SaaS Sticker Shock is real. According to Vendr’s SaaS purchasing data: from Q1 to Q2, net new purchase requests are down 16% and renewals requests are down 6.8% QoQ. Whether your product tends to fall in the ‘nice-to-have’ category or objectively business critical, you may face challenges. With the emphasis on caution and increasing runway, your customers are implementing strict cost-cutting measures. In this environment, having a superior product might not be enough to beat out competitors offering lower prices, discounts and more flexible contract terms.
SaaS companies have many tools at their disposal to stay competitive. Many will consider a reconfiguration in their pricing model, such as migration towards an ever more popular usage-based model. But implementing a pricing model change can be operationally (and technically) complex - as TechCrunch has described in a series of six steps. A quicker win might be to empower your sales organization to offer a variety of buyer-friendly contract structures.
Should you offer up front discounts for annual contracts?
Buyer preferences can vary, but by and large, there is a mismatch in what SaaS companies want and what SaaS buyers want:
In order to align preferences, there are two main options, with distinct tradeoffs.
Many SaaS companies will offer discounts ranging from 10-30% to buyers in exchange for opting for an annual+ contract. This locks in longer commitments and minimizes churn risk. But what do you give up?
- This is expensive! Using annual discounts to incentivize buyers to pay upfront results in a huge cost of capital. A discount of 20% equates to a 44%+ cost of capital.
- You might be leaving money on the table due to walkaways. Buyers face the same working capital problems that you do and, even with discounts, some customers that can’t pay upfront will settle for a lesser, cheaper product.
- Discounts lower your ARR now and later. Once a customer becomes accustomed to discounts, it’s almost impossible to increase the price for the same service later in time.
Alternatively, SaaS companies can eliminate sticker shock by allowing buyers to pay in smaller amounts over time (e.g. monthly), closing more deals with a short sales cycle. But, flexibility also comes at a cost:
- You are sensitive to churn.
- Your payback for services provided is longer; therefore, upfront costs (CAC, implementation, sales commissions) are not offset for months.
- You are ‘financing’ your customers, which can frequently lead to a working capital problem for your business.
- The faster you grow, the more money you burn, and the shorter your runway gets.
If you allow for annual contracts with a discount:
However, consistently under charging for your product and having a cashflow problem aren’t the only two options. Capchase and other alternative financing providers have financial tools that allow you to offer flexible payment terms to your customers and get the cash upfront. A fintech partner sits between you and your customers, advancing the full annual contract amount to you and then collecting payments from your customers over time. This helps you solve payment terms friction and close more deals and renewals quickly. And perhaps most importantly, no discounting means SaaS companies can recognize full contract values on financial statements - a key to maintaining top-line revenue, valuation, and ensuring access to debt and equity tools in the future.
But does financing your new and renewed contracts make sense?
For a SaaS business, customer lifetime value, sales velocity and sales efficiency are three important metrics for measuring success of your product and your go-to-market engine. We evaluated the impact of using alternative financing to bridge the gap between discounts and flexible contracts on one of our typical SaaS customers and found that closing less than one incremental contract per year allows for financing breakeven at an 8% financing cost.
However, the impact can be much more impactful than just breakeven. Alternative financing could result in moderate lift in sales efficacy, modeled through a 10% increase in conversion/retention, 4% increase in annual contract value (ACV), and a 20% decrease in sales cycle (days). By securing these increases, switching to contract financing would result in key profit drivers such CLTV, sales velocity, and sales efficiency jumping as much as 1.8x, 3.2x, and 1.8x respectively.
So, even in a market with lengthening sales cycles and depressed conversion and renewal rates, you don’t have to turn to discounting to secure annual contracts. And increasing your appeal to customers with flexible payments doesn’t require you to give up on the security of an annual contract. Approach a changing market with a changing toolkit. With alternative financing options, you don’t have to pick financial security or customer appeal: you can have both.