Welcome to the third edition of the Pricing Transformations series. In this article, we look back at 2021 and forward to 2022, measuring how our past predictions have stood up to another tumultuous year and laying out what you can expect in 2022.
You can read the first two installments in this series here:
Let’s begin by looking back at the year 2021. Here’s how we did:
- The continued adoption of product-led growth (PLG) best practices: we give ourselves a 5/5 on this one. Product-lead growth continues to be one of the best ways to rapidly scale a software company, and best practices are increasingly shared and understood. (See: The Ultimate Product-Led Growth Resources Guide.)
- Pricing models must be adaptable: 4/5 on this. We took off a point as there are still too few people who understand pricing models well enough to make them adaptable. The operating environment remained fluid in 2021, with some sectors doing well while others continued to struggle with the pandemic and the measures in place to manage it. At the same time, the first signs of a return of inflation began to put pressure on pricing models.
- Usage-based pricing gets normalized: 5/5 we are on a roll. 2021 was the year that everyone was asking about usage-based pricing and more and more companies began to experiment with it. (See The Usage-Based Pricing Playbook.)
- Pricing for social change: 2/5. The importance of pricing as a way to nudge people towards more responsible decisions remains controversial. Take carbon pricing. It has been normalized in some countries, but it is still a partisan issue in the United States. 2021 was not a breakthrough year for pricing for social change. Given the lingering impacts of the pandemic and the rising specter of inflation, the impact of pricing on community value will likely remain below the surface for most companies in 2022 but this remains a long-term trend. Science, conscious consumers, and next-gen founders will drive ESG innovation in 2022. (In case this is important to you, read more here: Weaving Social Consciousness into Corporate Identity – Community Value Drivers.)
- Join Steven’s research, take a short survey Growth Strategies in 2022.
Now onto pricing transformations for 2022. We’ve come up with five predictions for what’s to come.
Companies push usage-based pricing even further
Usage-based pricing (UBP) was an undeniable trend in 2021. 45% of SaaS companies said they had some form of usage-based pricing, up from 34% in 2020. A majority of the UBP holdouts expect to either test or launch UBP in the coming years.
Here’s the catch: most companies only dipped their toes into usage-based pricing rather than diving in headfirst. These companies might have introduced a new usage limit for their free plan or for an entry-level paid subscription, for example, rather than testing a more disruptive pay-as-you-go offering.
It’s easy to understand why companies would want to tread carefully. Fully embracing usage-based pricing rather than traditional seat-based subscriptions is analogous to making the transition from on-prem to SaaS in the first place. It requires rethinking everything, from billing and revenue forecasting to the role of Account Executives to how to drive a customer success mindset across the entire organization. Plus, companies face significant change management hurdles if they choose to migrate their legacy subscription customers onto a new pricing model.
But as SaaS companies see success with their initial usage-based pricing experiments, we expect to see many of them embrace usage-based pricing as part of a true business transformation.
Thankfully, there’s an ever-growing number of vendors who are building technology to make this transformation a little easier. Emerging vendors include Amberflo, Monetize360 (funded in October 2021), Octane (funded in August 2021), Metronome, M3ter, and many more. Meanwhile, the federal government is lending its support to usage-based pricing by amending its GSA schedule to allow agencies to “pay by the drink.’”
With more readily available tooling, a growing number of buyers, and an ever-expanding list of success stories, 2022 will be another banner year for usage-based pricing adoption. (See Usage-Based Pricing: Behind the Scenes of New Relic’s Transformation.)
Customer Value Management will supersede customer success
One of the most important changes sparked by the subscription economy, and the move to software as a service, has been the shift from customer support to customer success. Customer success introduced many techniques from customer experience management to help design the experiences that would lead people to use the service and then renew when the time came. The customer success leader is often the person who owns the renewal number.
As we shift from static subscriptions renewing at fixed intervals to include usage-based pricing, this will not be enough. We will need to focus on the value generated by that usage.
This means we need to move from customer success to customer value. Good usage-based pricing is based on the usage that ends up in something of value to the customer: not just clicks, but the completion of value paths (the sequence of actions that ends with something of value to the user). Someone needs to be responsible for defining these value paths, tracking them, and making sure that they are being completed.
This is the role of customer value and the customer value manager. Many value promises are made by marketing and sales. Many value assumptions are made by product management. The customer value manager is responsible for connecting promise to reality. Usage-based pricing is a powerful way to get everyone focused on what is creating value and how it is being delivered.
Inflation will dominate conversations on pricing strategy and tactics
U.S. inflation rates peaked at 13.5% in 1980 but have been under 6% since 1983. In 2020, inflation was only 1.23%. In December 2021, inflation was estimated at 6.8%. Saxo Bank, tongue in cheek, suggests that U.S. inflation could go over 15% in 2022 (see Outrageous Predictions).
Not many people think we will see double digit inflation, but something near 10% has become quite possible. How will this impact your pricing?
Before you answer that question, ask what will happen with interest rates. The common assumption is that central banks will crank up interest rates as they try to get inflation under control. Maybe. But during the low inflation/low interest rate cycle, governments amassed huge debts. High interest rates will suck up government revenues. Governments are likely to resist this.
If there was ever a time for scenario planning, this is it.
There will be pressure to raise prices to at least keep up with inflation. That could mean price increases of as much as 10%. This would be a very large price increase and the impact on demand would have to be considered. Be careful not to trigger a downward spiral where price increases contribute to inflation while driving down demand.
Before a reactionary price increase, stop, do some analysis. Ask:
- How will inflation impact our customer’s business and business model?
- How might this impact differ across segments or industries?
- How will higher interest rates impact our costs and our suppliers’ costs? Is it worth raising prices in every scenario? What will the impact be on customers?
- Can your product be positioned to help your customers manage inflation or interest rates? (i.e., if your product normally helps reduce operating costs, can it also lead to deferred capital investment?)
Inflation and, possibly, higher interest rates are an opportunity to rethink how you create value and how you capture that value in price. (See pricing and inflation – how to respond.)
We’ll take the “SaaS” out of “SaaS pricing”
SaaS pricing is a fairly new discipline. After years of neglecting pricing, SaaS companies have finally woken up to the importance of hiring dedicated software pricing experts and teams to help them navigate this important topic. Such teams are well-versed in different SaaS value metrics, methods of conducting pricing research, and how to implement pricing changes across a sales team.
All of that is great to see, and I don’t want it to go away anytime soon. But now “SaaS” is just one piece of the puzzle. Software companies have rapidly diversified their revenue streams into new and (sometimes) uncharted territories, including pay-as-you-go, payments, FinTech, data services, professional services, marketplaces, lead generation, hardware, and more.
Just look at Toast, the restaurant technology company that IPO-ed in 2021. Toast generated $823M in revenue in 2020. Of that revenue, only 12% came from subscription software. The remainder predominantly came from FinTech (78%) and hardware (8%).
Toast isn’t a rare outlier either. Similarly, Shopify, Bill.com, and MINDBODY generate substantial revenue outside of software subscriptions. HubSpot’s stock price jumped 16% in a matter of days upon the company’s announcement of new B2B payments and commerce functionality.
In 2022, “SaaS pricing” will become, well, “pricing.” Being successful will require going back to core pricing principles like measuring customers’ perceived value of a given product or service.
Top-tier talent will take this change in stride as pricing becomes a C-level and even Board-level priority for SaaS companies large and small. Now is the chance for that VP promotion or opportunity to build a best-in-class pricing team, but earning it won’t be easy. (See Inside Toast’s IPO.)
Pricing strategy will be about increasing company value and not just revenue or profits
On many pricing projects, there is a tension between volume, revenue, and profit optimization. The same price will not optimize all three. This basic fact of economics causes a lot of strife in management teams and with their investors. What if this is the wrong question?
Rather than asking how to optimize an operating metric, like revenues and ARR or profit or volume and market share, we should ask how price can maximize the value of the company over time. The conventional way to define this, the one used by most investors, is Net Present Value (NPV) or the present value of future cash flow. This means that revenues, profit, and risk are all important. Pricing strategy should optimize NPV.
Inflation decreased the present value of future cash flow. We were able to largely ignore inflation and assume low interest rates for the past generation. If that is no longer the case (the jury is still out), our pricing strategies and not just our tactics, will need to change. When calculating NPV, the discount rate gets multiplied by (not just added to) the inflation rate. Think about that for a while and see what happens to your value when inflation gets up near 10% (although we are not saying that it will).
In 2022, investors, boards, and executives will be asking their pricing teams how they can increase value. There are three levers, and all three need to be considered as a system: revenue growth (from new customers and existing customers less churn), profits, and risk (measured using the discount rate).
In 2022 pricing decisions need to be explicit on the intended impact on revenues, profits, and risk. Will we be right? What did we miss? We’ll see you back here in January 2023 to see how we did.