How to price SaaS and build a moat in the age of AI.

by | Jun 2023 | Build a Product

If you’re building a SaaS startup you’ve probably considered the odds that your business will be disrupted by the next wave of generative-AI startups. You may be wondering:

“How am I supposed to compete, how do I price my platform, and how on earth can I create an effective moat?”

It turns out the answer to all three questions is the same: by understanding value.


Let’s start with defensibility:

How to build a moat for your SaaS company.

Jake Saper from Emergence Capital believes:

  1. The medium-term moat, especially in the age of gen-AI, will be creating robust workflows around jobs-to-be-done.
  2. The longer-term moat will be capturing proprietary business outcomes data. Think about what data you’re collecting from your customers that LLMs cannot possibly get access to, and how you can leverage that data (with or without AI) to create unique, lasting value for your users.
  3. The best strategy for obtaining proprietary data is to have a lot of people using your product, so pick a pricing strategy that encourages usage (like value-based pricing, as I mentioned yesterday) as opposed to charging per seat, which can actually deter usage.
  4. The easiest way to incentivise users to share their proprietary outcomes data with you is by offering preferential rates and/or by providing them with access to outcomes data from other users.

Benefits of understanding business outcomes

What does Jake mean by “business outcomes“?

It’s actually quite straightforward. Just ask yourself: what impact is your software having for its users and what is that impact worth financially?

If you can calculate the value you’re providing to customers, you can:

Reduce churn

Make sure you’re communicating the value of your software to customers who are already paying for it. The cost of your software is plain to see in the P&L but value is much harder for customers to calculate. You need to do this work for them. If you can help your customers see the value you’re creating in hard numbers, there’s far less chance that they’ll churn.

Win more business

Likewise if you can present the benefits of your software to new customers with real numbers and testimonials, your ability to win business will skyrocket. No customer wants to “invest in software” but virtually all businesses want to improve their bottom line. Demonstrate how your solution increases revenue and/or reduces cost and your sales team will love you forever.

Differentiate from competitors

Founders often feel they can’t raise prices. They’re locked in a price war with competitors, and they don’t want to lose a deal because they were more expensive. But users can only make a decision based on price if they’re comparing like with like. Use what you know about your customers’ business outcomes to differentiate your software, demonstrate how your solution (unlike competitors) delivers real, hard value. Back this up with testimonials from happy customers. Do this well and it will appear like you don’t have any competitors. You’re in a category of your own.

Create robust pricing

I spoke with a founder recently who was fresh off a call with a prospect. They asked how he’d arrived at his price point and he found his own response problematic. He realised that by benchmarked his price against competitors he was essentially telling his prospect who else they should be talking to! Not only that, but he realised the customer was reviewing his solution based on vague promises. It would have been far easier, he admitted, if he could provide clear, tangible expectations in terms of hard benefits (like increased revenue or lower costs), soft benefits (like better morale), and business process benefits (like gaining the ability to measure KPIs that were previously impossible to gauge).

So how do you use value-based pricing in SaaS?

Many SaaS companies charge based on no. of “seats” or “usage”, but both these strategies disincentivise companies from using your product!

Here’s a simple way to think about SaaS pricing and value in the age of gen-AI, again inspired heavily by Jake Saper:

  1. The current paradigm of per-seat pricing is unlikely to continue due to cannibalisation. Software vendors will actually earn less the more effectively they perform because, as generative-AI increases efficiency and fewer people are needed, there will be fewer seats and and users to charge for.
  2. Instead the ultimate goal with pricing should be to tie yourself to the value you create. The more value you can create, the more customers will use your product and the more revenue you’ll make.
  3. The rule of thumb is to charge 10-30% of the value your software creates – perhaps more if you’re a monopoly.

In 2011, Marc Andreessen, co-founder of venture capital firm Andreessen Horowitz, wrote: “Software Is Eating The World”. If we don’t move away from per-seat pricing, it will eat itself too!

Ideally, every software vendor should always be working its way towards a unique, value-based pricing strategy, which is immersed in its proprietary aggregated business outcomes data. In other words, vendors should be measuring how their software is creating impact for its users, assigning that impact with a value, then leveraging that value in its pricing policy.

This kind of pricing can only be achieved over time, as it takes a lot of work, with the cooperation of your customers, to work out what to measure and how to calculate your software’s true value.

Generally speaking, it’s likely that you’ll need to address your pricing in the following three stages:

  1. If you have limited information, go to your first 5 customers with 5 different prices and see how they respond. Iterate.
  2. If you can identify and have data about other vendors in your space, start by charging a bit less than the obvious competitors.
  3. As you gain more customers, you should be aiming to perform an ROI analysis of how much value you’re creating (what’s the problem, how costly is that problem and how effectively are you solving it?). When you feel confident about your value calculation you can transition to a value-based pricing model, charging (probably) between 10-30% of the value you’re creating.

Credit

This is inspired by a brilliant podcast on generative AI with Jake Saper.

Image credit

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