How to price your SaaS product

You’ve started a business, built a product, and now Apple wants to be a customer.  Fantastic, but you’re now presented with a high class problem: how much do you charge Apple or any other large customer for you SaaS product?

 

One popular school of thought is to try and bludgeon Apple into paying as much as possible.  The thinking goes Apple has $56bln of cash on hand so they won’t mind paying a premium for a good product.  They won’t notice the cash is gone so take as much as you can.  This is non-sense.  Apple and other large enterprises didn’t get to where they are by overpaying.  We have one portfolio company that tried this with Apple, asking for $1mm a year for the product.  Apple, turned off by the size of the ask as it had no basis, came back and said they’ll pay $12,000 a month.  Our portfolio company of course took the contract.

 

So what should our approach have been instead and how do you determine the appropriate price for a SaaS product? The answer is to price your products reasonably based on your costs and capacity, and since you’re a new startup, explain this to the customer.  Winning a marquee client like Apple does tremendous things for a startup, but signing big customers unprofitably isn’t feasible, so by actually explaining to Apple and others how you came up with the pricing you did, you’d be surprised as to how receptive they’d be. 

 

Below is a rudimentary example.  Suppose you’re a 5 person company today which is the founder, a sales rep, a customer success rep, and 2 engineers.  Including overhead and salaries, let’s assume the combined annual expense is $400,000 to support this team.  That means we better make annual revenue of at least $400,000 per year from this team once they’re at capacity

 

Founder/CEO

$60,000

1 Sales Rep

$80,000

1 Customer Success Rep

$45,000

2 Engineers

$200,000

Other Overhead

$15,000

Total Expense

$400,000

 

The key thing to keep in mind is not only the total expense, but also the capacity.  If I know that the team above can support 20 clients total, then I have to charge at least $20,000 per client per year just to break even once the team is at capacity. 

 

The next major factor after capacity is sales rep efficacy.  The question you have to answer is “how many clients can my sales rep close per year knowing that I need to be charging at least $20,000 per customer?” In the example above, to keep things simple, we assume the rep can close 20 clients per year, hence the team above will break even after 1 year. 

 

Founder/CEO

$60,000

1 Sales Rep

$80,000

1 Customer Success Rep

$45,000

2 Engineers

$200,000

Other Overhead

$15,000

Total Expense

$400,000

 

 

Customers we can support

20

Customers sales rep can close each year

20

Size of customer contract

$20,000

 

 

Revenue

$400,000

Expenses

-$400,000

Cash Shortfall

$0

 

Where the SaaS model gets interesting of course is in how long you can keep the customer and the fact that the sales rep will close another 20 customers the following year.  Below is a rudimentary example of what your company looks like assuming the sales rep closes 20 customers the first year with the first team supporting those 20 customers, and then the sales rep closing 20 customers the second year which of course requires you to hire a 2nd team.  As you can see, the work the sales rep did in the first year with the first team is yielding a profit, while in the second year the second team also generates a small profit because the CEO expense is spread across two teams. 

 

Mini-model

1st Team

2nd Team

Founder/CEO

$30,000

$30,000

1 Sales Rep

$0

$80,000

1 Customer Success Rep

$45,000

$45,000

2 Engineers at $100k each

$200,000

$200,000

Other Overhead

$15,000

$15,000

Total Expense

$290,000

$370,000

 

 

 

Customers we can support

20

20

Customers Sales rep can close each year

20

20

Size of customer contract

$20,000

$20,000

 

 

 

Revenue

$400,000

$400,000

Expenses

-$290,000

-$370,000

Cash Surplus

$110,000

$30,000

 

In conclusion, do not make the mistake of thinking Apple or some other customer will pay a lot for your product because they have the cash.  Instead, as a young startup, show them what it costs you to support the team (don’t be afraid to show you’re building in a profit) thereby justifying the price you’re asking.  They’ll be far less price sensitive because they now know you’re not trying to rip them off, you’ll land Apple as a customer, and then you can say “hey, Apple is my customer” which will of course attract everyone else.  

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