Software Pricing Fundamentals Matching Your Pricing to Customer Value

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Audio Transcript

Jim Geisman: One thing that I don’t think an awful lot of software companies do at all, and do very well, is understand what sort of economic value and time to value they’re offering relative to current solutions.

What you’re really trying to do is persuade people that whatever it is that you do–and again we’re talking about B2B software–is better, faster or cheaper. It is always much better to be able to quantify that because it becomes much more believable. Now when you’re thinking about economic value, it is created in only two ways. Either it has an impact on revenue or it as an impact on costs and our focus is primarily on the revenue impact.

I would suggest that if you are developing an economic value proposition, that you try to figure out how your product is going to contribute to revenue for your customers. Yes it’s always good if you can decrease, defer or avoid costs but the last time I checked nobody prays for lower costs. They always pray for more revenue.

Now having said that there are these economic drivers–those are all the benefits–but there are adjustments to the value you deliver that have to do with the the risk of the project, the timing and the associated costs. So if you’re developing an economic value proposition or a value proposition of any kind you ought to at least allude to the value adjustments. Your implementation team may decrease the the risk of failure or increase the predictability of go live, things like that.

Now you know one of the things we’re commonly asked is what’s everybody else doing. Often they do that about price and metric. But the features that everybody else is doing is a very useful benchmark for what you ought to do. But having said that, you better have some unique value adding features above the base common features which have a market price range. You could take a look at almost any product category, sweep across the competitive landscape and say yeah you know entry level products contain these features mostly. Here are the range of prices and that gives the competing products the gray box.

Now you better have some significant, unique value adding features and when you do then the issue is how much is your value added worth. What you want to do there is you know if you have it, flaunt it. It’s a matter of what your pricing strategy is and we’ll say a little more about pricing strategy in a moment.

“It’s always good if you can decrease, defer or avoid costs but the last time I checked nobody prays for lower costs. They always pray for more revenue.”
Jim Geisman, Software Pricing Partners, LLC

This is a trumped-up example of a CRM product. It’s not that trumped-up and and you can see that there’s a financial impact of providing better service hitting numbers faster or doing transactions at lower cost and the real issue when you’re doing this evaluation you’re understanding how much the customer (your customer) is getting out of your application but the real issue in pricing is how much of that is going to be your share. What’s your share of the pie?

We happen to use a rule of thumb, we talk about 10x which means that the client should derive 10x the value that they would be willing to pay you. The reason for that is when people make adjustments to their perception of economic value, you’ll still wind up doing pretty well 3X to 5X.

On the other hand, if you take a look at a lot of products that are out there–I’m thinking about some of the CRM products–they can have a tremendous economic impact. But people are being paid a pittance, like 10th’s or 100th’s of a % of the economic value they create, so you need need to be careful.

But still the issue here is how much money is the customer going to get out of the benefit and how much should they pay you for the privilege of having that additional value. I would suggest that when you’re looking at prices is don’t look at at price through one lens, look at it several different ways. I’m sure you do this: often it’s a matter of research and of competition and then you run your numbers internally.

But I think what you want to do isis use multiple ways of coming in on the price. What we found is when you do economic value some and some demand estimation along with competition, profitability and customer research, you wind up with some overlapping ranges that kind of makes sense.

Then the issue is here is where do you want to be in the acceptable range. I think if you come at pricing multiple different ways you’ll be much better off than if you only come at it one way, which may be just looking at what the competition does. By the way, the large bars–economic value and voice of customer research– are really the things that you ought to weight the heaviest. The demand estimation methodology that we use is more of a rough tool.

On competition, our advice is that you don’t you should never let the competition drive your business but you should be mindful of them because the competition often sets the market environment that you are selling into. Many times competitors–especially in well-established markets–will set the tone for you or other new entrants and therefore you have to know what the competitors are doing.

People are always chasing after competitive price points. This is a bit of a sidebar and I think the reality is you never really know how much a customer paid unless it was ordered off the web–in which case the prices there are standard but of course there are no standard prices when you’re doing big deals. There are ways of realizing higher revenues when you do big deals but that’s beyond this discussion. The competition is something that you need to pay some attention to.

Often what happens is people run the project economics before they do the project and then try to make sure they cover the costs. This really is a backwards way of doing things.

I think what you need to do is focus on the customer and figure out what is a fair price to pay for the packages that you’ve constructed. Then make sure that the numbers that result from that will do what you want to do internally.

“Customers really don’t care about your costs, they only care about your ability to stay in business.”Jim Geisman, Software Pricing Partners, LLC

I mean customers really don’t care about your costs, they only care about your costs so you can stay in business. When you’re figuring out whether a project will be profitable, the profitability is pretty much up to you. It represents how well you can control your costs, how well you are able to develop your marketing efficiencies and things like that. But again, the customers only care about you delivering a product, being around long enough and then you get to worry about the rest.

Now when you’re in an acceptable range, it turns out that you just pick a point and the point you pick has to do with the pricing strategy you want to follow. The point is that people are not as price sensitive as you may think and in fact if you know you’ve got a range that may be plus or minus 10% or 15% from the center people really don’t care where you are as long as it’s in an acceptable range. And it’s a price point you can justify. Up to now we’ve been been talking about single products as it were and the question becomes (especially if you’re embedding analytics and you’re coming out with a new product): How much should I charge for a series of products?

We use a technique called relative pricing that you may find valuable. It turns out as human beings we’re not very good at guessing at absolutes. But we’re pretty good at estimating relative values and while you may not be able to tell me how much that bag on the left costs you know that the bag on the right is probably more costly because it’s bigger and you can take a look at the things that are in there and kind of swag.

Well whatever price you might pay for the bag on the left you may wind up paying 50% or 30% or 100% or more for the bag on the right. Of course nobody sees that bottle of wine that’s sitting on the bottom of the bag that was minted back in 1938 and is worth thousands. But putting that aside, we’re much better at assessing relative values. So let me just show you how one can do that using prices that are already existing. First of all, again this is the salesforce model, you see the price points above and in essence what happens is there are prices that you are paying for different tiers. So the first tier sets out what the base price is, the second tier adds $40.00 worth of value, $60.00 in the third set of features and $175.00 in the final set of features.

So one way to do this relative pricing trick is to understand what the value add is of the incremental features of one of the products in your tiered offering. You can do that on a dollar basis, you can do it on a percentage basis, it really doesn’t matter. But I would suggest that however you do it you also do an exercise where you take a look at the percent of value that you are asking somebody to pay versus the percent of maximum price.

The reason for that is the maximum price and the percent of value (presumably that’s a 100%) and then everything else is below it.

You’ll notice that the three dots on the lower left: You get 40% of the value for roughly 10%t of the maximum price. 60% of the value for 20% and then if you doubled the value and you go from 20 to 40 you wind up adding another 20% in the terms of the price. But one of the things that’s interesting is that final delta of $175 is really 40% of the maximum price but you only get 20% of the features. By the way we calculated value is we just counted checkmarks. That’s not the way to do it, but that was just easy and convenient.

So you might ask yourself well why would I want to charge 40% more than the previous tier for only 20% of the value? That’s a pricing strategy. You may conclude that if somebody is at the higher tier and they’re going to trade up you have them hooked. Or you may take a look at the features and say you know those are really specialized features and we don’t sell a lot of them but the people that want those features in the offering don’t pay a premium. It should reflect a conscious decision.

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About the Author

Chris Mele

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Chris is a software monetization and pricing expert and former CEO of an award-winning SaaS company. An avid scuba diver, Chris should probably move closer to the beach.

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