Please note: This is the third post of a three part series that focuses on how your SaaS metrics tie into onboarding customers, company growth, and generating the recurring revenue needed to not only stay afloat, but thrive in the booming SaaS industry. If you’re new to the series, have a look at the first post on Customer Acquisition Cost and the second post on Eliminating Churn.
In parts 1 and 2 of this series focused on SaaS metrics, we discussed how important monitoring your customer acquisition and retention metrics is to the health of your SaaS business. However, you may have noticed we can’t help shining a big, beautiful spotlight on the bond between improving those numbers and your pricing process. There is a delightful land in the SaaS space where customer happiness and plump profits dance together to epic slow jams, but only if you have a pricing strategy that can defend your ark as you travel churning seas of ill-fitting customers who threaten your company’s growth and profitability.
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All whimsy aside, we’ve emphasized throughout this series that ensuring your company can profit while providing enough product value to keep customers satisfied is essential if you want to prevail in this treacherous sea of SaaS. But to align your positioning, packaging, and pricing with your target customers is not only important for reducing customer acquisition cost (CAC) and churn, it’s also the key to monetizing those customers and generating the monthly cash flow needed to grow successfully. As such, let’s begin by exploring the importance of monthly recurring revenue (MRR) before we look at how a value based pricing strategy ties into improving MRR and monetizing customers more effectively.
Why Is MRR so Important?
You can boost the numbers by providing clients the option to purchase annual contracts, but let’s be clear, SaaS is generally a recurring revenue business based on smaller cash payments made in monthly increments. Calculating and studying your MRR shows you just how well your SaaS business is actually operating and may help you discover what areas need improvement before you attempt to accelerate growth.
While it’s true that the time it takes to recover your CAC and hopefully begin profiting depends on the efficiency of your sales team and how you optimize your funnel, simply increasing these monthly payments is obviously a surefire way to recover CAC faster and increase profitability. Unfortunately, very few businesses make the connection between maximizing monthly profits and leveraging their pricing strategies.
Improving your MRR stream has everything to do with better pricing, from upselling customers using add-ons and bundling to proper value metrics and customer segmentation. If your MRR isn’t enough to sustain operations or further growth, then there’s a good chance your value proposition and services aren’t aligned with customer value perception. This, in turn, makes it nearly impossible to justify prices that work for both your bottom line and your customers, but we’ll discuss how to prevent this from happening after boiling down MRR.
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How Do I Calculate MRR?
If you’re already familiar with calculating MRR, skip to the next section.
Unlike the formula for Customer Lifetime Value we introduced last week, the recipe for calculating your company’s monthly recurring revenue is fairly simple. To determine your MRR, you multiply the total number of paying customers by the average amount they pay you every month, otherwise known as the average revenue per user (ARPU). The formula is pictured below.
MRR = Total # of Paying Customers x Average Revenue Per User (ARPU)
You can see from this basic calculation that increasing your company’s average deal size is crucial to increasing your monthly revenue, but ensuring you can earn more cash from each of your customers is a lot harder than simply acknowledging more money would improve the numbers. You need to be able to monetize those customers effectively while ensuring they don’t churn out and look for other services, and one of the best ways to do this is pricing customer fit. Charging each customer segment for every unit of value they receive is one of the biggest components of a complete pricing strategy that puts value at the forefront, and most importantly, brings in more money.
How Do I Boost MRR with My Pricing?
A proper pricing process will help you convert more potential customers into paying ones, upsell customers you’ve retained as their own businesses grow, and ultimately increase MRR, so let’s look at some ways to actually implement a better pricing strategy.
Ah yes, positioning. As mentioned in our post on eliminating churn, customers churn out when they can’t find value in what they’re buying. Part of preventing this is developing the right product, but the other half of the battle is ensuring you’re working to acquire the right customers. To charge customers a profitable price that represents all of the value they’re receiving requires you to match up your customer segments to the appropriate services that relieve their pain points, so knowing your customers is essential.
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In addition, your products need to be priced along value metrics so customers who receive more value from your product are charged more for each unit of value. Customers will convert to paid tiers and upgrade to premium services if you can justify price changes from one plan to the next and convey easily how much value they’re getting for the money. You also need to make sure each tier of your product is aligned to a particular type of customer. Once you define your customer personas and align each of them with the right plan and the right features, pricing and value will work together to bring in more revenue for your business.
Speaking of plans, determining the right packaging and presentation for your services is critical to using differential pricing to your advantage. Develop premium services, bundles, and add-ons that will enable you to upsell/cross-sell customers so that you can persuade them to move into product tiers that bring in more cash every month. This falls in line with pricing along a value metric, but using the right packaging for your product is all about having an attractive product mix with scalable pricing that appeals to bigger clients who are willing to pay more to obtain more value as well as price sensitive consumers who need less of your service.
If your company offers a free plan or free trial, packaging and its relationship to pricing becomes even more crucial. Free users are pointless unless they’re eventually willing to convert, so it’s important to use a proper set of plans and continual engagement to give these customers the incentive to upgrade to paid tiers and profitable services. Uncover what features and product options your customers actually care about so you can increase their willingness to pay and factor them into your MRR.
The most important part of a value based pricing strategy is determining the price sensitivity of your target customers. You can increase the customer’s willingness to pay with a great service and superb value alignment, but understanding price sensitivity is the key to knowing which direction to go in and what needs to be redeveloped as your business moves forward.
Simply put, customer data is the best indicator of whether your pricing is justified by your offerings. You can’t raise more monthly revenue before discovering how your target segments perceive the value of what your building. Price sensitivity data also tells you if your prices may be too low, and after you cull this precious data from your customers you may find that you can raise prices on certain plans without increasing churn.
Collecting this type of data and implementing a value based pricing strategy is no small feat, but it’s impossible to pick prices that reflect the value perceptions of your consumers without actively seeking their input. Hitting the grindstone in this manner not only helps you isolate the qualities that separate your product from the copycats swarming the market, it also gives you the greatest amount of data to make an informed decision about your profit maximizing price, and that’s the clear path to the golden revenue stream of your dreams.
Stay tuned for the conclusion of this SaaS metric series, where we’ll bring all of the SaaS metrics we’ve discussed under one roof and show how the pricing process and customer value tie into improving every vital calculation.