Your pricing model is the difference between a thriving SaaS and a dead one.
Understanding your people/markets, your presentation, and why you price the way you price is absolutely necessary to your success. If you’re looking at this now and thinking to yourself, I’m more interested in building the thing and marketing it, and I don’t really need to worry about how it’s priced, there is a good chance you’re going to fail. So don’t skip this chapter.
Metrics are how you make decisions. And with the right information, decisions are easy.
So let’s start out with the most basic aspect of your SaaS business:
Revenue - Cost = Profit.
Simple right? Now let’s take it a step further for your SaaS.
In just about any business, including SaaS, you have the following major concepts:
LTV is exactly what it sounds like, it is the lifetime value to you of a customer. This means that if the average customer pays you $10 per month and generally sticks around for three years, then their lifetime value is $10 x 36 months = $360. You will have different types of customers that pay more or less, get value out of different aspects of the system or use more or less resources in the system, and last more or less time. These are defined in-depth by the different customer personas a bit later in the book.
This too is exactly what it sounds like. If you add up all the work you're doing to attract new customers, then divide this by the number of paying customers you brought in, then you have your CAC.
It stands to reason that if you're going to stay in business that the LTV has to be higher than the CAC, right? But by how much? According to PriceIntelligently.com, it always needs to be higher than 3 to 1, preferably a lot more. That means that for every dollar you’re spending to acquire a customer, you’re making 3 dollars. According to the same source, if you continually optimize your pricing, you can get this up to 11 to 1.
Let’s examine this a bit more because it is really important that this part is clear.
Let’s say your LTV to CAC is 3 to 1. That means that you made $3 for a spend of $1 and now have $2 left over to 1) improve the customer experience and 2) operate the business and 3) have some money remaining (profit) for growth. It would seem like if you made $3000 and spent $1000 to make that much, then having $2000 left over would be enough. But it isn't. When you actually do the numbers and add up all your costs outside of marketing you realize that it costs a lot of money to run a business. If your competitors are operating at say a 5 to 1 LTV to CAC, how long do you think you're going to be able to compete with them?
So that's the name of the game. Maximize LTV & minimize CAC while keeping your customer experience optimized, system working, while growing and staying competitive.