The SaaS Pricing Dilemma: Discounting for annual upfront payments
In this article, we briefly discuss how discounting strategies can erode value for SaaS companies in the medium to long term, and ARR Squared as an alternative approach that provides SaaS founders the financing to continue to grow their businesses without discounting.
Discounts are provided by SaaS companies to incentivize their customers to pay their annual subscriptions upfront. There are usually two justifications for large upfront discounts provided, first, it brings in much needed cash in the door, and second, it helps manage a key metric, churn, as customers are locked-in for a year.
We believe, discounting is a suboptimal strategy for the following reasons.
Discounts can produce more churn, its just delayed
Discounting can create a false sense of complacency and not address problems with the value proposition of the product. Churn can be viewed as a feedback mechanism from your customers which can help you improve your product or establish customer success strategies to help customers get more value from your product. Upfront payments from annual contracts delays the signal from churn for a year. When customers eventually churn, you have actually lost time and opportunity to improve the product and customer success, and can expect further churn from other annual customers from the same or later cohorts.
Discounted consumers are expensive
Excessive reliance on discounting may have undesirable effects, as discounted customers are typically going to be more sensitive to price, and any increase could impact renewals. Some discounting could encourage loyalty for newer SaaS products, but overdoing it can lead to customers being conditioned to subscribe exclusively when discounts are being offered. This creates a dilemma, as while discounting brings in paying users, it also means that SaaS companies are underpricing their product, generating less revenue, which eventually impacts valuation and future fundraising.
Discounting actually lowers LTV
While discounting might appear effective to build early traction, the drawbacks can begin to outweigh the benefits of excessively relying on a discounted pricing strategy. Sales associated use discounting to shorten the sales cycles. Customers that churn out will inevitably have negative effects on the bottom line as SaaS businesses would have then wasted a considerable portion of the cash spent on acquiring them in the first place.
This implies that it will inevitably take much longer to recoup the investment for building traction through discounting. This is a common theme for SaaS companies known as the Cash Flow Trough which incentivizes them to seek short term gain, but potentially hinders their growth over time with higher acquisition costs and lower retention rates. Each discounted sale therefore puts pressure on these companies to convert more sales within a shorter period of time in order to maintain their current trajectory, thus setting themselves up for more work ahead.
ARR Squared helps founders get the biggest benefit of discounting, i.e. getting cash upfront for their annual contracts, but none of the downsides discussed above.
ARR Squared offers SaaS founders an instant cash advance against the full annual contract value of their subscriptions. This provides SaaS founders the flexibility to invest in growth without having to rely on discounting to finance critical activities such as product development and customer acquisition and retention. This results in better equity valuations for later rounds and minimizing dilution for founders and early stage investors.
