Decoding pricing in SaaS companies with Redpanda

Summary

SaaS founders must walk the tightrope of having to price their product attractively while also protecting long-term profitability. Understanding one’s target market from the beginning is crucial for shaping the business model. Leveraging diverse perspectives internally and gathering competitive intelligence externally empowers founders to develop strategic pricing models. This might involve usage-based pricing or tiered features, with a focus on capturing value and offering discounts based on the customer's perspective. Ultimately, the key to success lies in achieving harmony between value capture and customer satisfaction.

The path to pricing your product can feel like a labyrinth, especially for early stage SaaS founders. At every turn, you have to consider how to strike a balance between attracting customers and ensuring long-term profitability for sustainable growth. Price your product too high and you risk scaring away potential customers. Price it too low, and you might struggle to generate the revenue needed to fuel further development and expansion.

We spoke to Alexander Gallego, founder and CEO, Redpanda Data, about equipping founders with the knowledge and strategies needed to craft a pricing model that fosters success. Redpanda’s end-to-end streaming data platform is a developer favourite, which supports every kind of form factor, from embedded IoT devices to the largest cloud workloads. But it has also perfected product pricing in a way that supports sustainable growth. 

Alexander says, “Pricing was top of mind on day one.” His initial focus, he adds, wasn't on a specific dollar amount, but on a key principle:

“I wanted to prove to myself that I was building a real company with a mission critical system people were willing to pay for, while using it in production." - Alexander

It is important to understand that such an early focus on pricing is not just about revenue. Pricing, he explains, helps founders understand their target market. Are they building a high-growth company or something more niche? The answer to this question informs the entire business model.

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A multi-voice approach to pricing

Once founders have decided to be cognisant of the pricing from the beginning, they often stumble on to the next question. How should they think about pricing for a product that solves a unique problem, or is a potential disruptor? In other words, how should they price a product with no market history?

Alexander’s solution: leverage diverse perspectives.

For instance, sales professionals understand product features and positioning, but “the engineering team is a much better source of information.” They can explain why a specific feature justifies a higher price point based on the tangible value it delivers. 

“The sales executive will give you a high-level reason why,” he explains, but “the solutions engineers will just tell you, ‘this one product feature was the reason why we were able to create a meaningful impact’."

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The first principles of pricing

Once these basics are in place, entrepreneurs need to have a measured approach to pricing software right. Alexander has a checklist for B2B infrastructure products, with some key principles to consider, especially for founders of open-source companies offering value alongside free versions.

1. Pay for usage: For smaller companies that typically use fewer resources, a per-node price worked well for Redpanda. This is like a flat fee per machine the software runs on. For larger companies that use a lot of resources, a per-core pricing strategy works better. They are charged based on how much processing power they need.

2. Define the essential: By reserving premium features for paid plans, companies incentivise upgrades and capture the value created by those functionalities. 

3. Straightforward and easy: Ultimately, the goal is to demonstrate the value proposition clearly and justify the pricing structure. Don’t add too many layers, keep it simple. 

However, Alexander cautions that for open-source companies, it’s important to make sure that you capture enough of the inordinate amount of value created for end users. Make sure customers aren't getting too much for too little. 

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Unlayering the pricing strategy

Unit economics and product complexity are essential considerations for SaaS pricing, but achieving sustainable, profitable growth is paramount. 

“Software is a high gross margin business. And you should try to capture as much gross margin as the market will allow you to clear,” - Alexander.

The key is to balance this focus on profitability with the realities of the market. For instance, SMB pricing is often more standardised with usage-based discounts, whereas enterprise pricing can be more dynamic.

“There is a market clearing price for any product. For example, when you hire someone, you're never paying what the person is worth, as that is fundamentally unmeasurable. The person may be worth an infinite amount of value. But what you’re paying is the market clearing price for that person's skills and time to work for a company, - the same is true for products” he explains. 

This dynamic approach allows for flexibility. Strategic discounts can be used to acquire high-value enterprise customers, but the core pricing structure should ensure healthy margins over time. 

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Finding the sweet spot with discounts

For many SaaS businesses, discounts can be a powerful tool, whether it is a discount on a product line or only specific features. But they need to be used strategically.

Alexander offers insights into discounting as a combination of market research, customer discovery, and an understanding of the business’ core value proposition. 

Before chalking up a discounting strategy, it is important to understand the customer’s perspective for software pricing:

1. Do more with less: Reducing costs for the customer lets you price competitively. “You sell software because you want to do more with less. You lower cost,” says Alexander.

2. Enable new capabilities: If your solution opens new revenue streams for the customer, “you can command much higher prices”.

3. Security and compliance: Solving security or compliance issues adds value too. “On the risk and compliance side, you have almost unlimited pricing potential,” he explains. 

Understanding these customer issues can guide founders to use intuition and cost benchmarks to arrive at a fair and competitive price. For example, mission-critical software commands a lesser discount compared to a nice-to-have software or feature. 

However, the long-term goal for any business should be to capture market value and eliminate giveaways.

“Once you get your first ten customers, you shouldn’t really sponsor any more,” - Alexander 

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Use competitive intelligence

For founders, there are two main approaches to entering a market: educating customers about a completely new problem-solution space, or capitalising on an existing market with a superior product. In the second case, gathering competitive intelligence through investor networks is crucial. Investors have a large portfolio of companies, some of them may be paying a competitor. Learning about their value proposition and moving quickly to offer competitive pricing is one way to approach discounting. Finally, responding quickly with data-driven pricing is essential. 

The key consideration for a competitive pricing strategy, according to Alexander:

“The question to ask here is, are you a part of this company's success? The second question is, do you have the features that are going to help them be successful?” 

Pricing for new features

Keeping customers engaged and growing their value is essential for SaaS companies. A question founders often grapple with is how to price new features for existing customers. There are three main ways to look at this:

Cloud-based subscriptions: For cloud-based subscriptions, a consumption-based pricing model is ideal. “More features mean more consumption and that should be the driving metric,” Alexander explains. Customers pay for what they use, and there's no need to restrict access to features.

Self-hosted deployments:  For self-hosted deployments, unit economics are crucial. “You just want to capture a value proportionate to the value that the customers are getting from the product,” he adds. Here, feature gating might be appropriate, but the goal should be to encourage customers to use more features and increase their overall value.

Customer Usage Patterns: Ultimately, the best approach depends on customer usage patterns. If customers tend to use all features or none, a consumption-based model is ideal. However, for customers who might only use a specific subset of features, feature gating can be considered.

The key to sustainable growth in the SaaS world, as evident, lies in deftly balancing value capture and customer satisfaction. By prioritising these elements, founders can craft pricing strategies that deliver value for their businesses and that of their customers.