Of the many questions software executives must answer, those concerning software pricing may have the most significant impact on their company’s overall success. Pricing has a profound effect on nearly every aspect of a software company’s operation, including:
- The type and volume of customers the company attracts.
- How easily and frequently existing customers grow into bigger and longer-term customers.
- The features and functions the product delivers over time.
- The company’s profitability, scalability, and valuation.
Yet pricing is one of the least understood and most neglected disciplines in software, with companies of all sizes relying on their own perceptions of value, competitor benchmarking or “gut feel” to establish their pricing.
We’ve studied software pricing for over 30 years and want to share some fundamental elements that can help you build a more effective pricing model for your software company.
Pricing is Only One Element of Software Monetization
While it gets the most attention, determining the actual price you charge for your software is only part of a complex and interconnected strategy that has enormous influence on your ability to build, grow and scale your organization. This collective strategy is known as Software Monetization.
Software Monetization involves three main elements:
- Licensing: The metrics around which your products are sold (e.g., number of users, transactions); what’s included, payment terms and timing.
- Packaging: How products, features and services are configured and offered to customers.
- Pricing: The amount to be paid, along with parameters for discounting and other incentives.
To determine how these elements apply to your product, you must first have a clear understanding of the customer and their buying process–from their various end-users to their buying influencers and decision-makers. Among the most important questions to dive into are:
- How will your product and services be used? By whom?
- How are your customers achieving value with your solution?
- How does that value change over time, or as your customer uses more of your solution (e.g., adds users, more transactions, etc.)?
- What is the value of your solution compared to alternatives?
- What other buying participants need to understand the value delivered by your solution?
This information can be gathered by interviewing customers (both executives and end-users), observing them using your solution, and by talking with your sales and marketing team, including listening to sales calls. If you have it, analyze any data you collect regarding feature and functional utilization.
Armed with this insight, you are ready to consider the key monetization elements.
Software Licensing: The foundation on which your revenue is built.
When your customer buys your solution, the premise on which they pay you is defined by your Licensing. Will they be paying you for each user of your solution? Each transaction? The volume of data they consume? This critical metric defines how you and your customer capture value and how that value scales.
Your Licensing also defines the usage and deployment rights, what is and is not included in the price, and payment terms and timing.
Here are a few guidelines to follow as you think about your Licensing:
- Align your value metric with the way your customers perceive and receive value from your software.
- Ensure payment and contractual terms are consistent with your customers’ business model (e.g., their need for predictability)
- Make sure your payment and contractual terms are easy to understand and unambiguous.
- Make your rights-to-use consistent with the flexibility your customers need.
Software Packaging: The connection between your solution and your customers.
Customers are attracted to your solution by associating value to its combination of features and services. Your Packaging model is the way you connect different classes of customers to the combination that best matches their needs.
Packaging plays an essential role in key sales performance areas—lead generation, deal velocity, customer growth and lifetime value. This is because an effective bundling of products, features and services makes it easier for prospects to align the software’s cost to the value they extract from it and for customers to clearly understand how they can grow with your solution as their needs evolve.
Keep these concepts in the forefront as you consider your Packaging:
- Aim your package options at specific classes of customers who extract value in similar ways.
- Within each package, provide meaningfully different value for different types of customers.
- Resist overly complicated packaging structures that encourage bespoke deals and decelerate deal flow.
- Ensure natural upgrade/upsell migration when customers need more functionality.
Software Pricing: The control knob for profitability and valuation
Once you have worked through your Licensing and Packaging, you can turn your attention to Pricing. Your list prices are a rational outgrowth of understanding how your customers gain short- and long-term value from your solution, a detailed analysis of your transaction data and your true competitive environment.
A critical step in your Pricing development is establishing a structure for discounting. Unstructured discounting is a leading contributor to software revenue and profit shrinkage and lower-than-expected software company valuations.
Use these guidelines as you develop your Pricing:
- Make your price structure simple, unambiguous and easily understandable by customers and salespeople.
- Avoid tiered pricing schedules that customers and salespeople can game or exploit.
- Standardize your discount schedule and adhere to it, and closely monitor transaction data to confirm adherence.
- Ensure your structured incentives (e.g., volume, discount for pre-payment, length of contract, etc.) encourage the desired customer behavior
- Be sure to address your customers’ range of ordering scenarios across the portfolio.
Pricing Philosophy: Building trust with your prospects and customers.
Now you can step back and reflect on your philosophy of pricing: Will you play the short game and seek to maximize each and every transaction–or will you play the long game and maximize the portfolio of customers, giving up shorter-term revenue opportunities?
Keep these concepts in the forefront as you consider your philosophy:
- Each time you veer away from your scheduled prices, you release a data point into the marketplace that another buyer can use against you in the future. Opportunistically pricing some customers more than others can carry severe hits to your brand image, especially in market slowdowns or pandemics.
- Stay focused on transparency and high trust to achieve maximum deal velocity. Closing many deals in the time it takes competitors to close one deal will put you in a superior growth position longer-term.
- Message to customers that discounts are earned, never given. Software companies get great economies of scale that can be shared back with customers—but they should be earned via larger upfront commitments.
- Remember that early in the lifecycle of the business model, salespeople need flexibility. Later, that flexibility needs to be rebalanced with control to achieve scale. Avoid subscribing to the myth that salespeople need discretionary discount approval ranges to close deals. Rely instead on a well-structured Monetization Model that you can iterate and improve on over time.
Continually Improve Your Monetization Model
Monetization in the software industry is perpetually fluid. New competitors, technology advancements and integrations, and even societal issues (e.g., labor shortages, remote working) can alter market dynamics and challenge well-considered plans. Your Monetization strategy should reflect this. Once you’ve established your Licensing, Packaging and Pricing infrastructure, be sure to embed frequent qualitative and quantitative data reviews into your process to assess how the model is performing and identify opportunities to improve it.
Pricing may be the most powerful lever a software company can adjust to affect revenue, profit and valuation. By tending to the elements of Monetization in this manner—ensuring your Licensing, Packaging and Pricing are solidly in place—you will have a strong foundation for success.
How can you make sure your software pricing strategies are successful?
When you’re thinking about your software pricing strategies, follow these steps to help ensure they achieve the results you desire. If you’re striving for success in your software pricing, you may find our monetization and pricing services beneficial. Contact Software Pricing Partners to learn how decades of experience can help your company reach new heights.