Bessemer Venture Partners recently published an insightful benchmark report for SaaS companies, “Scaling to $100 Million.”
As the report states:
“Optimizing your costs and expenses is key to building a winning cloud company. In cloud, gross margins measure how effective companies are in delivering their software to customers, and they average 65-70% across company lifetimes.”
Margin is influenced by more than just cost and expenses
Now I completely agree with this – however, I’d like to address an area where I see a lot of SaaS businesses negatively impact their gross profit margin: The quality of their company’s revenues.
No matter how cost-effective you are or how well you keep your direct cost, cogs, and expenses under control – if you’re selling too cheap, your SaaS gross margin will consistently be challenged by your investors (and your CFO), simply because it is so important to meet their valuation targets).
Let’s dig into what impacts the challenge of selling too cheap.
Selling too cheap has two components:
- The price you’ve set yourself
- The price your customer base is willing to pay
This brings me to a fundamental problem:
The mismatch between price and actual value perception.
Let’s start internally:
How often do we set our price by simply copying the pricelist of our direct competitors? The SaaS industry is notorious for that.
How often do you hear stories from founders like ‘We’ve made our price 10% cheaper than our competitors – and that gives us an advantage.’
Wrong! Copying the other vendors pulls you in a race to the bottom that you can’t win. The focus is on ‘cheaper’ instead of ‘value.’ What’s worse – often, your competitor has set its pricing wrong to start with. So if high gross margins is what you’re after – stop copying your competitor, unless you’re significantly outperforming them on the cost of delivery.
Let’s now take an external view:
From the customers’ perspective, perception of value is around seeking the confidence that their investment will bring them an advantage. And I deliberately talk about ‘investment’ and ‘advantage’ here.
The value they perceive goes beyond the money factor. The formula is much larger. For example, think about status and how other people will perceive them. Then, think about the impact of being freed from frustrations or stress and how this will help them achieve their aspirations – faster.
The problem is not merely a sales problem. It’s way deeper.
The problem starts with the choices you make in R&D and product management i.e. with your product roadmap.
Does the roadmap address the problems that are most valuable and critical challenges your ideal customers are struggling with? Going wrong here creates a ripple effect if you aim your price calculation to be about value.
Then there are a range of marketing challenges that play a role here:
- Segmentation: How clear you are about who you are ideally for and who you’re not for. Going wrong here is the recipe for a price war (and will by the way also increase your customer acquisition cost and negatively impact your CAC ratio.
- Positioning: A fundamental one because this is all about whether your ideal customer will perceive you as ‘the one’ because of the difference they believe you can make for them.
- Value proposition: Your ability to hit the right nerve with your ideal customer. Getting under their skin by articulating the exact problem they struggle with and how that makes them feel – and from there create a strong desire to work with you for the long term (which is critical to customer retention and keeping churn low)
- Pricing: Taking all of this into account and translating subscription fees structure into a value story – using metrics your customer understands and encourages them to use more of your solution (not less). This automatically will impact your recurring subscription revenue streams.
This leaves me with a question for you as a CEO to reflect upon:
Are you using all the levers optimally to deliver benchmark gross margins in your category?