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The perverse effect of discounts
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September 17, 2021

The perverse effect of discounts

SaaS as a business model is revolutionary in itself.

When the business model first became popular in the 1990s, the traditional “pay upfront” business model of sales quickly became a minority. With monthly payments, software became more affordable, company revenue more predictable and product improvement more flexible.

However, the SaaS business model didn’t come without its negatives. Since monthly revenue is lower than costs, most SaaS companies take over 3 months to recover their cost per acquisition and marketing expenses.

This often results in SaaS companies using discounting tactics to acquire more customers, or offer annual subscriptions at a discounted rate. But it’s not a sustainable approach.

The effects of discounts

Although a popular sales tactic, using discounts will generally have a negative effect on your SaaS company. Here are a few ways how:

Lower brand value

One of the main negatives of offering discounts is that it decreases the value of the brand and product or service overall. Not only does your customer view your product as lower quality, but it also trains them to only buy when there is a discount. This can quickly lead to a downward spiral where discounts lead to more discounts, further decreasing the brand value.

A lower brand value attracts price sensitive buyers. These types of buyers are harder to upsell to, and also won’t be so happy when a discount is removed and they are forced to pay full price. Price sensitive buyers are also less likely to become long term customers.

Lower quality customers

As a SaaS company, you want to be focusing on retention rather than acquisition -- that’s how you recoup your costs and make a profit.

But price sensitive buyers coming through discounts are low quality customers, and these are particularly bad for SaaS companies. Why? Because it increases churn. High churn rates means you actually end up losing money on each customer.

Discounts usually bring in customers that stay on for a short period of time — as a SaaS company, not only do not recover your cost per acquisition costs, but the average lifetime value of a customer drastically decreases.

In fact, according to data, SaaS discounting lowers LTV by a staggering 30%.

Unpredictable growth

One of the main advantages of the SaaS business model is that growth is predictable every month. But with too many discounts, this ceases to be the case. Customer loyalty isn’t consistent so churn increases and your monthly revenue varies widely from month to month.

This can mess up a SaaS company’s growth strategy since it’s hard to predict churn rate when it fluctuates so much.

A high churn rate also means it’s a lot harder to get a good picture of who your persona is, since they don’t stay on for long enough. Not understanding your target market and not building a loyal customer base can quickly tank a company.

Revenue loss

One of the most obvious downsides is that too many discounts can seriously affect revenue. Most annual discounts are 20% to 30%, which essentially devalues the product by the same percentage.

As a SaaS company, you likely get valued on your revenue. By issuing too many discounts that decrease revenue, you risk getting a lower valuation and therefore make it a lot harder to raise money in the future.

Two solutions: use discounts carefully & non-dilutive financing

Use discounts carefully

The most obvious way to solve the problem of discounting is to use discounts carefully. Here are a few tactics to use discounts without negatively impacting revenue or increasing churn rate.

Be discreet: don’t make discounts public or publish a huge banner on your website as this can upset customers who’ve paid full price. Instead, put discounts in places where customers have already taken action -- such as joining an email newsletter or using a referral.

Use segmentation: instead of letting everyone know that you’re offering a discount, it’s best to offer discounts to those you know would be receptive to deals and are most likely to convert successfully.

Don’t make them predictable: if you make your discounts predictable, your customers won’t be willing to pay full price and will simply wait for the next discount in order to renew their subscription. Use discounts sparingly and highly targeted towards the right customers.

Non-dilutive financing

This is a new type of financing for SaaS companies that are looking for ways to increase their revenue without undermining the value of their product.

Non-dilutive financing is a type of financing that turns MRR customers into upfront capital. By turning your recurring revenue streams into its annual value, you get to cover your cost per acquisition costs while also receiving additional cash flow to grow your company. It’s a solution that avoids using debt, outside investment and most importantly, discounts.

As a SaaS company, non-dilutive financing allows you to enjoy the full advantages of using a SaaS business model while also being valued at the correct price.

Discounting is a short term strategy that is not sustainable in the long term and can negatively affect your brand and product value. If you’re a SaaS company that’s looking to grow, you want to be looking for tactics that increase customer retention, rather than acquisition. Make sure to use discounts sparingly and consider using non-dilutive financing methods.

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