If you are a food enthusiast and a bit into economics, you may have stumbled upon the Big Mac Index. It was created by The Economist as a somewhat jovial way to measure, amongst different countries, a theory called Purchasing Power Parity. Despite its light-hearted origin, this theory plays a crucial role in economics and, interestingly enough, in the tech world.
What peaked my interest in this topic was a recent podcast episode by the Bootstrapped Founder where the host, Arvid, when explaining the concept of purchasing power parity, mentioned that when we set a wrong price for our SaaS product, we could be potentially ruling out whole countries from our customer base.
This sent me down a rabbit hole of research and discovery, and here I am, writing this article to share my findings with you. More specifically, I'll shed light on how you could leverage purchasing power parity when setting prices for your product. Let's dive in!
What is Purchasing Power Parity?
So, you may be wondering, what is purchasing power parity? Purchasing Power Parity (or PPP) is an economic theory that attempts to compare the currencies of different countries via a "basket of goods" approach. What this means is, if you had $20, how much of a certain set of goods (e.g., a basket of apples, a pair of shoes, etc.) can this buy in your country, and what is its equivalent value in another country's currency? Or in other words, how much is $20 worth in your country vs. another country?
The goal of purchasing power parity is to compare the purchasing power of different currencies and use this information as a basis for setting prices. For example, if we compare the US dollar to the Indian rupee, we find that (as of writing this article) $1 is worth about 83 rupees according to the current exchange rate. This means that if you exchange $1, you get 83 Indian rupees in return.
However, when we consider Purchasing Power Parity, we find that $1 is equivalent to about 23 rupees. This means that the amount of goods or services you could get for $1 in the United States, you could get for 24 rupees in India. In other words, your $1 has the purchasing power of 24 rupees within India.
Now, if you are a SaaS founder, you may be wondering, "How does this apply to me?" Well, let's find out!
How Does Purchasing Power Parity Apply to SaaS?
For a SaaS startup, the world is your market. But while access to customers is available globally, not every potential customer is in the same economic conditions. While a $50 per month subscription for your fantastic service may be fine for a consultant in San Francisco, it may not be worth it for someone in Lagos where cost of living is significantly lower. This is where purchasing power parity shines.
Purchase Power Parity Adjusted Pricing
Adapting your price according to the purchasing power parity of your clients' locations, or using a 'tiered pricing structure,' can help increase conversion rates in markets you might have previously thought simply couldn't afford your product. It's a strategy that takes into consideration both currency exchange rates and relative purchasing power to establish a pricing model that's fair and inclusive while also opening a revenue stream in hitherto untapped markets.
For example, you're not setting a flat $10 rate for all of your global customers. Instead, you're taking the purchasing power parity into account and adjusting your prices accordingly. This could mean $10 for your users in the USA, $7 for those in Turkey, and $5 for those in poorer regions like India.
How to Calculate Purchasing Power Parity?
Now that we have a basic understanding of purchasing power parity and how it can be applied to SaaS, you may be wondering, "How do I calculate purchasing power parity?" Well, I'm glad you asked! While researching this topic, I decided to create a tool that would make it easy for SaaS founders to calculate purchasing power parity for their products.
If you head over to our Purchasing Power Parity Calculator, you can quickly calculate purchasing power parity for your product. All you need to do is enter your product's price in USD, and the calculator will automatically calculate the purchasing power parity for more than 190 countries worldwide. It's that simple!
Downsides of Purchasing Power Parity
While the concept of Purchasing Power Parity may sound great on paper, it is not without its challenges and limitations. If you're considering using PPP as a pricing strategy for your SaaS product, it is important to understand and be aware of these potential downsides.
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Firstly, Purchasing Power Parity (PPP) is built on the notion that goods and services would cost the same in different countries when exchanged at the current currency rate. This assumption can sometimes be far from reality due to several factors such as government regulations, tariff barriers, taxes, and shipping costs. These factors may influence product prices in certain countries, redirecting the actual purchasing power.
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Secondly, PPP can be trickier with digital goods than physical ones. The price of a SaaS product doesn't necessarily correlate with local income levels because the costs associated with production, such as software development and server maintenances, remain constant regardless of where it's sold. Therefore, it might be unsustainable for a SaaS company to drop prices too low, even if their intention is inclusivity for lower-income markets. We could go further into this topic, talk about profit margins, and how we could adjust them, but that's a topic for another day.
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Furthermore, the application of PPP in your pricing strategy could result in complications with your recurring billing. Say you use Stripe or Paddle to manage your subscriptions. In that case, you may need to create multiple pricing plans for each country, which can be a tedious and time-consuming process. Additionally, you may need to adjust your pricing frequently to account for changes in exchange rates, which can be a hassle.
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Lastly, and perhaps the most significant challenge, is the risk of abuse. If you offer your services at reduced prices in poorer regions, there's a risk of exploitation by clients from higher-income regions who might pretend to be from lower-income regions to access cheaper prices ("price spoofing"). Though, there are ways to prevent this. Let's take a look.
How to prevent abuse of Purchasing Power Parity?
While there's no foolproof way to prevent abuse of purchasing power parity, the best way to prevent it is to use a combination of strategies. Here are a few ways you can prevent abuse of PPP:
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Use a third-party payment processor - Using a third-party payment processor like Stripe or Paddle can help prevent abuse of PPP by making it harder for users to spoof their location. These payment processors have built-in fraud detection systems that can detect suspicious activity and block it before it happens.
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Use Geo Restrictions - Using geo restrictions can help prevent abuse of PPP by restricting access to your service based on the user's location. For example, you can restrict access to the PPP pricing plans to users in certain countries, and hide them from users in other countries.
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Use a VPN detection service - Using a VPN detection service like MaxMind or IP2Location can help prevent abuse of PPP by detecting users who are using a VPN to spoof their location. These services can detect VPNs by looking at the IP address of the user and comparing it to a database of known VPNs.
These are just a few ways you can prevent abuse of PPP. There are many other ways you can prevent abuse of PPP, such as using a CAPTCHA system or requiring users to verify their identity before they can access your service.
I highly recommend doing further research in this area to make sure you're taking all the necessary steps to prevent abuse of PPP.
Wrapping Up
That's it for this article! I hope this article has given you a better understanding of purchasing power parity and how it can be applied to SaaS. As I mentioned earlier, you can use our Purchasing Power Parity Calculator to calculate purchasing power parity for your product and let us know what you think!
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