Dan Greenberg

SaaS and Pilot Purgatory

One of the more subtle aspects of any business is pricing, and that is especially so with startups. It's a massive topic which I have neither space nor expertise to cover in full. Here, I will cover just a few subtopics. But first, I will offer general advice:

Ask your customers what they would pay either explicitly, or implicitly through market tests. And realize that price structure and payment schedule are also important, often more important than the absolute amount.

Let's explore a little.

There has been a lot of success with subscription models for Consumer applications. Just pay $X per month for <whatever>. Freemium models abound, where you pay nothing for basic functions to draw you into to paying for advanced ones. Each of us has dozens of subscriptions to things now, some annual and many more monthly. Consumer markets, generally, have:

A very large number of (potential) customers
Who can "sign off" on the small dollars per month
But churn at high rates.

This then implies a business strategy of:

Marketing that is as broad as possible to get as many customers into the top of the funnel
For small chunks of value with low-cost (no touch) on-boarding
And trying to keep them just a little longer via auto-renew and other annoyances.

That is, it's a volume business. Some parts of B2B are like that. For instance, the Google services that power this website qualify - a large number of potential customers who can pay $10/month but could hop to WordPress at any moment. But a lot of B2B is not. My observation is that the differences in customer sets - and therefore the differences in GTM, pricing, and more - fall into tiers dependent on the number of potential customers.

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For the top two, I am not qualified to give advice, but I have experience and opinions about the latter two!

SaaS

Software-as-a-Service (SaaS) models - and the many other members of the "as a service" family - have become very popular. In fact, they are so ubiquitous in some cases that we just take them for granted. When was the last time you thought of Gmail as "Email as a service"?

The hard part about SaaS pricing is that there is a temptation to price at marginal cost plus. Since marginal costs are low, the service price is low, right? This is financially irresponsible. Below the line costs must be covered out of the gross margin. Those costs include Development, Marketing and Sales, rent, profit, and more. For Consumer applications, they make it up in volume: the number of subscribers is so high, that it takes only a minimal amount from each to cover all those costs.

But Enterprise SaaS cannot take advantage of the high volumes of customers that Consumer applications can. Their divisor - the number of customers to cover operational costs - is 2-4 orders of magnitude lower. They can deal with this in either/both of two ways. First, they can raise prices so that the gross margin is larger. However, it's infrequent that they can do so sufficiently with that sort of spread in divisors.

The other alternative is to reduce operating expenses. Dollars spent on churn reduction are often more effective than dollars spent on Marketing to load the top of the funnel with new customers. Improved on-boarding reduces the costs of customer support, even if that improvement requires an expense on training. (Of course, it's even better if on-boarding and the UX are so smooth that training is not needed!) Anything that reduces the Cost of Acquiring a Customer (CAC) and improves LifeTime Value (LTV) is important.

As operating managers, it's your responsibility to do the analysis to ensure prices are high enough. If customers reject those prices, you have not demonstrated sufficient value, and that's either a Development issue or a Marketing/Delivery issue. Regardless, you need to watch the CAC and LTV carefully and take action if things do not track to projections.

Core Software and Pilot Purgatory

But sometimes it's not enough. My experience is that this occurs when the "cost of first project" (CFP - I am making this up right now! You read it here first!) is comparable to the LTV. The CFP is the cost of acquiring the customer, including negotiation and contracting, as well as the cost of onboarding and training that customer to get their first project success. If that does not lead to a renewal and additional projects with that customer, it's a sure bet that your business is on the wrong course. But CFP is not usually tracked directly: Marketing tracks CAC, Sales tracks sales velocity, and Customer Success tracks onboarding. It's difficult to see the issues on a general management level.

Tangent: complex implementations often have an implementation services component. Large consultancies - like Accenture - are built on implementing ERP, EHR, and other large, critical systems. There's nothing inherently wrong with this, but realize that they take a large hunk out of the value the customer is ultimately paying for... a hunk that you could share with the customer to both your benefit.

The customer view of a high CFP is high risk: do they want to go down this expensive road with you to an uncertain return? Probably not. So, the answer often is confidence-building steps: crawl, walk, run. "Let's run a pilot." I have lost track of how many companies have pitched me on "we have N pilots, and if we convert them to full engagements, we're all gonna be rich!" The "if" there is doing a lot of work.

The truth is that pilots - even paid pilots - can be signed for my mid-level managers. To a startup, $25K sounds like a lot; to a $B company, it's in the noise. What then happens? The startup gets a number of pilots relatively easily, spends all their resources serving them, and then discovers the horrible truth that their customer contact can't possibly sign for a full engagement. Welcome to Pilot Purgatory.

Pilot Purgatory is a well known phenomenon. I can always tell if someone is experienced if I say "pilot purgatory" and they start nodding their head. There are some great articles about it, from A Practical Guide to Scale Industry 4.0 to this one that I just found with a simple search. If you will be selling big packages to big customers, learn what Pilot Purgatory is before continuing.

I will share one trick to avoid Purgatory: once you have Product-Market Fit (PMF), never sell pilots. That is, your Preseed round should have gotten you to a Minimally Viable Product (MVP) and your Seed should have gotten you to PMF. In that time, pilots are crucial to your understanding of the use cases. Do them. And please - pitch them to investors as such. These pilots are not practice steps in your to-be sales process. They are for requirements gathering and product development.

Once you have PMF, stop doing pilots. Your A Round is all about setting up your GTM/RTM... learning to do repeatable sales. (Later rounds - "growth rounds" are about scaling what you create with the A-Round funding.) With PMF, sell full engagements with the option to exit early. For instance, sell one-year engagements with the option to exit after three (paid) months. "But Dan," you say, "That's just a 3-month pilot and then a 9-month contract, right?" Wrong. A full engagement has to be sold to an executive, not to a mid-level. With an executive bought in, there's no starting from scratch at the 3-month deadline, and it's easier for the customer to forego the option to exit than to sign up for a new engagement. And you will learn a lot about pricing in this exercise. Is it more difficult to sell full engagements than pilots? Yes, but if you can't sell this deal up front, there's little hope you could have sold the pilot-upgrade.

And regardless: focus on reducing onboarding time and effort. Note that that is not "minimize Customer Support/Success" - quite the contrary! Your emphasis should be on reducing the time it takes the customer to start getting value.

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