Our company is built on the premise that an effective pricing strategy is a software company’s single most influential variable for successful business performance. Its impact on growth drivers such as customer acquisition, retention and expansion, top- and bottom-line revenue and enterprise value is direct, measurable and scalable. Conversely, an ineffective pricing program can impede those objectives.
But how do you know if your pricing strategy is effective or ineffective? In our work analyzing and fixing pricing models of hundreds of software companies, we’ve found several telltale signs of pricing problems.
Five of the most common problems we find with a company’s pricing strategy:
1. A customer base littered with bespoke deals.
If you were looking at a graph depicting your customers with similar use cases and the prices they pay, would it show a wide discrepancy? If so, you wouldn’t be alone, but you would be in a pricing predicament.
Overly flexible pricing often signals a lack of rigor in the pricing model. While it may result from a corporate desire to do whatever is necessary to add new logos, there are important reasons why the practice is ultimately counterproductive:
- A sales team with great flexibility in the pricing will often justify off-schedule discounts for reasons that may never pay off (e.g., future growth potential, marquee customer, etc.). This leaves money on the table.
- The risk of customers learning what other customers are paying is very high. With no structured model to defend the discrepancies, this can create distrust among buyers.
- As buyers and sales teams both believe there is pricing flexibility, negotiating time and deal friction increase, elongating sales cycles.
- The more one-off deals you have, the less scalable your organization becomes (and the less scalable, the less value your company has to investors).
2. Purchase options that include unlimited, or “all-you-can-eat” use.
Software is not a tangible asset with a value that depreciates over time. Rather, software is a product that is constantly getting better, with a development roadmap of daily, monthly and yearly improvements that increase its value. However, if the customer has you locked into a sweetheart deal of unlimited usage at a set price, you’ll miss out on revenue from the software’s accruing value. The self-destructing version of “all-you-can-eat” says, ‘Here’s a flat fee of $10,000 or $100,000 for the year to use the software all you want.’
A key to effective pricing and packaging is to make sure you can still get existing customers to pay for capabilities that come out in the future. Too frequently pricing strategies ignore tomorrow’s value and instead reflect a period in time when you were a bit hungrier for new customer logos, rather than optimizing revenues.
3. Prices that don’t account for customers’ varied budget cycles.
Most customers are willing to pay for what they use, but nobody wants a variable bill. It is not easy to budget for a bill at $10,000 for a few months, then have it jump to $30,000 or $60,000. In fact, when the cost exceeds expectations or the investment amount exceeds the budgeted amount, people lose their jobs, pilot projects get canceled and software gets yanked out. While it may be appealing to think that the more your customer uses the more they’re going to pay, you must make sure this aligns with the buyer’s business and the issues they are facing.
For example, if you’re selling to the federal government, you need to know that it’s a longer-term contract and they’re not going to accommodate the kind of fluctuation inherent in typical consumption pricing strategies. If you’re selling to a school, you need to understand their budgeting cycle and the cadence of when those dollars are approved and for what time frame. There won’t be a budget for you to hit them in month 18 with a cost overrun. If you are selling to certain commercial customers, they might be a little more tenable to variations in pricing. Your pricing strategy must reflect the industry and the dynamics at play.
4. Enacting pricing changes without modeling the impact on legacy and net new revenues.
Every change in price impacts new customer acquisitions and renewals in some manner. For some of your customers, the new pricing will be less than their existing contracts. This may come back to bite you at renewal time, when the customer will either fail to renew or demand the lower price you now offer to new customers.
Then there will be customers who will be asked to pay significantly more. If you don’t proactively communicate with them and they notice the new, higher prices online, they may start searching for alternatives, and you probably won’t even know until it’s too late.
While many companies avoid the tedious work of a detailed impact analysis, you simply must understand the effect of your pricing changes in advance. This takes expert pricing analytics to review all the net prices paid and compare them with the net prices of your new pricing strategy. And it involves mucking around in the messy world of your billing data, which may or may not be clean. This isn’t a game of broad strokes, aggregate trends and some market research surveys. You have to simulate the price changes account by account by account. Pricing is about mitigating risk. Skipping out on impact analysis homework maximizes your risk of things going wrong.
5. Complex or confusing pricing.
If you overcomplicate what you’re doing and try to get the pricing really super accurate, then the salesperson has to find answers to a much deeper set of customer questions to quote the deal. This creates additional sales friction. Salespeople have it hard enough as it is, and overcomplicated pricing and packaging loses deals. Your pricing should help you be perceived by customers as easy to do business with. If you make it too accurate (complicated), buyers will choose a different vendor whose pricing is easier to understand and seemingly poses less risk—even if the solution is a less capable one.
You want your pricing strategy to be as elegant as your software. Pricing elegance comes from combining simplicity to the customer with the ability for you to be paid fairly for the value you deliver.