In my previous blog posts, I have discussed at length the complexities of establishing an enterprise pricing structure, the dials on the model to optimize revenue and growth, and building a long term view of the price strategy. In this last post in the series, I want to go back to an even more fundamental concept: Value.
Ways to define Value for your Pricing Strategy
Pricing is really about establishing and communicating the value that your product or service brings to your customers. The price of a product really needs to be consistent with its value in the following aspects:
- It is the value that your target customers will realize by using the product or service in the intended use case, compared to the case where they do not have a similar product or service
- It is a value that your target customers can perceive and are used to measuring or (even better) quantifying
- It is communicated in measures or metrics that the customers are familiar with and that they believe are important
- If your product or service delivers any value in conjunction with other peripheral products and services then your price needs to account for the incremental values or costs of these externalities.
A software product can be valuable in many different ways. For example, it can be an essential enabler of a business function, such as sales force automation.
In a brand new market created by a disruptive technological innovation, there is no historical data or competitive pressure to set the price at any particular level.
In this case, the value of the product can be considered as the value of having that particular business function, which can then be measured as outputs generated by this new business process, or improvement in productivity of existing processes, increase in outputs (sales), or reduction in waste.
For more mature product categories there are more competing products, and therefore there will be price competition and far more options for the buyers.
For most companies, the value of software is typically determined by the laws of supply and demand, and tends to be driven down due to price competition. In such a case, most of the value of the software will be tied to how it is differentiated from the competition by offering unique functionalities or scalabilities that are not easily replicated by competing products.
In such a market, having a focused customer segment is crucial. By building features that are valuable for a particular market segment, the company produces a product that is more valuable for customers in those segments, and can therefore charge a premium price over competing products.
It is also important not to get overly distracted by price reactions of customers outside of youe target segments, because your pricing model is probably not right for them in first place (at least not in terms of how they perceive the value of the product).
Another thing to consider is that the value of the product does not simply scale linearly with usage or complexity. Your product is vastly more valuable, for example, when it has a built-in network effects, whereby the more people use it, the more valuable it becomes.
If your product can leverage the value of its network of customers, you should price it with this exponential growth in mind. This is an example of a positive externality whose values only become important as the product grows in scale, but need to considered in evaluating the overall value of the product.
Establishing the value of the product is also important because it adds clarity to the pricing model and makes communicating it to the customers a lot easier. To avoid causing sticker shock, the pricing model needs to speak to the values that customers are familiar with, and ultimately, it needs to be consistent with how the success of the product is measured.
Why not establish the measures of success upfront and link them with pricing components, so your customers automatically have a product success scorecard that doubles up as a price list?
For example, if you know that customers in your market typically require a ROI of 20% on technology investments, then your pricing needs to be consistent with this — after taking into account all costs and benefits associated with your product — from the perspective of the customer.
To wrap this up, I would like to recommend a few additional thought provoking blog posts by experts and practitioners on the same topics. Many of my thoughts were guided by them:
- Startup Tips for Enterprise Software Pricing by Dharmesh Shah
- How to Price New Enterprise Software by the Oulixeus team
- Most Common Enterprise Software Pricing Models by Paul Rudo
- The High Cost of Enterprise Software by Craig Mullins at Database Trends and Applications.
Image by Tom Buford Marketing