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If there was ever any doubt that the “Pricing is Marketing” mantra of Sixteen Ventures is true, just look at the SaaS and Web App pricing related stories that have come out lately. From the positive, where RightNow used changes in pricing in an attempt to disrupt the status quo in the SaaS CRM world, to the extreme negative press generated by Zendesk – and the accompanying customer backlash – last week when they jacked up their prices. I’ll focus on the latter of those two examples in this post.

I’m going to lay it out plain and simple so there are no misunderstandings: you need to get your pricing as right as possible out of the gate – don’t just guess or make up numbers. Once you are in the market, you will learn new information, customer buying behavior, feature bundling problems, etc. This is like the Mike Tyson quote “Everybody has a plan until they get punched in the face.” This isn’t terrible, as long as you got it close in the beginning – but if you are off by a significant factor, or if you didn’t train to fight Mr. Tyson, then you are going to have a hard time changing your pricing without hurting your existing customer base, or you’re going to get knocked out as soon as the bell rings

Pricing is not static; rather, it is fluid over time, moving with market conditions, time in market, market segmentation, etc. This doesn’t mean it changes every day, or week, or month, but it is not something that you figure out once and then never think about again – until you need to make a huge adjustment. You want to avoid huge adjustments, and you can do that by getting your pricing as right as possible out of the gate and then monitoring it over time. Ensuring that your prices are part of an overall pricing strategy that is aligned with your overall marketing strategy is critical. It appears that Zendesk didn’t get their pricing close to right at first and then had to make some significant, sweeping changes; and they paid for it – and likely still are.

It is even more critical for startups that don’t have time in market and historical data to pull from to start with a solid Pricing Strategy. If you understand why you are developing the pricing that you are, you are more likely to get it right. Ask most startups what their pricing strategy goals are and some statistically significant amount will say something about “making sales.” Then they’ll ask what you mean. On our Pricing Page Tune-Up™ sign-up page, for example, we ask what your Pricing Page goals are; included selections are User Growth, Increased Sales, Lead Generation, Market Position, etc. Remember: Pricing is Marketing.

But many companies don’t get it even close to right at launch – likely because they neglected to develop or execute on a real pricing strategy. So what if they need to make a big change, like Zendesk did, and raise prices? Is it even possible to do this without a negative outcome? The answer is yes, but you need to have a strategy and execute according to plan. Some people will always be upset by a price increase – they will be vocal in their opposition. Let them vent and then let them move on. Have you successfully raised prices without causing a backlash? Please comment on this post and share your story!

Engage or Alienate

If you have a mailing list, a registered user base, or active customers using your app, you have what we refer to as a voluntarily captive audience; exploit it! When you need to raise prices, there are only two options with your users and customers: engage or alienate. Its your choice – I suggest the former. One method is to find your top users – the oldest active users – and get them to help you. Engage (there’s that word again) with them. For startups with a beta user base, this is your chance – the kids these days are calling this “customer development” – whatever the term is, get out and talk to your users and existing customers. Maybe even call them on the phone.

Find out what these folks want, if they’ll pay for it, what they’ll pay, how they’ll pay, etc. Just like anything, this should be executed according to a well thought out plan. Not only will you learn a lot while you engage the user base, you could even create evangelists. The more engaged and respected users and customers feel, the more they’ll be happy to help you – which is what you’re asking for.

The backlash from the Zendesk users was more likely that they felt betrayed and less about the actual pricing. Pricing is neither good nor bad – its empty – its all about perception and the betrayal likely clouded the perception of their customers (that, coincidentally, is very Zen-like itself). If Zendesk had actively recruited their customers to help or otherwise made sure that every customer knew something was going on with pricing, the customers might not have revolted in such a way. In fact, had Zendesk done this, they would have been made aware of some of the use cases that they should have known about, but obviously didn’t consider – the ones that lead to the 300% price increase some customers mentioned.

But to find out on a blog or via email after the fact that the prices are now 300% higher is a slap in the face. Consider that your current users (especially early adopters, beta testers, etc.) and customers want to feel special – like they’re in a club – and by telling outsiders first, you take away that special feeling of belonging that we all long for. At the end of the day, would Zendesk still have alienated and irritated a segment of their customer base? Sure. But it would have been a lot smaller and they would have had the rest of the customer base to defend them – rather than add the attack!

Grandfathering is NOT the Answer

Okay, so Zendesk admitted that they messed up with their price hike. They probably needed to do something to respond to the backlash, but what they did seems to further indicate that they really didn’t have a strategy going into this. What did they do? They “grandfathered” existing customers and are only applying the updated pricing to new customers. Let me make this very clear: “grandfathering” prices is not an acceptable alternative to having a good pricing strategy or failing to execute on it!

So, while the tactic of grandfathering prices might appease some of their customers, what is the cost – in real dollars, PR, position as the market leader, etc? Why would a company backpedal on something that was good – their new pricing? Ultimately, this all comes down to lack of a strategy, lack of preparation, and an overall inability to execute if they did have a plan. It shows they didn’t talk to anyone outside of perhaps some “star” clients and now it shows that the new customers are going to get the “bad” pricing. Pricing is Marketing and what message is grandfathering sending?

Remember, it isn’t like this grandfathering is a secret – especially when the CEO posts this to their blog and it gets picked up by Techcrunch and every other tech news site – exactly Zendesk’s target audience, by the way. It is clear that those who were members on or before 5/18/2010 paid one price and anyone else that joins after that date has to pay more. Period. What a great way to entice new customers to join, right?

Some commenters on the Zendesk site and Twitter said that they were talking to Zendesk about becoming customers in the days leading to the price hike and were not told about the pending changes nor given the option of locking in “legacy pricing.” Way to start that relationship off on the right foot! I imagine sign-ups slowed immediately following the announcement and will be slow to come back until this gets swept under the virtual rug. Which it will, but that 2Q update to investors will be interesting, to say the least.

While the majority of this post has been talking about how to engage existing customers and users, it is very important to consider the impact of these changes on new customers. Does your value proposition correlate to the new prices? Obviously Zendesk didn’t talk to their customers to get to this point so by continuing with the pricing, are they going against the customers’ value perception? What about trust – are new customers going to trust that they too will be grandfathered on the next huge price increase?

It should be obvious that you just don’t want to get to this point. It is much better to be transparent leading up to the pricing change than during the backlash and accompanying backpedaling. Forced transparency is ugly! But what happens if you do find yourself in this situation? How should you handle it? There are a lot of different ways to work with this. Keeping in mind that Pricing is Marketing, you want to make sure you clearly understand the Value Perception from the eyes of the customers who will pay the higher price. Nobody wants to pay a higher price just for the privilege of doing so. What’s in it for them? Can we give them something more?

Perhaps you could consider one of the following if you must raise prices and are backed into a corner where grandfathering seems to make sense:

• Grandfather privately – reach out to the legacy customers and tell them that their existing pricing will be in effect for some amount of time
• Offer to let new customers lock-in “legacy pricing” for some amount of time if they sign-up in the next 30 days
• Add value to coincide with the increase in price – this is the preferred option – is there a much-requested feature or service you can dedicate some resources to work on in an effort to appease them?

So, if grandfathering isn’t the answer, what is? Strategy – plain and simple.

Intentional Alienation – or – Firing Unprofitable Customers

There is the reality that sometimes it is just wise to get rid of customers that cost more than they are worth – a strategy that was undertaken by Ning when it dropped its use of Freemium. Raising prices to force low-profit or high-cost customers to leave your company and hopefully bring their troubles to a competitor is a valid strategy. Just be prepared for the backlash! From what I’ve seen, it is usually the low-end customers that do the most complaining – they have more time to do that sort of thing which is likely why they are low end clients.

They will be loud, vocal, and spread the bad word everywhere they can. When they do, you know you did the right thing – now they will move to your competitor and be unprofitable for them. Win – Win. In dealing with them, it is wise to just let them vent and then let them move on. If you have a strategy in place and know that this will happen, it is easier to deal with them and you won’t be as tempted to give in to the noise.

But to be clear, Zendesk obviously didn’t just irritate the low-end customers – they hit everyone equally hard. Again, this is something you will want to avoid. By having a complete pricing strategy at the beginning, you will know who your target audience is and perhaps save yourself from having to deal with a similar mess.

The great thing is, with SaaS or Web Apps, you can actually create different versions of your application for different target market segments – in this case low-end and high-end customers – with the same code-base! This is why we advocate decoupling the pricing strategy from revenue model in SaaS and why single-instance, multi-tenancy – or everyone using the same version of the app – is a key component of real Software-as-a-Service.

A great example of a this is the company behind SendPepper and OfficeAutoPilot. They have one marketing automation SaaS product that, through feature configuration and skinning, serves two very different market segments. Nothing like being able to send people to “the competition” and having that company be… you. Behold, the power of single-instance multi-tenancy in SaaS that few companies really understand and take advantage of.

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Lincoln Murphy (@lincolnmurphy on Twitter) is Managing Director of Sixteen Ventures, where he works with SaaS & Web App companies on Business Strategy, Revenue Modeling, Distribution and Pricing Strategy – check out the new Pricing Page Tune-Up™ service for on-demand Pricing Page feedback and improvement recommendations.