Should you include a price increase rider? - Poll Results
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talio.
There is an active debate going on as to whether multiyear B2B SaaS contracts should include a provision for an automatic price increase. In fact, the contract does not even need to be multiyear for this to be an issue. We are seeing more and more annual contracts that include a clause that says what will happen with the pricing on renewal.
Before sharing our own approach to this question, we reached out to the wider community to get insights.
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On March 1, we shared a simple poll asking:
“Should B2B SaaS contracts include a price inflator clause?”
We shared this link across the Software as a Service - SaaS Group, the Professional Pricing Society, the PDMA (Product Development and Management Association), and the Value Management groups on LinkedIn and on Steven Forth’s personal feed.
Here are the results. N = 136.
The four possible responses (this was a LinkedIn poll, so we had to keep it simple) …
No, Price Should be Fixed
Yes, for Inflation
Yes, for Innovation
Price Should Vary with Value
Some comments left were …
“It depends. If we are talking about a 10-year contract for garbage collection, wage fuel and truck inflation should be baked into periodic price increases. If talking about a relationship contract on, say, med tech, prices could go up or down every year.” (From pricing thought leader Tim Smith, a person worth following if you engage in pricing.)
“We’ve just recently looked at this. We ended up removing these clauses. For us, it felt like it limited us by capping the increase. Especially if we repackaged significantly and wanted to increase above the clause rate to reflect the new amount of value in a package. The exception is multi-year contracts where we feel price lock-in or pre-agreed escalation makes sense.” (from the pricing leader at a European SaaS vendor).
“Irrespective of the industry there should definitely be a clause regarding price increases. The type of clause would probably depend on the industry: Manufacturing/Retail : Inflation-related clauses as well as value
SaaS/Software: Value and Innovation.” (from Nikhil Kotcharlakota)
“I am a big supporter of inflation-based increases but pre AI apart from wages there were really no other costs..so that argument will get weak when inflation goes back to that 2-2.5% range…” from pricing consultant Karan Sood.
What is Ibbaka’s advice? Well, it depends …
No Price Should be Fixed
Seventy percent of B2B SaaS contracts that we review do not have a price increase provision. Pricing on renewal is simply not mentioned. The vendor believes this means they are free to change prices on renewal (and legally they are correct), but the buyer assumes that the price will not change on renewal. This mismatch can cause problems.
Even if you are not going to include an automatic price increase clause, you may want to ask your lawyer (or the AI you use instead of a lawyer) to draft a clause that makes it clear that prices may increase at renewal.
It is worth remembering that no matter what you write in your contract there will be some.
Ibbaka has less experience with B2C pricing, which is its own discipline, but our impression from reading the subscription agreements we use is that the best practice is to state the price at which the next renewal will take place. This is in part because many B2C subscriptions are triggered through promotions with a low starting price. We have heard from a number of large B2C subscription companies that they have to defend against people canceling accounts and searching for the next promotion.
Yes, for Inflation - nope, inflation has never been a good reason to raise SaaS prices
As inflation moved up beginning in 2020, followed shortly thereafter by rising interest rates, there was a flurry of talk about raising prices in response to inflation. Buyers in general pushed back on this, pointing out that
(i) SaaS costs were not directly impacted by inflation and that
(ii) Saas vendors seldom transferred savings from lower costs to their buyers.
In any case, inflation has come back down and will likely be under 3% in 2024 and under 2% in 2025. SaaS companies need higher price increases than this to support NRR.
Yes, for Innovation - maybe, but with caution
Part of the promise of the SaaS model is continuing innovation. One reason SaaS has crushed on-premise as a business model is that the innovation cycle is faster and innovations can be pushed out continuously. It can be difficult to monetize this continuous innovation as each of the improvements can be small and as the customer has quite often not explicitly asked for them they may resist paying for them. We can even see this with generative AI, which is getting layered into many applications without the request or consent of the buyer.
If one can commit to constant innovation with regular releases, at least quarterly preferably monthly, and customer success is trained to communicate the value of these innovations, an annual 5-8% price increase may make sense. This is for sustaining innovation (in the Christensen sense). But be careful that your competitors are not doing the same thing but without the price increase. These routine price increases can be used against you by an astute competitor.
If your innovation is more discontinuous and disruptive this incremental approach is not a good choice. You will often be delivering innovations that are worth much more than an 8% or even 10% price increase. You will need to work harder to realize the price increase, but you will have the choice of raising prices on existing packages or introducing a new package.
Using an automatic price increase to capture the value of innovation should only be used when one can reliably deliver continuous innovation that outmatches the competition. It should not be used when the innovation model is discreet or disruptive.
Price Should Vary with Value, of course, but this is done with pricing design and not a clause in a contract
This goes without saying. It is the foundation of value-based pricing. But it’s not really a justification for built-in price increases. The way to capture value is with a metric that tracks value. This could be a usage metric, so long as that metric is associated with actual value or any other variable that tracks a large part of the value in the value model. The art of value-based pricing is to find a metric that goes up and down with value and that can be used as a pricing metric.
In addition to tracking value, a good pricing metric
Can be tracked on your own system
Is predictable
Will be accepted by the buyer
See When to price using revenue value drivers, when to price using cost value drivers
Discounts can change over the course of a contract
Discounts are the other side of the coin to automated price increases. Discounts do not need to remain constant. They can change with time. Having a discount that decreases year to year can have the same result as an automatic price increase. As many B2B software contracts are negotiated with discounts designing a discount that goes down year to year can have the same result as a routine price increase while being more acceptable to a buyer.
