I was reading a question posted by Harlan Beverly on LinkedIn about whether FREE was a good pricing strategy for a new SaaS offering or not, and it was interesting to read all the arguments and realize that there seems to be no consensus about it. For those in favor or open to a free pricing strategy, a good book on the topic is FREE by Chris Anderson. However, I wanted to tackle the discussion from a different angle and give a framework to analyze if FREE is a good pricing strategy for a SaaS offering or not. Disclaimer: if you have funds to do expensive but effective pricing research, then do it. If you are a small and medium size business trying to go to market ASAP, take a look at this approach based on the RBV (resource based view of the firm):
This theory is based on four criteria to decide if a resource could be a source of competitive advantage: Valuable, Rare, In-Imitable and Non-substitutable. In the case of a product or service, if it meets all these criteria then I would argue that FREE IS NOT A GOOD PRICING STRATEGY and that there are opportunities to maximize profits by charging an appropriate price that could be determined with the help of adequate research.
This is all about prospects and clients willing to pay for the product of service because it either makes things easier, faster, cheaper or it can help generate more revenue. I think that it is prudent to assume that all products are developed with the assumption that there is a need for them and thus willingness to pay for them. But, this does not mean that you may capture that potential source of revenue.
If the product or service has enough unique benefits and features, then it is rare and has the potential to be valuable. So, many new SaaS offerings are good candidates to command a price above zero. If one finds a combination of a big enough niche market that cares about the unique set of benefits and features of your product or service, then there is a business opportunity obviously.
This is a key criteria as it relates to the sustainability of the source of value. If the offering was easy to replicate, then it would be hard to sustain value over time. This criteria is closely related to FREE pricing, when SaaS providers strip down their software versions to offer it for free they are embracing the fact that their upgraded version is hard to imitate. Also, in many cases, having a free version of the product is the source of in-imitability. If the size of the user base positively influences the value of the premium service, having a FREE version may help to generate a large user base that make the benefits and features hard to imitate. Think of what would be the value of the premium services of SaaS firms such as LinkedIn, job aggregators or even Google, with Google Free search services and Google AdWords, AdSense and other revenue models they have.
The previous three criteria are a must to create sustainable value and thus be able to command a profitable price, but if one could achieve similar results with a more cost-effective SaaS offering then it will be hard to charge a profitable price. The market dynamics will overtime drive prices and margins down. These changes in the market could take a long time or very little time, but that’s for another post.
Social media practices, web 2.0 tools, open source and online collaboration in general are supporting the development of more and more free tools and SaaS offerings, and thus putting more pressure on firms to create offerings that are valuable, rare, in-imitable and non-substitutable, so they can charge for them. There is much to be discovered as these forces develop at different pace, what they have in common is that all of them are growing their user base faster than other marketing practices.
I can think to a couple of scenarios where free could be a good strategy even if the offering meets all the RBV criteria: When the offering’s benefits and features grows with the company, think of Quickbooks, Email transmission solutions, Job-posting solutions, CRM solutions, etc. The other scenario is when a service needs a large user base to then put on top of the user base premium services, think of LinkedIn, Google and Facebook. Twitter is next.