The software trade has always been central to the institutional investment world. Silicon Valley and its subsequent lookalikes were literally built to capitalize on the industry’s unique potential for fast growth and skyrocketing valuations.
So private equity, venture capital, family office and other professional investors have gotten pretty good at evaluating software investment opportunities. They know how to gauge the quality of a solution, calculate its market potential, assess the competitive environment and judge the skills of the management team. They use this expertise to determine if and how much to invest in a given software opportunity—and at what valuation.
Some investors—a new generation of advanced operators—have also begun to incorporate a highly sophisticated review of the software company’s pricing data into their evaluation process, as well as in their ongoing work with their portfolio companies. By adding this capability, they gain a deeper understanding of the company’s revenue drivers and costs, and can identify significant improvement opportunities. Not only does this help them create more value for their investments, but it also gives them a competitive advantage in closing the deal in the first place.
The Treasures Investors Find Hidden in Software Pricing Data
In general, when sophisticated investors dig into a software company’s pricing data, they are looking to ascertain the degree to which the model facilitates or hinders revenue and how effectively it captures the software’s value. Specifically, they are looking at these elements:
1. Deal data
Investors are mining detailed transactional data along with data on lost deals, capability usage patterns and more. By doing so, they can gain precious insights such as where revenue leaks are coming from, where obstacles are getting in the way of deep deployment and how pricing inconsistencies are elongating sales cycles—all of which tell them where additional value can be created.
2. The software licensing structure
Investors will look at the structure of the software licensing to understand potential revenue opportunities and pitfalls. To uncover these elements, they want to know:
- How strongly does the metric(s) that pricing is based upon (e.g., number of users or contacts, amount of transactions used, etc.) align with the customer’s perception of value?
- Are there unexploited opportunities to reframe how the company charges for its software?
3. How the software is packaged
An effective packaging structure is oriented around features the customer perceives as a need and provides a roadmap for customers to expand their relationship. It shouldn’t be overly complicated, as that can lead to bespoke deals/custom packages that decelerate deal flow. Investors want to access data that tells them if the packaging is reducing sales friction and accelerating sales velocity…or not.
4. Discounting behavior
How the software company discounts its products—in actuality, not just in published list prices—is one of the most vital components for investors to understand.
- Is the discounting programmatic, where customers earn pre-established discounts for purchasing more?
- Or is it discretionary, with a wide range of customer discount deals on the books?
A messy discounting (or surcharge) data pattern can indicate a problem with other aspects of the model, cast doubt on future revenue projections or expose market fairness vulnerabilities (on the other hand, to a savvy investor, poorly constructed discounting can also signal a quick improvement opportunity).
5. Customer scalability
For the typical software company, a significant portion of growth should come from generating additional revenue from existing customers. Investors who scrutinize pricing data are paying particular attention to how the model responds to customer growth opportunities.
- Does it line up with the value the customer derives as they increase their use?
- Does it work as well for large customers as it does for small ones and vice-versa?
A Competitive Advantage for Software Investors
Until recently, software investors who wanted to analyze alternative pricing scenarios would rely on variable assumptions and market research to fuel their models. But now, with some profound leaps in technology and pricing-specific data expertise, real-time data feeds are revealing much greater decision clarity.
For example, the serverless pricing management software developed at Software Pricing Partners can model line-item level impacts from pricing changes, allowing investors and analytical teams to identify how potential pricing changes would sway revenue, and visualize how customers, industries and products would be affected. Further, as pricing changes roll out, analysts can study transaction and usage data to finely tune new pricing and packaging. Investors and their portfolio companies gain an unprecedented level of effectiveness to identify and implement improvement opportunities.
This explains why more and more Investors are now making pricing data a focal point with their portfolio companies, as the impact of an optimized pricing model on revenue, profitability and valuation can be enormous. But investors are also analyzing pricing data on the front-end to secure an advantage in winning new deals. By identifying quick-to-fix pricing-related gaps and miscues—which can swiftly add revenue or profit—they may be able to justify a higher valuation than competing investors.
Today’s software investors would be well-served to recognize the emergence of pricing data expertise as a tool to grow value for their investments. It is becoming a building block for their portfolios. For software company leaders, this development is sending a new and clear message: the stronger the pricing data story, the better the ability to attract and negotiate with investors.
For more on this topic, watch this video of Chris Mele discussing the importance of pricing for software investors.