GrowthPad

The ironic thing about subscription businesses is that most companies spend countless hours perfecting product features, agonizing over marketing and communication material, and diligently focusing on new user acquisition. Yet, most businesses take shortcuts when it comes to pricing. This is a critical mistake. A firm’s monetization strategy defines its business success more than acquisition or retention.

Why Monetization Matters

In a recent study conducted by Price Intelligently across 512 SaaS companies, monetization had the largest impact on a company’s bottom line. The study showed:

• For every 1% improvement in acquisition, the impact to the bottom line was 3.32%
• For every 1% improvement in retention, the impact to the bottom line was 6.71%
• Yet, for every 1% improvement in monetization, the impact to the bottom line was 12.7%
  
  

Yes! Monetization improvements are 4X more efficient than acquisition and 2X more efficient than retention when it comes to improving your bottom line. The core metric that aligns all teams within a subscription business should be revenue and/or profit – not acquisition (i.e., number of signups) or retention (i.e., monthly churn).

The Virtuous Cycle of Business Success

When a business improves profitability, it’s able to reinvest into further driving acquisition through hiring more sales staff (in the case of enterprise businesses), investing in additional content licensing & creation (in the case of media businesses), or being able to pay for higher SAC than competitors (all subscription businesses). But most of all, the improved revenue & profitability can be reinvested back into the business to make the experience better for existing members, thereby improving retention – creating a virtuous cycle of business success.

Typical Approaches to Pricing

When a company is figuring out their pricing strategy, they lean into one of three practices:

1. Guessing / Using Intuition – “This feels like the right price to me.”
2. Looking at Competitive Offerings – “Our competitors are priced here, so let’s price over here.”
3. A Simple Cost Plus Approach – “My costs are X, let me charge X + 20%.”

However, for such a critical aspect of the business, teams should be leveraging more rigorous approaches. The preferred method when it comes to monetizing involves breaking down the task into three subsections:

1. Identify your target audience(s): For every business, you’ll have different audiences you can attract; each audience will have different features they’re looking for, and a different willingness to pay. For example, let’s assume your business is a cloud-based storage subscription – the average consumer may value ease-of-use, your prosumer may value account security, and your enterprise customer will value disaster recovery. It’s important to understand your segments before deciding on pricing.
2. Identify your levers: What will you charge for? With any business, you can charge on a variety of factors (number of users, number of streams, number of resources consumed). Prioritize the levers that are easy for consumers to understand what they are paying for.
   
3. Narrow Options Using Consumer Insights & Testing:
   • Analyzing Consumers: While these topics are too advanced for this class, I recommend to read up on Van Westendorp’s Price Sensitivity Meter, Maximum Differential Analysis, and Conjoint Analysis for a deeper understanding of how you can survey consumers to narrow your pricing options.
     
   • Actual Testing: Finally, the most accurate way to assess your pricing strategy is to test. It’s become common for global companies to test a new pricing strategy in a small country before making it available in more markets. See Spotify’s recent example here.

How do I Test Pricing?

With caution. The challenge with price testing is that it tends to be a sensitive topic amongst employees, consumers, and even regulators (see Robinson–Patman Act). Most of the focus will be around the concept of “fairness.” But what is fair? I found this paragraph in this HBR article, How Machine Learning Pushes Us to Define Fairness, to provide helpful context. I highlighted the definition that resonated with me.

We have long taken fairness as a moral primitive. If you ask someone for an example of unfairness, the odds are surprisingly high that they’ll talk about two children who receive different numbers of cookies. That’s clearly unfair, unless there is some relevant difference between them that justifies the disparity: one of the children is older and bigger, or agreed to do extra chores in return for a cookie, etc. In this simple formulation, fairness gets defined as the equal treatment of people unless there is some relevant distinction that justifies unequal treatment.

I encourage you to always apply the Wall Street Journal (WSJ) test when considering price testing – “I am comfortable running this test even if it was made public and ended up being a cover story on the WSJ?” Here are a few real-live examples. In your opinion, do these pass the test?

How Often Should I Optimize Price?

Constantly. Many firms decide on a pricing structure and stick with it. However, considering how important monetization is to overall business success, companies should be investing in regular research and testing of monetization. At a minimum, firms should be conducting pricing research quarterly, and assessing their pricing annually (even though they may not change the price on an annual cadence).

How Should I Think About Price Increases?

To drive increased retention, your subscription needs to continue to add benefits and value to encourage continued retention. Inevitably your costs will increase (or your desire to increase profitability) and thus a price increase will be in your future.

Advice on conducting a price increase:

1. Do your research – you’ll want to avoid a high price hike that triggers a mass defection, or too low that you trigger some consumer response (i.e., elevated churn), yet do not achieve your business objectives.
2. Invest in messaging – you want your consumers to know why the prices are increasing and explain the logistics (price change immediately versus next billing cycle?). The best companies explain how this price increase goes into improving the service for members.
3. Pace it out – consider spreading out the price increase so it doesn’t hit your audience all at once. Some ideas include targeting new members before you impact existing members, doing region-by-region, or phasing it by member tenures. This smooths out the churn spike and allows you to assess if the price change is having the intended impact.

See some messages for price increases from subscriptions services:

Great blog post analysing Netflix’s recent price increases here.

What Cadence Should I Bill?

Many subscription businesses wonder – should I bill daily, weekly, monthly, quarterly, yearly, or for multiple years? Here are just a few examples available today – a weekly LA Times, a monthly/annual Slack, and a 3-Year Disney+ Subscription.

Your billing cadence should align with your product. Broadly generalizing, you typically see shorter duration subscriptions (i.e., daily, weekly) in emerging markets where the consumer is used to the concept of sachet pricing. You see longer term (quarterly, annual) where there is payment friction (i.e., enterprise sales) or you benefit from locking in a consumer during a period where they are likely to churn.