A founder emailed me last week to raise the question of whether performance pricing for SaaS companies is an effective technique. Performance pricing means explicitly pricing of product in terms of the customers’ revenue gained or cost reduced from its use.
Conceptually, performance pricing is very rational. The buyer should be willing to pay between 10 to 15% of the revenue or cost savings for the use of the product. And as classical economics instructs us, this type of pricing mechanism optimally aligns the incentives of the buyer and the seller. But the reality is more nuanced.
I was first exposed to performance pricing in the ad network world. In the late 2000s, hundreds of ad networks popped up each promising slightly better performance for their advertisers and their publishers. These are my observations from the evolution of that industry.
Performance pricing is a challenging go to market strategy for one key reason: it cedes the startup’s pricing power to the customer. This has three key ramifications.
First, each year when the contract comes up for renewal, the customer will ask, “What have you done for me this year?” For a traditional SaaS product that charges by the seat, the product’s value resides in the product use. Salespeople can sell engagement, utility, insight. In contrast, performance pricing focuses the conversation to one thing. How much did the numbers improve? If the SaaS startup cannot continuously improve the performance for the customer, the customer is bound to churn.
Second, performance pricing commodifies a category by reinforcing a single dominant purchasing parameter: performance. Vendors will all compete on percent improvement of the key metric. This is a very challenging sale, unless a SaaS startup has a substantially better product, and the ability to continuously maintain that lead. Otherwise, to win sales teams must discount, depressing pricing and leading to the ultimate commodification of the category.
Third, sales teams lose leverage. If the only metric that matters is performance, then great account executives won’t be able to shine. Building a relationship won’t be valued in the category, or at least it’s not enough to overcome sub-par performance. Sales hiring, sales retention, and sales management will suffer. That’s why many companies who offer performance-based pricing prefer self sign up.
Though performance pricing makes sense theoretically, it changes the power dynamics of a sales conversation, ceding all of the leverage to the customer. A startup will face greater churn rates, stiffer competition, tougher sales management, and ultimately commodification. The pricing mechanism itself reinforces that the product is a commodity. And who wants to be in that kind of market?
Unless the explicit strategy of the start up is to somehow disrupt an existing commodity industry with a novel technology that performs much better than incumbents and couples it to a very efficient self sign-up customer acquisition strategy, performance pricing can be a tough go-to-market.
Published 2017-05-09 in Pricing
Tomasz Tunguz is partner at Redpoint. I write daily, data-driven blog posts about key questions facing startups. I co-authored the book, Winning with Data. Join more than 20,000 others receiving these blog posts by email.
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