Dear SaaStr: What’s a Resonable Discount for an Annual Contract? How About a 3 Year Contract?
First — you don’t want a true net discount at all.
What I mean what you want is a pricing structure that anticipates discounts so the net effect is revenue positive. Later, when you implement a CPQ and other more sophisticated systems to manage pricing for a large sales team, these processes and systems will be designed to help you do just that, at least in part.
Before then, think instead about marking up the prices of non-annual contracts to account for churn. You’ll likely want non-annual contracts to be priced 20%-30% higher to account for the effect of churn, but the exact % can vary.
So raise prices ~25% on non-annual contracts so you can price in a 20% “discount” for annual contracts and not have a true discount to targeted pricing at all.
Second — note your views on this will change based on how much you value cash, especially multi-year pre-paid contracts.
Any additional multi-year discounts (e.g., 40% off Year 3 for paying all 3 years up front) in the end will “harm” your ARR unless your churn is high. Because if churn is low and you’d renew that customer anyway for Year 3, you’re giving up a bunch of future revenue tomorrow for more cash today. But the cash up front in the early years may be totally worth it in the first few years.
Later, if your net retention is high, multi-year discounts may hurt your long term top line. So instead, vendors often move to guaranteed pricing for 3 years in exchange for a 3 year contract (i.e., no price increases) instead of a discount. This doesn’t work well until you have the #1 brand in the space, but then it can work pretty well. Big enterprise customers are very receptive to this, once you have a dominant brand.
Net, net my learnings and advice are this:
- In the early days, align discounting on closing faster + maximizing cash. There will be some tension between the two, but not too much. Pay reps a full commission on Y2 and Y3 up-front pre-paid deals. That’s cash to you, after all. And allow enough flexibility in discounting to learn, and to get the deal closed this month. In the early days, closing Facebook for $50k this month is much more important than closing them maybe for $80k 6 months from now.
- As you approach $10m in ARR, short-term cash will still matter, but won’t be as critical. You’ll start to think longer term — about ARR goals years out. Then, you need to switch to optimizing around the most revenue per lead/opportunity without sacrificing NPS. You may move to nontransparent pricing. You may move away from discounts to pricing protection. You will be more willing to lose deals to low-end competitors. Discounting will become more data-driven, policed by software, and focused.
- Understand that with SMBs, a 15%-20% discount is well understood as the general incentive to go “annual“. But. But — most won’t choose it if they are small SMBs. Be very careful before forcing them to.
- Understand that with bigger customers and enterprises, discounts will generally be expected, so mark up your pricing to build that discount in. That way, it’s less stressful when you have to get it. And once you do deals big enough to get procurement involved, realize they’ll likely ask for a second discount. So build that into your pricing, too.
A related post here:
