Q. Dear Zenagos,
I’m an experienced senior technologist, and I’ve created a SaaS reporting tool that I want to sell to CIOs. I think I can build up the company and sell it to a technology consulting firm within five years. The thing I’m struggling with is the price. I could undercut the competition with a really low price, but is that the smart thing to do?
Pricing is a complex topic. There may be fancy terminology and formulas for calculating the optimal price for an offering, but it is rarely straightforward to collect the data you need to plug in to that formula. For this reason, pricing is a great profession – the majority of pricing analysts earn more than $100,000 a year in base salary (Deloitte, 2009). So, if you’re struggling with what to charge for your offering, you’re not alone. We only have enough space here to skim along the surface of the topic; if pricing interests you, figure out who researches pricing at your favorite business school and follow their research. You can dive as deep as you want.
Look at the Competition
The easiest thing to do when you are considering what to charge is to look at the competition. Is there an offering exactly like yours that prospective customers will consider? If your offering is not unique, then that can put pressure on your price. Do everything you can to differentiate your offering, whether with additional features or customer service. The more unique your positioning, the more control you will have over your pricing.
Cheapest Isn’t Always Best
Consumers often use price to draw conclusions about quality, so undercutting the competition may not be the best choice. If you could attend a college free of charge, would you do it? In cases where higher prices signal elite quality, the low price position may not be the best option.
Pricing to Achieve an Exit Goal
If you think you will be able to grow your company quickly and then sell it, then one way to think about your pricing decision is to set a goal for the value of your company upon exit and then work backwards.
You can use a comparables (or “comps”) method to derive the revenue (or net income) you would need in order to achieve a $5 million sale. This is similar to the method used by your realtor to set the price when you put your house on the market. The realtor looks at the prices at which similar houses have sold and makes an argument for the price you should set. In this way, you would look at comparable businesses and check the multiple of revenue (or EBITDA or net income) represented by the final acquisition prices. For example, let’s pretend that businesses in your field have been selling for about 7 times their annual recurring revenue (“ARR”), written as “7X.” So, if you want a $5 million sale, and most similar SaaS companies are bought for seven times revenue, then you need $5 million divided by 7, or about $714,000 (or “$714K”) in ARR.
3. Work Backward from the Revenue to the Price
This is obviously a simplified analysis. There are many other factors to consider, including taxes, debt, and risks. It’s always smart to assume that some things will go wrong and build in buffer where you can. And, there are a wide variety of pricing strategies, including starting at one price and then gradually moving to a target price. Most entrepreneurs figure out what the market will bear by putting a price out there and seeing how the market responds.
Regardless, if you have a very wide range of potential prices that you could charge, consider bringing your ultimate goal into the analysis. You are more likely to achieve your goal if you plan directly toward it.
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Deloitte. (2009). Is there a career in pricing? An insider’s view of the pricing profession. Retrieved on August 5, 2023, from https://www2.deloitte.com/content/dam/Deloitte/us/Documents/strategy/us-consulting-ppm-is-there-a-career-in-pricing.pdf