you’re providing. A phenomenal aspect of the subscription and SaaS economy is that we now have the ability to build features and other value adding functionality into our products extremely quickly.
Yet, understanding what your customers or target customers value and making sure you’re using data to get to persona-pricing fit can take quite some time, as it’s an ongoing process of continual price optimization. We all know that, especially if you’ve read almost anything we’ve published.
To answer this question, we looked at the data from just over one million different subscription consumers and just under two thousand companies. Here’s what we found.
First up, one of the highest impact drivers of willingness to pay is getting your brand and support in order. When measuring a customer’s affinity for a company’s brand and then cross referencing that data with the customer’s willingness to pay we found that those customers who perceived a company’s brand positively had between a 16% and 41% higher willingness to pay than the median. Those on the negative perception side had 15-33% lower willingness to pay. Based on this data, brand not only drives higher willingness to pay, but also can very much detract from your ability to sell to your customers at the level necessary to succeed.
Similarly on the support front, those customers who perceived a company’s support positively had between a 12% and 36% higher willingness to pay than the median. Those on the negative perception side had 8 to 16% lower willingness to pay. This indicates that bad support isn’t taking away from willingness to pay as much as good support is driving willingness to pay.
If you need a more tactical focus on willingness to pay, you should attack your value proposition. In a previous set of studies we looked at a fake B2B sales product and a fake B2C fitness product, we kept all copy and descriptions the same except we varied the value proposition. For both products we found that the value proposition caused a large variance in willingness to pay.
For the B2B product, certain value proposition were able to decrease willingness to pay by 20% while other were able to increase willingness to pay by 20%.
Our B2C example saw the same effect with a negative 10% to a plus 15% swing based on the value proposition. Essentially, how you position your product can greatly influence the value perception from a customer.
Finally, make sure you revisit the social proof you’ve implemented around your product and purchasing funnel. In both B2B and B2C displaying customer logos and providing testimonials increased willingness to pay considerably.
On the B2B side case studies increased willingness to pay by 10 to 15%. In B2C these case studies boosted willingness to pay from 5 to 20% with specific case studies having the biggest effect.
Remember with all of these tactics your aim is to make sure your prospect or customer understands the value they’re getting when it comes to your product. Since price is the exchange rate on the value you’re providing, these pieces of communication allow your prospect and customer to understand your value at a deep level, which ultimately allows you to get what you’re worth.
If you have a question you would like to see on the ProfitWell Report, send me an email or video to email@example.com and if you found this episode (or any other episode) to be valuable, please share on Twitter and LinkedIn. That’s how we measure if we should keeping doing this or not. We’ll see you next time.
If you ask someone to define “culture” in your office, you might get a response about ping-pong tables or beers on tap. But we know culture constitutes something so much greater. It’s the collection of habits you accept and nurture within your organization. It’s molding the same foundational principles that drive the core of behavior, but also having fiercely diverse views in all other aspects.
And this is where your skeptics come in. While skeptics can be incredibly difficult to deal with at times, they are key to building a solid culture, which is something Katie Burke, Chief People Officer at HubSpot, believes to her core. She discreetly recognizes the difference between skeptics and cynics, embracing feedback from skeptics as the way to ultimately grow (and better) your organization.
For a young company, choosing a pricing method and establishing your overall pricing strategy can be daunting - it's the moment where you find out how much people actually value your beloved idea and how much they're willing to pay for it. That’s why it pays to get your pricing methods right.
And when we say it pays, we mean it. The choices you make with pricing methods and setting the right pricing are essential to determining the growth of your subscription business. Even a 1% improvement in pricing results in an average increase in profits of 11.1%.
What are pricing methods?
Pricing methods are ways of calculating the price of goods and services by taking into account all factors that can influence pricing strategy. Factors can include the product or service, its life cycle, market competition, and target audience.
Choosing between pricing methods isn’t always easy, but it’s something no business can afford to get wrong. The best pricing method for a given company is itself based on several different factors - the scale of your company, the size of your public profile, your finances, and, of course, your product will all dictate which pricing methods are feasible and which ones aren’t.
4 popular pricing methods for SaaS Companies
Some pricing methods are better suited to SaaS pricing strategy than others. Let’s take a look at four particularly popular pricing methods, and see how well they suit the SaaS model.
1. Cost-plus pricing
What is it?:Cost-plus pricing is one of the most widely used methods of determining price. Its principle is that your company makes something, then tries to sell it for more than was spent making it. Simple, quick, and broadly representative.
In order to create your target rate of return, simply calculate your cost of production, then select your desired profit margin, and put the two figures together.
Pros: This hugely simple pricing strategy requires minimal resources to execute, demands very little market research, all the while providing full coverage of your total cost and a consistent rate of return.
Cons: It’s highly inefficient. It generates a very inexact picture of your costs and creates an arbitrary margin that has very little to do with how much your customer is actually willing to pay. Plus, this market research-free approach keeps you ignorant of competitor strategies. If you’re running in a densely packed field, this can be a crucial stumbling block further down the line.
Is it the pricing method for you? While cost-plus pricing may be popular and easy, it’s actually not well-suited for most SaaS companies, principally because the value a software company provides is traditionally much more than its cost of doing business. At best, it’s a decent stop-gap pricing strategy when you don’t have much time to devote to figuring out your perceived value and just need something to tide you over while you work on fulfilling those orders or improving your product.
Competitor-based pricing is a more research-intensive approach than cost-plus. Assess the pricing of your immediate competition and average the results for a price point in a competitive ballpark.
Pros: A competitor-based pricing strategy can be effective, so long as your goods are congruent with those of your competitor. If your industry is particularly saturated with competitors, competitor-based pricing is likely to give you an accurate pricing point that will allow you to remain competitive while focusing on adding superior value compared to your peers. It’s also less likely to lead to financial ruin - what’s good for your competitor is good for you!
Cons: By essentially copying your competitors, you run the risk every student with a wandering eye runs into during a test - if your customers are making mistakes in their pricing, then you’ll likely inherit those mistakes too.
Competitor-based pricing brings a certain stability, but its extremely local and context-dependent focus can lead to a stifling focus on short-term thinking, as well as plenty of lost opportunities where a plan more singularly adapted to your company’s vision would have benefited you financially.
Is it the pricing method for you?: The risk of homogeneous thinking goes double in the SaaS field because of the importance of buyer personas. Defining your personas, and tailoring your market approach to them, is so important. Go too far with competitor-based pricing, and you’ll find yourself selling more to a competitor’s customer base than to your own.
We can see the risks and benefits of competitor-based pricing in this graph. Companies A, B, & C have all used competitor research to plan their price points - B & C are almost identical in that sense. When times are good, they all fare equally well - but when there’s a downturn, they all fall at the same time, with Company A being a little quicker to react and change tack. Company D was more dynamic in its approach, started lower, and had a dip or two along the way, but was able to cope better with the downturn in the market.
3. Value-based pricing
What is it?: Value-based pricing involves basing a product’s or service's price on how much the target consumers believe it is worth. With value-based, you'll be creating your entire strategy around your customers’ expectations. It’s an excellent way to build bridges with your customer base and to learn crucial new information about your product.
Pros: One of the core advantages of value-based pricing is the ability to nail your sense of willingness-to-pay (WTP). Willingness-to-pay is essentially the value your customer places on your product, whether your pricing is in line with perceived value or if a lower price would be more appropriate. WTP is key, and you can only grasp it by studying your audience.
Value pricing is also great for iterative learning - presenting prototypes to your buyers and letting their reaction tell you what’s good about your product and what needs to be improved. Once your minimal viable product is developed, your features and product updates can then be dictated by consumer demand.
Cons: Making that customer outreach and quantifying buyer personas take time - especially if you don’t have a ready pool of customers to choose from.
What is it?: The demand-based pricing method uses levels of current general market demand, as opposed to customer-specific research, to determine pricing strategy. It’s the most responsive of the four methods we’ve looked at and the easiest to implement “on the run.”
With demand-based pricing, your product is set at several different prices, and the customer’s willingness to purchase it is measured at each one to determine a representative set price that’s not too high or too low. There are a few different ways of doing demand-based pricing:
Skimming: Starting at a very high price and lowering gradually. Great if your product is appropriate for the Premium model and for establishing very healthy, early profit margins.
Discrimination: Leveling different charges for your product based on different demands; for example, hiking or reducing an airplane or concert ticket price depending on the proximity of the event.
Penetration: Starting at a very low price to increase market share and brand loyalty initially. Good if you have a lot of cash runway and need to build up that market share and know how to monetize that brand loyalty to offset the initial losses.
Pros: Demand-based pricing is a good way of assessing the lay of the market while still building revenue and customer knowledge (albeit indirectly). The different ways of approaching demand-based pricing make this a versatile pricing method appropriate for a number of business models.
Cons: Because the data is relatively less complete, the monetary price must be adjusted to compensate for non-monetary costs that will be involved in setting customer willingness-to-pay. For instance, if your product has a particularly high time- or convenience cost, WTP will be affected. Making these kinds of adjustments can be hard and lead to missed opportunities, particularly when the fluctuations of market demand are also taken into account.
Is it the pricing method for you?: For astute readers of market demand, the demand-based pricing method can prove a versatile route to success. It is not, however, the most stable among the available options.
The right pricing method encourages success. Pricing methods can be dizzying, but that’s because there are so many ways of positioning your product for success. You should choose your method based on your product - regardless of which method you choose, if you’ve chosen right, the results should be similar.
Secure more customers
Setting a price point that entices customers to buy is key to success. The right pricing method helps you aim your product towards the right customers and navigate around competitive products.
If you set the wrong price, you’ll be digging yourself out of a hole with every sale. Set a price that helps your business grow, even if it is higher/lower than you might initially be comfortable with.
Value your products
Your perfect price point will show customers that it is worth it to spend on your product, while at the same time providing extraordinary value. Perfecting that price point with a working pricing method has as much to do with your company’s vision as it has to do with your product as it is now. To make a success of your pricing strategy, make a success of your product/service.
Choosing the best pricing method
Growing your subscription business has never been harder, and however great your product is, however brilliant your promotional strategy, there’s no time for bad choices when it comes to your pricing methods.
From CRM software to coffee beans, shaving blades to designer gowns, recurring billing is the lifeline for every subscription business.
It’s easy to see why—automatic charges for subscriptions are simple and convenient for customers and predictable and sustainable for companies. Though recurring billing is appealing to everyone, it isn’t without its drawbacks. Certain factors need to be accounted for when billing this way, and using an effective pricing strategy becomes crucial to success.
Today we’re taking a look at what recurring billing is, some of the pros and cons for both merchants and customers, and how to optimize your recurring billing strategy to maximize revenue and minimize churn.
What is recurring billing?
Recurring billing is when a subscription business charges a customer’s credit card for products or services on a regular billing schedule. Subscription services tend to charge this on a monthly or annual schedule, until the customer withdraws permission or cancels their subscription.
Any product or service that a customer purchases on a regular basis can be a great candidate for recurring billing, from internet or cable bills to gym memberships and household consumables like cleaning supplies or pet food. In the digital realm, SaaS and other membership-based companies allow customers to sign up for an ongoing subscription, billing them automatically on an agreed-upon day each billing cycle.
Recurring billing benefits businesses and customers alike
The reason so many subscription businesses have adopted recurring billing is because of the benefits for both customers and businesses. Customers enjoy the convenience and simplicity of automatic payment methods, and merchants benefit from prompt and consistent payment.
If you haven’t already, here’s why you should consider adopting recurring billing for your business.
Convenience for customers and merchants
The simplicity and convenience of recurring billing helps foster peace of mind for customers. Customers simply sign up and input their payment information once, knowing the company will be paid automatically each cycle. Instead of relying on their memory to make sure bills are paid on time, customers set it and forget it.
For merchants, predictable and reliable revenue simplifies every aspect of doing business.
A subscription billing solution allows for more accurate forecasts of how much revenue your business will bring in over a set period of time in the future, making it easier to forecast your success (or, god forbid, giving you an early failure indicator). With accurate forecasts, you can make more educated growth decisions, investing wisely in sales and marketing without fear of overspending.
Consistent and regular cashflow can also free you from the sales and marketing treadmill. You can focus more effort on retaining existing customers and providing the best possible service, rather than spending all your time pitching potential leads that may only purchase once.
Offering subscription billing lets you set lower prices in return for regular scheduled payments.
While you might be charging more over a period of time than you would for a lump sum payment, customers often prefer to pay smaller installments. This is great for getting new customers on board and better for customers looking for a discount.
Automating your billing also eliminates much of the administrative work that goes along with collecting payments and managing sales. These cost reductions can then be passed on to your customers to help lower prices even further.
Now we’ve seen how recurring billing can benefit both subscription-based businesses and customers, let’s take a look at a few of the drawbacks that come with this billing solution.
Recurring billing does have some drawbacks
Subscription business is exploding in every sector, but recurring billing alone isn’t a silver bullet. The added complexity for merchants and the risk of billing errors for customers means automated payments aren’t always suitable for every company.
Recurring billing can sometimes make it more difficult for customers to correct billing problems. They may not even notice problems with the amount they’re paying for quite a while—and when they do notice, it can take significant time and effort from both parties to resolve any issues.
Managing recurring payments can be more complex than managing one-time sales. You need the right tools and processes in place for tracking customers on different billing cycles, paying different amounts, and with different contract lengths. Most SaaS companies combat this complexity by using an integrated subscription management tool that helps ensure customers are always charged the right amount at the right time.
Customers need to feel like they’re getting value from the service over time. If they don’t, then they’ll churn. If they do, they’ll renew. On the surface, it sounds straightforward, but managing churn is anything but simple—it’s a process that looks different for every business and every market.
There is one major factor, though, that can help reduce churn in nearly every subscription-based business, and that’s lengthening your subscription cycles. Annual billing has been shown to be more successful at reducing churn than monthly billing.
On the administrative side, annual billing cycles reduce the need for monthly invoice management, giving you time back to spend on more valuable tasks. Though the higher upfront cost means a bigger commitment from customers, it gives companies more time to prove their value before customers make the decision to renew or cancel. And this additional value leads directly to lower churn.
There’s a strong correlation between increasing the proportion of annual versus monthly billing cycles and reducing churn—companies with a majority of customers on annual contracts see dramatically lower churn rates than those who only offer monthly contract lengths.
Recurring billing and your pricing strategy
Whether you offer your customers monthly or annual plans (or both), make sure you’re managing your pricing to maximize revenue. Setting the right price for your recurring billing can have a huge impact on your bottom line, boosting your profits while keeping your pricing plans attractive to customers.
Pricing strategy is an untapped lever for most companies offering recurring billing. After looking at over 500 SaaS companies, we found monetization had by far the biggest impact on the bottom line, four times the impact of improving acquisition and double the impact of effort to improve retention.
Value-based pricing—using data to find out how much customers are truly willing to pay for the value you provide—is the ideal strategy for setting your recurring billing rates to maximize value. Yes, value-based pricing takes time and dedication to get right. But nearly every recurring revenue business will see enormous benefits in terms of higher profit, more competitive products and services, and more effective sales and marketing by pricing around value.
Recurring billing is the lifeline of all subscription businesses
Automate recurring payments to make them convenient and flexible for customers, to ensure predicable revenue for merchants, and to help ensure your business is sustainable and profitable.
Remember, though, that recurring billing isn’t a panacea, and it won’t solve all your subscription difficulties. Keep complexity to a minimum, set your pricing based on value, and you’ll be well on your way to a successful subscription business.
The term “dunning” sounds less than inviting (potentially why it's an overlooked process for many subscription businesses). That and its reputation as a process that both customers and companies hate to deal with.
Nevertheless, dunning is a process you have to work at. A great dunning process is the best way of finding out why a customer account is not sending you payments. It requires direct, sometimes repeated, communication with your customers and can sometimes turn into a long and unwieldy process. But a dunning process done right saves you potential customers, recovers lost revenue, and drives down delinquent churn.
What is dunning?
Long story short: dunning is asking customers for money they owe the company. This usually happens after a credit card has been declined, a payment gate has encountered an error, or the customer has insufficient funds.
It’s true that dunning is widely disliked by both business owners and customers. Business owners can find the task of trying to acquire payment from difficult-to-contact or uncooperative customers laborious. On the other hand, customers often find dunning invasive and even intimidating.
However, this bad rep comes more from the way in which many companies choose to approach their dunning as opposed to flaws in the process itself. Companies frequently abandon best practices of customer service when approaching their customers about failed payments and instead play the role of the cold-hearted debt collector.
Look at dunning the same way you’d look at selling — as an opportunity to create (or, in this case, recover lost) revenue.
Reasons credit card payments are declined
Because the success of your business depends on customers making consistent payments, it’s easy to get frustrated with them when they don’t. Sometimes, it can even seem as though some customers are purposefully attempting to avoid paying you. Most often, however, customers behind late payments don’t even know there’s a problem.
Customers’ credit card information is outdated
Many customers forget to update their cards on different accounts because they have forgotten the card is expiring, or they may have forgotten that the expiring card is the one linked to their account.
This is one route to failed payment - and to delinquent churn - that you can head off by sending reminders to customers in advance of card expiry.
Their card Is reported lost or stolen
Things happen: your customer could have lost the card and put a hold on it until they found it again, in which case informing subscription providers is understandably unlikely to be too far up their list of priorities.
Their account has insufficient funds
Likewise, if a customer is struggling to pay their bills, your service may not be a top priority for them. A little flexibility on your part can really pay off here. Reach out and gauge the situation with the customer, and see if there’s any way for you to help.
5 best practices for your dunning process
Repeat the words to yourself, over and over again if you have to: “The dunning process can be a positive customer experience.” As the company and the party making the first move, it’s your responsibility to set the tone and intent very clearly from the start. Follow these best practices and you may even find that dunning enables you to strengthen your relationship with your customers.
Make your intentions & next steps CRYSTAL clear
It’s not unusual to get spam emails or false dunning letters from companies asking you for money. When composing a dunning email, choose your language and tone of voice carefully and make sure the following are clearly expressed:
Who you are: a friendly agent from a trusted company
The payment type (credit card, automatic account withdrawal, etc.) and suggestions as to why the payment may have been declined
The amount and nature of the outstanding balance, for instance, “You’re on the $10 per month plan and owe $40 for the last four months”
When you will process the next payment
A link back to your payment page and any further payment instructions
Get your subject line right
Subject lines are what get customers to open an email. Make sure it is professional and clear, so they know it’s important.
An example of a good subject line is, “Action required: Payment failure due to [EXPIRED CARD].” It’s direct and to the point. You can tailor your approach to your company’s general persona without sacrificing directness. For instance, Spotify, which takes a more informal approach to customer communication, will give a dunning email a subject line that reads, “Oh no, your payment failed.”
Don’t use poorly automated subject lines that look like spam (“Account NO#X9999903 Payment Query .x”), poorly contextualized subject lines (“Payment Due Now”), or subject lines that take an altogether too chummy approach (“There’s a Payment We’d Like to Talk to You About”). Bad dunning emails are not only likely to get your customers reaching for the spam button - they risk damaging the trust your customer has in you.
Now that you have your customer’s attention, be empathetic. View them as a customer, not as a debtor, and approach the correspondence with the same tact and friendliness you would when trying to make any other garden-variety sale. Remember: the dunning process is an opportunity to recover lost revenue.
And the recoverable revenue is not restricted to the last payment that didn’t go through. Make a point of telling the customer that you want to make sure they keep enjoying your services into the future as well.
What you must absolutely not do is blame your customer. Chances are your customer is completely unaware:
that their payment has not gone through and
why their payment wouldn’t have gone through
Explain why their payment wasn’t made with as many details as you can provide. Your customer is smart — they will sniff out your assumptions about them if you signal your doubt in their good intentions to pay what they owe. Doing so will reduce the likelihood of actually receiving that payment (if for no other reason than a customer being harassed by their service provider is highly likely to churn).
Keep it concise
No one likes to receive long, depressing emails about making payments. A couple of paragraphs, and sound formatting choices can get the job done in a dunning email.
If you’re including technical information about payment plans or aspects of service, use lists and bullet points to make the information digestible. Make sure that any key metrics or other points (e.g., deadline dates, amounts due) are in bold text to draw the reader’s eye.
And remember, most people read their emails on a mobile device - format accordingly!
Know when to stop
The verb “to dun” literally means to harry someone with unwanted information. Perhaps that’s the source of its bad reputation, come to think of it.
While you should see it as an opportunity to recover lost revenue, there’s still a point where you have to let go and accept that a customer may be lost. If you have sent four emails over the last payment period with no response, it might be a good time to stop and terminate the service you’re providing to that customer.
Benefits of a great dunning process
It's never fun to chase people down for the money they owe you — for you or for them. But when you do it well, it pays off (not just financially).
As we’ve seen before [link to prior article when available], keeping churn low is all-important for any SaaS business. Delinquent churn - where customers do not actively leave your service but are passively churning out through delinquent credit cards - is a particularly serious and easily overlooked churn metric for companies to keep an eye on.
By making sure that their payments stay good-to-go, you’ll keep more of those at-risk-of-churn customers.
Positive customer experience
If you have a dunning process that approaches the customer in the correct way and helps the customer recover their account instead of blaming them for not paying, you’ll make it considerably more likely that they’ll trust your methods and stay with your service.
Your approach to dunning should be part of a broader approach to customer experience that sees opportunity in unlikely places. You want your customers to stay put - don’t just say it, show it by helping them come back to using your service. If their payments have stopped because they’ve forgotten your product, then dunning can be a great way of reminding them of it and the great people behind it.
Reduce churn by automating the dunning process
It frankly doesn’t matter how big your company is or how fast you’re growing - losing money to failed payments is just not a loss that you should be accepting. In fact, the bigger your company gets, the larger share of your churn the credit card delinquencies are likely to account for (sometimes up to 40% of it).
With solutions like ProfitWell Retain, you can drive that churn down. Retain™ combines world-class subscription expertise with algorithms that leverage millions of data points to win back customers.
More than double your recovery rate
Thanks to ProfitWell’s in-depth knowledge of customer dynamics in subscription technologies, the strength of Retain’s proprietary technology, and the degree to which the solution is customized for every client, Retain maintains the highest recovery rate in the market.
Get 100% ROI, guaranteed
ProfitWell’s Retain staff augment your churn team. You only pay for performances, not for the software, so 100% return on investment is guaranteed.
Set up in 15 minutes
ProfitWell Retain offers a full service, but onboarding is straightforward. We handle testing and deployment of algorithms and plug right into your existing billing system, so everything is safe and compliant. But your customers won’t even know we’re there — everything is fitted out in your company’s branding. Front-to-back setup takes only 15 minutes.
It's all about the customer
When you’re keeping an eye on fulfillment of payments and another eye on the state of your revenue, it’s easy to forget that customers are people too - things slip their mind and, hey, mistakes happen. Just because it happens to be a payment to your company that wasn’t delivered doesn’t mean that you shouldn’t approach the dunning process like you would any other customer interaction. It’s the customer’s happiness that pays, after all.
Vigilance against fraud is important - and there are solutions out there that can clue you in to who among your customer base might be more likely to commit fraud. But the mistake that many companies make with the dunning process is to be suspect from the start. Be patient, empathize, and educate your customers. You may find that dunning management becomes a notable way of improving your relationships with them.
This week, Ed Laczynski from Zype asks us a key question to understand an important mechanism in growing a subscription company: How do you increase expansion revenue, and quickly?
Yet, expansion revenue isn’t the easiest metric to increase, so to answer this question we looked at just under four thousand subscription companies. Here’s what we found.
Increases in your average revenue per user can stem from many places. You can raise your price, get higher end customers, or coax more upgrades from your current customer base. Regardless of where expansion revenue comes from, it’s absolutely crucial to your success, especially in the world of subscriptions, because you want a healthy amount of expansion revenue to offset any churn that may creep into your business.
First up, we should understand what’s good expansion revenue from a benchmark perspective. The most efficient companies, when looking at lifetime value (LTV) to customer acquisition cost (CAC) ratios, are fueling that efficiency mainly off expansion revenue.
Note that companies who have an LTV to CAC between three and five are seeing a median of just under 20% expansion revenue as a proportion of their total revenue. Those with an LTV to CAC above five are pushing above 30% in terms of expansion revenue.
Essentially, more expansion revenue is definitely better, but we want to get into a world where we’re seeing 20% or more of our revenue coming from expansion. A bedrock way to make this happen is to use what’s known as a value metric as the center of your pricing. A value metric is what you charge for – per user, per 100 visits, per thousand videos – it’s a measure for some proxy of value that you’re providing your customer.
The beauty of a value metric is that customers are only paying for what they’re using, so churn tends to be lower with companies using this type of pricing model. Expansion revenue tends to be much higher, as well.
Those companies using a value metric are seeing 30 to 100% higher levels of expansion revenue than their feature based pricing counterparts. Note that this gain occurs for both functional based value metrics, which would be a pricing model like per user, and for outcome based value metric, which would be like per conversion.
A bit more tactically, customer success also has a pretty significant impact on expansion revenue. Those companies utilizing either scalable or dedicated customer success teams are seeing 60 to 120% higher levels of expansion revenue than those who have no customer success indicating that the use of humans communicating value and spurring upgrades can actually greatly impact your bottom line.
While there are certainly very tactical offers and gimmicks you can use to increase your expansion revenue, the truth is that great expansion revenue requires you to put value at the core of your operations. Using a value metric in your pricing is a very specific decision that requires some careful thought. Making sure customer success exists in your business costs time and money. Yet, if you remember that subscriptions are all about relationships, these decisions become easier, because you’ll want to continue to do things that get as close to customer value as possible.
That's it for this edition. If you have a question, send over an email or video to firstname.lastname@example.org. As always, if you got value here or on any other week of the report, we appreciate any and all shares on Twitter and LinkedIn. That’s how we know what you all want to see. Until next time.
Today Vinish Garg from vhite asks a classic question in the subscription world: How does a customer's contract length affect average revenue per user (ARPU) and churn?
To answer these questions, we looked at the data from over three thousand subscription companies. Here’s what we found.
Relationships are where the beauty of the subscription economy truly shines. For the first time in the history of business, we have a revenue model where the relationship with the customer is baked right into how you make money. Interestingly enough though, we don’t have to test that relationship on a month to month basis – we can (and should) lock in a longer term. What’s the best term though? 1 year? 2 years?
As to not bury the lede - increasing the guaranteed term of your contract with your customer absolutely lowers churn.
Regardless of ARPU, those companies with a higher percentage of annual contracts see significantly lower churn. This is because these customers have only one purchasing decision per year (albeit a larger one) whereas their monthly counterparts have 12 purchasing decisions per year. Note that the correlation is pretty strong here with those companies that have 100% annual contracts seeing 80% lower churn than those who only do monthly.
We don’t have enough data on multi-year contracts, but qualitatively we’ve seen the effects to be similar with one important exception. As you increase the term beyond 1 year, the reduction in churn is minimal, meaning there isn’t much to be gained in terms of retention for 2+ year contracts.
There is much to be lost though with longer term contracts. While many people use two or more year contracts to guarantee they recover acquisition costs, the impact is you lose out on the ability to increase prices or your overall average revenue per user.
Note how those companies using monthly or annual contracts tend to have some fairly decent increases in ARPU over the years. The flexibility of these contracts ensures that as the product improves, the price can also improve. Remember, your price is the exchange rate on the value you’re providing. Those with longer term contracts tend to have fairly flat ARPU, mainly because so much focus is being put on the longer contract that these terms don’t provide a lot of flexibility.
Of course, a big lurking variable here is longer term contracts tend to be used for much larger deals, so what should you do?
Well, in most situations you should definitely optimize for a healthy dose of annual contracts. Axiomatically I would say that most companies out there should avoid contracts longer than a year, strictly because you want to be able to raise prices over time. Some industries won’t be able to avoid the long term contracts due to constraints from the cost of acquisition, but these folks should then make sure contract terms are flexible enough to warrant price increases, especially as the product improves.
Well, that's all I have for today. If you have a question, ship me an email or video to email@example.com and if you got value here or on any other week of the report, we appreciate any and all shares on Twitter and LinkedIn. That’s how we measure if we should keeping doing this or not.