Day 38

We're building a startup in 80 days in public. Day 38 was on Mar 3 '22. You can find today's entry at Day 67.

Today's posts:

Calculating SaaS pricing in reverse

Instead of asking what kind of revenue you can expect with your product, we like to turn the question around. Start with the kind of revenue you need to consider the product viable, and then work backwards.

These are the kind of exercises we do when noodling with possible pricing models for

Let’s keep it simple and pick a round number: one million in annual recurring revenue. What does it take to get to that revenue with different business models?

Option 1: free with pro upgrade

With consumer software you want people to try your product before asking for money, and the easiest way to accomplish that is by offering a generous free version. We can then sell a Pro upgrade for $50 (one-time fee).

1 million divided by $50 = 20.000 customers per year. 20 thousand. That sounds like a lot.

But not every user buys your software.

Maybe 10% of trial users do.

Trial users = customers * 10 = 200.000 trial users.

How many website visits do you need for that? Maybe another 5x, if the signup process is good.

Unique visits = trial users * 5 = 1 million visitors.

One million unique visitors per year, or 20k per week. Not an impossibly high amount, but it’s not peanuts either. Where is all that traffic going to come from?

Ads? That’s hard to pull off when you’re bootstrapping. Funded competitors will outbid you the moment you get traction. Besides, when you already have the expense of many free users you can’t afford to throw money at opaque ad systems.

Organic search traffic? Maybe, but it takes a long time to build traffic like that with articles and other content.

Twitter? Interviews? Youtube? Magazines?

You’ll need a massive marketing effort to get that kind of traffic going. And you need to do this every year, just to keep your revenue from collapsing. Let’s see if we have better options.

Option 2: prosumer subscription

Okay, let’s see what happens if instead of charging $50 once we use a subscription model.

The big challenge for consumer subscriptions is churn. Also, repeatedly charging a credit card will lead to a much higher customer support burden, plus you only get maybe 24 months of revenue on average from each customer. Maybe your product will have best in class net retention, but 5% monthly churn is typical for consumer subscriptions and at that rate you lose about half your customers every year.

That means you can charge $50 once or $25 per year for two years. The rest of the math will be the same as in scenario #1 which shows that subscriptions are no panacea. You still need a ton of traffic to get new trial users to get new customers to replace the ones that have churned.

Option 3: subscription for teams

The problem with scenario #1 is that you need a ton of traffic and awareness that we don’t know we’ll be able to get. The problem with scenario #2 is you add a bunch of complexity (subscriptions, renewals, cancelations, unpaid/overdue subs) but the LTV (lifetime value: the total amount paid by a customer for the duration of the subscription) of a customer won’t be much higher because of churn. The entire point of running a subscription service is that your customer base can accumulate over the years, but you won’t be able to do that when your customers leave in droves to chase the next cool thing. The harder you work at growing your business the more relentless churn will be in dragging you back down. 

We can kill two birds with one stone by introducing a subscription for teams: churn and volume. Team subscriptions are automatically more sticky than individual licenses because moving everybody to a different product is a hassle. This means dramatically lower churn. If your product is for small businesses or teams within larger businesses your churn will be maybe 2% per month (= 20% annually). And when you sell to a team you’re selling multiple licenses at once. That’s much faster than selling individual licenses!

If you charge $50 per month for a Teams subscription with 2% churn your LTV is 20x-30x that of individual prosumer subscriptions. That’s a huge difference!

Now, you only need find 400 customers for 1m in annual revenue. That’s 2 new customers a day and you’re golden. That sounds way easier than the 20.000 customers demanded by scenario 1.

You might have noticed that 400 customers @ 50 a month is only 200k and not 1m. That’s true, but you only need to compensate for churn, here. If you have 2000 customers at 50/mo and you lose 20% of those each year, then you need to find only 400 new customers to retain revenue. Any sales beyond that will grow your business. The math checks out!

Unless Thymer becomes a smash hit, our revenue will have to come from team subscriptions. Right now, I don’t see any other way. The bright side is that we should be able to keep the single user version of Thymer free or cheap because it won’t bring in much revenue anyway. The downside is that we might end up serving two different audiences, and that features that make sense for a Thymer Team make no sense for a single user version of Thymer (and the other way around). I’m sure this will turn into a careful balancing act. 

← Previous day (day 37)Next day (day 39) →

You can follow us on Twitter @jdvhouten and @wcools and look for #80daystartup

Read more

Work/new-life balance
Durable tech
Early user feedback
Spending time to save time
Products want to be platforms
Always be launching
Enjoying the journey
Work-life balance
Recap @ Day 59
Perils of caching
Making sense of contradictions
Trust signals
DIY javascript error logging
Taxes: an automation story
Magical thinking
Start small
High conviction, low conviction
Most deals fail

Post archive