September 10, 2013
Discounting Makes You Work Twice as Hard. Here's Why.

Almost all SaaS startups strive to generate consistent growth. Nowadays it seems every emerging company has a “growth hacker” on the team devoted to increasing reach and awareness using advanced marketing tactics and modern metrics. When it comes time for fundraising, the incredibly high user adoption rates of companies like Facebook and Snapchat make it easy to rake in substantial amounts of venture capital despite the lack of a decent monetization model.

Yet one common misconception among founders and investors alike is that if your business is growing significantly everything else will fall into place. We understand the slow play, but many companies optimize for growth and user adoption rates without much concern for maintaining profitable margins or changing consumer behavior, slashing their service prices and giving away valuable products that provide little incentive to upgrade to paid.

Discounting and Software Don't Mix

Economics 101 teaches everyone that lower prices lead to a greater quantity demanded, but there are huge holes in this logic when it’s applied to pricing your software services. Discounting works well in retail because brands can create excitement and apply pressure to consumers by limiting supply (or making it appear limited), but the same is not true in the software space. Due to the non-physical, unlimited nature of software, discounting and freemium offers actually condition customers to devalue your product.

discounting

photo credit: Liis Klammer

Lower prices and free plans will increase users, but a large amount of those users will never turn into ideal customers, and they certainly won’t perceive your service as a great value at a price point that’s profitable for your business. Don’t believe me? Let’s walk through the consequences of price cuts and freemium offers in further detail before offering you some alternative suggestions that will ensure you can generate revenue and growth.  

You Make Less Money!

This might seem pretty obvious, but it’s a consideration founders often ignore when trying to maximize their user acquisition numbers. Offering discounts on your product will inevitably shrink your margins, which ultimately puts the hurt on your bottom line. Fewer profits mean less money for every part of your business. A smaller marketing budget means less sustainable growth. A smaller engineering budget means a smaller engineering team, which leads to less innovation and slower product iterations. Most importantly though, a smaller budget means doing less of the fun things at a startup, like getting the Uber ice cream truck to come to your company doorstep or filling the office mini fridge with microbrew. Not cool.

The rate of user adoption might be the ultimate metric at a startup, but cash is a startup’s lifeblood. Growing a successful business is a long-term endeavor and discounting your product to drive growth is like taking steroids. It might give you a boost in the short-term, but eventually the health of your business will take a beating .

Discounting and Free Plans Destroy Your Branding Efforts

As I mentioned before, discounts reduce the perceived value of your product. If customers are already acclimated to a lower price point, it becomes that much harder to justify an exchange rate for your product that represents the full value of the offering and sustains your business. Free plans potentially do even more damage because you’re giving away such a significant portion of the value you’ve created. In order to turn users into loyal, paying customers, your service needs to consistently demonstrate and deliver value as the customer’s business grows.

What’s more, you could actually be losing customers through discounts. For some products, high prices increase customer demand because they reinforce a prestigious brand image or the value of particular features. Think about the luxury automobile market; do you think the super-rich would still pine for a Rolls-Royce if they knew they could get a 50% discount? That example is a bit of a stretch, but the lesson is discounting does nothing to build or preserve brand value. Lower prices can lead customers to question the quality of your service, turning them from value buyers into customers who base their purchasing decision solely on price. Unless you’re targeting a segment of price sensitive consumers (and there’s nothing wrong with that, just look at WalMart), the drawbacks of implementing discounts far outweigh the benefits.

prestige pricing

photo credit: yannickminet

They’re Also Unsustainable

One of the biggest problems with discounting and freemium offers is companies use them to expand their pipelines before they figure out who their ideal buyers are. It’s far more difficult to move customers up to premium products or charge them a profitable price if you don’t understand what drove them to your service in the first place. The customers conditioned to devalue your service make it almost impossible to develop a working revenue model and a sustainable business, even if you can persuade a percentage of those customers to stay by continuing to cut prices and offer promotions.

Most businesses that give away the farm have a tough time demonstrating the true value of their services and retaining users further down the road. Switching costs for consumers are negligible, and those less-than-ideal customers you spent time and money baiting will churn out the minute you put a proper price tag on your service. Undoing this type of price conditioning is an uphill battle (just look at Ron Johnson and how he fared trying to implement an everyday low pricing strategy at JCPenney), and to maintain growth you’ll have to develop a completely new customer acquisition process in addition to a better pricing strategy.

How Can I Increase Growth & Revenue Without Giving Away Value?

There are plenty of ways to increase your rate of adoption and maintain revenue without using discounts and free plans, so let’s examine a few of the basic steps a nascent startup should take before it resorts to issuing handouts.

1. Understand Your Audience and Segment Effectively

Before you send a tidal wave of users down the pipeline with promotions, it’s crucial to know exactly what type of customers you’re looking for. We’ve said it time and time again, but a full understanding of your buyer personas is essential to developing a product or service that will grow with your customers and ensure their loyalty to your brand. Do the research and uncover what sends your ideal customers through the sales funnel, because even if higher prices slow down your user adoption rate, at the very least you’ll know what aspects of your service need retooling to acquire more users at prices that maximize revenue.

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photo credit: marfis75

In addition, each customer segment will perceive value differently, and it’s important to use the features and value drivers that appeal to each segment to market your product in different ways. Rather than running a huge promotion that won’t appeal to everyone or convey the right message, create more specific value propositions based on the size of the customer’s business, geography, and income. If you still feel it’s necessary to use discounts, do it discretely in pointed campaigns to upsell customers to services with higher margins or to keep specific customers away from competitors.

2. Create a Free Trial or an Entry-Level Tier

Free plans with no time restraints have to be pretty ugly to convince potential customers to upgrade, and most of the time they convince prospects your service isn’t worth purchasing. A great alternative for SaaS businesses is implementing a free trial. Instead of giving up a portion or all of your product for an unlimited amount of time, allow your customers to test out your service for a few weeks so they can see the value your service offers. If your product is a great fit, those prospects will convert to loyal, paying customers.

In addition, developing an entry-level plan is a great way to attract more price sensitive customers. If you can pare down the features of such a plan but still maintain the essence of your service, you can capture this particular segment for the time being and work towards upselling them to premium products with higher margins later on.

3. Implement Promotions That Add Value

In the software realm, adding additional value doesn’t cost nearly as much as developing your core product, and a little ingenuity and a few extra benefits can go a long way.  Rather than using discounts and promotional campaigns that cause customers to devalue your service, try boosting the value of your product by increasing the number of users allowed, improving features, or expanding services with premium add-ons. Introducing new product bundles with higher margins can also have a positive impact on your bottom line if they appeal to your customers and their value perceptions, and sometimes a different package is all it takes to persuade customers to purchase a larger portion of your service.

To learn more about pricing specifics, check out our Pricing Strategy ebook, our Pricing Page Bootcamp, or learn more about our price optimization software. We're here to help!


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