Everyone enjoys getting a good discount. But, while discounting may make customers feel good about purchases made, it’s not always the best strategy for certain businesses. Data suggests using unnecessary discounts can have a negative impact on your business.
Discounting is widely used in retail, and for good reason, but does it work in SaaS? Let’s find out. We’ll go over the different types of discounting, the pros/cons, some alternatives, and if you should consider discounting in your SaaS pricing strategy.
Discount pricing is a pricing strategy that involves deducting a certain percentage off the original market price of a product or service. People are drawn to discounted products because consumers love feeling as if they are scoring a good deal, and discounts also create a sense of urgency that might drive more customers to convert.
3 types of common discounts
While all discounts strive to take a certain percentage off an original market price, there are different discounting techniques. I’ll walk you through some of the most common types of discounts—seasonal, clearance, and volume.
A seasonal discount is exactly as it states—businesses offer discounts on seasonal goods or during particular seasons. Sometimes seasonal discounts are applied to out-of-season merchandise. For example, when spring arrives, department stores may place a discount on winter coats since they are no longer needed.
The word “clearance” is a marketing term businesses use to indicate their products are for sale at unusual discounts, and for a limited time only. Retail stores may offer clearance on discontinued items with the hopes of liquidating what’s left in stock.
A volume discount incentivizes customers to purchase goods in multiple or large quantities.
Stores will reward people buying in bulk with a reduced price on the group of products. Businesses are able to reduce inventories when people buy in bulk.
The strategy behind giving discounts
For retail, discounts can be great for liquidating unneeded products. But for SaaS, the pros of discounting are not as obvious as the cons. The idea of scoring a deal makes people feel as though they beat the system; however, your price is the exchange on the value you provide, so you need to tread cautiously when discounting. Let’s dive deep.
The pros and cons of a discount pricing strategy
Let’s begin with the good that can come from a discount pricing strategy.
1. Reduces the activation energy
By offering a discounted price, customers don’t have to think too hard when making the decision to buy your product. Having a discount reduces the activation energy for the user to sign up by allowing them to try the product until they are ready to commit.
2. Can close deals
Deals that are on the fence may be saved by offering the prospective customer a discount, so discount pricing is a simple way to increase sales. This should not become the norm for all sales efforts, but it could be helpful when trying to close that one deal.
And now, the not-so-good side effects of discounting.
Decreased willingness to pay
Willingness to pay goes down for users who came on with a discount. When offered a discount right off the bat, upselling them on other products is a lot more complicated. Additionally, customers who started with a discount won’t be too happy when that discount is eventually removed and they are forced to pay full price (which takes us to my next point: churn).
Discounted customers have more than double the churn rate than those who weren’t given a discount, so giving a may shorten the average customer lifecycle. Oftentimes, discounts bring in new customers who only make one purchase. If you look at the graph below, which is broken down by the level of discount, you’ll notice a strong correlation of churn increasing as the discount level increases.
Part of the reason we love a recurring revenue model is because we can predict growth. However, once you start discounting, it becomes increasingly complicated to predict. Customers that are acquired with a discount are more likely to churn, but it’s more difficult to know when they will do so, making growth unpredictable.
Why discounting is a short-term strategy
You can’t discount yourself into becoming a successful business; it hurts your bottom line too much and isn't ideal for new products. For SaaS specifically, discounting is a short-term strategy because the cons outweigh the pros. It circles back to everything I mentioned above—higher churn rate, lower willingness to pay, lower profit margin, and unpredictable growth. Additionally, when you discount a product, the perceived value takes a hit. Customers won’t be in for the long-term if they feel your product isn’t of high value.
How to add value to your discounts
There are multiple ways you can appeal to customers without discounting. Here are three different tactics that are more effective than discounting for the long term.
1. Create an entry-level tier
An entry-level tier allows you to drive folks to your main product while also allowing you to capture customers with a lower willingness to pay. For this you will need a value metric, which means as your customer uses your product more (bandwidth, installs, contacts, etc.), that customer should be charged more.
2. Add value instead of providing negative discounts
Part of the reason businesses resort to giving discounts is because they know people love getting deals and feeling special. But, you can make people feel special without cutting your prices. Instead, add more units (e.g., more user seats or a premium service). Remember, when adding value, a little goes a long way without facing the long-term implications of discounting.
3. Improve your marketing segmentation
You can get more out of your customers by improving your marketing segmentation. With this, you need to understand the trigger features and value propositions of your customers. Furthermore, your marketing messages need to be deeper and more specific. If you’re selling to a niche customer, value will be different amongst different size companies, locations, and incomes.
Does ProfitWell recommend discount pricing?
So, the question remains…does ProfitWell recommend discount pricing? The short answer is no. In general, customers on discounts have worse retention rates so it should not be a core part of your strategy. However, selectively using discounts to lower the activation energy of someone signing up for a product can be a good tactic.
By Patrick Campbell
Founder & CEO of ProfitWell, the software for helping subscription companies with their monetization and retention strategies, as well as providing free turnkey subscription financial metrics for over 20,000 companies. Prior to ProfitWell Patrick led Strategic Initiatives for Boston-based Gemvara and was an Economist at Google and the US Intelligence community.