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SaaS market segmentation for value-based prices and profitable growth

SaaS market segmentation
for value-based prices and
profitable growth

Introduction

How do you grow your business as fast as possible? The answer for many Start-ups seems clear: Sell to as many people as possible. Which means literally everyone who is not up a tree on a count of three. But is that the best way to grow? The most successful one? A rhetorical question, of course.

What’s the problem? The group of everyone comes with a maximum of heterogenity. How could you combine all their needs under one single umbrella? The inevitable result is an Average Joe product, heavy on features but low in depth without dedication to solve specific problems. A commodity, not a game changer. There are enough of in every market. Who wants to buy another me-too product?

The problem deepens

How much can you charge for a commodity? A premium price? Certainly not. What many start-ups end up with is some kind of competitive price, chosen more or less randomly like:

  • A “psychological” number: 99$ because it’s scientific proven this works better
  • A popular number: 50$ because what everyone does can’t be wrong (only that it completely is)
  • The median: The competitors prices range from 50$ to 100$ resulting in a price of 75$ to avoid being too cheap and too expensive

There is indeed a psychological effect from the competitive price: The public confession that the product is NOT better than the competition. Because if it was better the price would be higher, wouldn’t it?

But killing the margins does not necessarily end here. What’s the solution if the business does not get any traction or things go south? Giving discounts. For everyone – just like this. Not for upfront payments, customer loyalty or exceptional large deals. A desperate and futile attempt to grow by numbers at the expense of margins. Deep, down, below.

Research from Price Intelligently shows that the average SaaS company spends just 6 hours in total determining their pricing strategy despite it being 2x as efficient as improving retention and a whopping 4x as efficient as acquisition in terms of growth.

The end of the road

In order to understand whether your unit economics add up to a profitable business model, you need to look at the ratio between two numbers: lifetime value per customer (LTV) and customer acquisition costs (CAC). The ratio between these two has to be greater than 1—otherwise, you’re losing money on each and every new customer.

Price Intelligently

The ratio between the customer lifetime value and the customer acquisition costs is the single most key performance indicator for your business. Selling to everyone drives the customer acquisition costs high and the prices low.

Research says that:

  • The median cost for a SaaS company to acquire a dollar of new customer revenue is $1.18. (ForEntrepreneurs)
  • The median startup spends 92% of first year revenue on customer acquisition, taking 11-months to payback their Customer Acquisition Cost. (Tomasz Tunguz)

It’s not hard to imagine that this simply can’t work out because there are more costs than marketing and sales and venture capital is not infinite. Not even talking about bootstrapped SaaS start-ups.

Based on the experiences of successful (and unsuccessful) SaaS companies, you need an LTV/CAC ratio of at least 3:1 to run a successful business.

Price Intelligently

Why does that happen?

Because it is hard to get the more-is-better-thinking out of people’s heads. The fear of loosing business if not selling to everybody and being too expensive. It’s paradox because industry research leaves no doubt that high growth is the result of the exact opposite. It’s the quality of customers that matters, not the quantity.

  • High-growth SaaS companies generate 40% more leads, per month, than their slower growing counterparts. (Insight Squared)
  • However, those same high-growth companies generate 60% fewer sales opportunities than low-growth companies. (Insight Squared)
  • High-growth SaaS companies close deals that are 2.8x the average size of deals closed by low-growth companies. (Insight Squared)

Jason Lemkin brings it to the point: „if you haven’t lived it, understand that Deal Size is the single most important factor in your SaaS business model.  Because it will completely define how you do sales and marketing, and to a just somewhat lesser extent, prioritize feature development and product/engineering.“

How to find profitable customers?

Market segmentation is the activity of dividing a broad consumer or business market, normally consisting of existing and potential customers, into sub-groups of consumers (known as segments) based on some type of shared characteristics.

Wikipedia

There are plenty of methods and criterias on how to perform your market segmentation. Geographic, demographic etc. and while they all play their role in the grand scheme to define a target group there is one thing that stands out as the most important – the customer need.

In business a need is simple. Because in the end everything comes down to improve the business performance. Your clients want to increase their revenues or save costs whether directly or indirectly. And that’s one important thing to remember, one thing that should run through all your communications. People have problems, they don’t need tools, they need solutions. Start your market segmentation with identifying common problems.

Qualification

Wait a second. Because a problem needs further specification. There are 2 factors that determine if solving a problem is profitable – for you and your client:

  • Importance: How important is the area, the process or activity to the organization?
  • Urgency: How does the problem affect your client’s organization?

No matter how awesome your product is, if there is no problem important and urgent enough, you can’t solve it. Sounds logical doesn’t it? That’s exactly why selling to everybody does not work. The importance and/or the urgency are simply not high enough.

This can be applied to any product category and this is the true art of market segmentation. Determining the importance is, in some cases, pretty easy. It’s safe to assume that the project performance matters for a software developing firm. More than for a company doing only internal projects. Who would have a greater interest in buying a solution if the project performance sucks? Obviously it’s not always that easy and a complete market segmentation requires further details to define your ideal customer. But it’s definitely worth to dive into and find out.

Most companies are sure they know their customers. But the truth is the majority of businesses have no idea who their customers really are. Even worse, they are not putting real effort into finding out.

Price Intelligently

From zero to hero

As soon as you define your target group around a specific problem with great importance and high urgency you can build (or recreate) a dedicated solution. One that solves a specific problem better than any of the superficial tools in the market that are built for „companies of all kinds and sizes“. 

That’s a product that generates real value and this is only the beginning. Because it also produces reasonable and valuable feedback. Leading to a product that is continuously improving and delivering more value. One that is truly „10x better than existing products“. The sky is the limit.

Remember that customers generally care ONLY about their Desired Outcome and how it affects them (at least when they are searching for a solution).It is the benefit of the benefit of the features… or the emotional benefit. It’s their Desired Outcome.

Lincoln Murphy

A new business model

When you grow your product from a mere tool to a dedicated solution your business completely changes. Because you deliver real value and not only leave your competition behind but also their low-profitable pricing strategies. You will enter the realms of value-based pricing. The growth wonderland with all the fun, action and adventure you can imagine.

This could easily be called “Customer-Based Pricing” because that is effectively what it is. Instead of looking inwardly at your own company, or laterally towards your competitors, with value-based pricing you look outward. You look for pricing information from the people who are going to make a decision depending on your price: your customers.

Price Intelligently

Another 10x rule says that creating a ratio of at least 10:1 between the value and the price is a good strategy. I don’t that this is carved in stone but it’s a good way to start. As there is no perfect information it all comes down to what the customer believes is the value to price ratio and if it seems favorable. Your job is to build, raise and eventually meet these expectations but that is a story for another time.

Market segmentation is the key to profitable growth. Because it helps you identify who needs your product the most and gets the largest benefits of. If your client wins, you grow, if your clients wins more, you grow more. Plain and simple.

If you need some more motivation: A 1% increase in pricing strategy yields an average 11% increase in profit. (Harvard Business Review). You know what to do!

Key takeaways

  • Selling to everyone results in an average product and low-profitable competitive prices
  • Driving customer acquisition costs high and the customer lifetime value low
  • High growth companies generate more leads, less sales opportunities but close much larger deals
  • Market segmentation helps you to target potential clients with a problem whose solving is of great importance and urgency
  • Allowing you to grow from a mere tool to a dedicated solution that provides exceptional value
  •  For which they are ready to pay a value-based price maximizing your profit and growth