Dear Friends,
A quick reminder on upcoming keynotes from my colleagues: Javier Anta and our colleague Scott Bradley will speak at the EPP Global Retail & E-Commerce Pricing Forum on September 26th in Barcelona.
In case you missed them, here are other posts since the last newsletter:
Foundation of a pricing strategy: A pricing strategy is built on three key information sources—costs, competitors, and customer value—which interact to form economic frameworks that drive the seven pricing games within the Strategic Pricing Hexagon. You can read the full post here.
E-commerce opportunities for wine brands: Wine brands can capitalize on e-commerce opportunities by offering diverse, tailored digital experiences with high-quality content to attract younger consumers. You can read the full post here.
Decline in online grocery prices: The recent 3.7% decline in online grocery prices may encourage more consumers to shop for groceries online. You can read the full post here.
Changing a pricing model involves far more than getting the math right and developing a business case with a clear ROI. Companies must also make a case for change because a new pricing model will affect selling methods, communication strategies, incentives, and much more. It can change the way the business operates.
Software as a Service (SaaS) companies are facing those challenges now as they seek ways to reconcile pressure from buyers with the need to earn money from vast new opportunities such as generative AI (GenAI).
In this edition of the newsletter, my colleague John Pineda breaks down these challenges and shows how SaaS companies can capitalize on their pricing opportunities. While John focuses primarily on SaaS in his contribution below, some of the insights are relevant for companies in any industry where subscriptions are currently the standard pricing model.
The Next Revolution in Software Pricing Models
Independent software vendors (ISVs) have come a long way since the days of the “set it and forget it” approach to pricing. But they are now at a critical crossroads, not only because of the countertactics that buyers are deploying, but because the standard seat-based subscription model may not be the optimal choice for monetizing a groundbreaking technology such as GenAI.
In our IT Buyer Pulse Check, conducted in March in collaboration with Gerson Lehrman Group, the top measures for buyers to reduce their software and application spend were to rationalize the number of seats (40% of respondents) and to ask suppliers for discounts (33%). At the same time, the areas where the most buyers plan to increase their spending in the next 12 months were cloud services, AI and machine learning applications (including GenAI), and security infrastructure.
These two trends help frame up the pricing challenges that ISVs face, which we summarize at a high level in the matrix below.
For existing products, we believe that ISVs still have some leeway to price for a higher share of value, even though they have implemented noteworthy price increases over the last two years. But they need to be thoughtful about communication, customer engagement, and competitive dynamics as the pressure for discounts grows and buyers shift their attention – and their money – to GenAI.
The New Opportunities for Software Monetization
For some new products such as GenAI, we see many ISVs currently taking a more tactical approach instead of making a major strategic move by shifting their pricing models to the right. Working with subscriptions as their basis, they are creating good-better-best tiers for GenAI-augmented applications or embedding GenAI as a free feature. One risk with these approaches is the ability to cover the cost to serve, because of the high upfront training and operating costs of GenAI applications.
We feel that the most lucrative opportunities likely come from shifting the pricing model to the right, which means moving away from seat-based models and implementing consumption-based or outcome-based pricing models. The stakes are high, because the pricing model decisions that companies make today will have far reaching-effects that will determine how quickly the adoption of GenAI continues to accelerate, who benefits from it, and how much money organizations can reinvest into improvements and competitive advantages.
In other words, these pricing decisions will determine whether GenAI will be a moneymaker for the industry or whether it will eat the industry’s pricing model. The former can happen if companies use GenAI to create incremental value they can package and monetize strategically and if GenAI applications augment rather than replace users. The latter can occur if companies turn GenAI into table stakes by building it into existing offers with no existing incremental revenue. That approach can dilute margins over time because of the significant costs of training, running, and maintaining GenAI models.
There is also the perceived threat GenAI will automate away the user base to such an extent that consumption-based models can’t compensate. How much to charge also matters, because a high price point under a consumption model can make customers more selective on when and how they use the applications and thus discourage experimentation.
Why Revolution and Not Evolution?
There is a clear need for ISVs to change their pricing models, but changing pricing is hard! Those reasons are encapsulated in what we refer to as the 10/20/70 breakdown.
Getting the strategy and math right is essential to set the direction and magnitude of the pricing model change, but that represents only 10% of the overall work. It involves understanding customers by segment, getting the economics and desired behaviors right, and setting a clear vision for the transition.
Changing systems and products to adapt to the new pricing model accounts for another 20%. That means adapting the underlying technology platform and data layers, including the metering and telemetry capabilities to track consumption and the enhancement of system visibility, with admin consoles for monitoring KPIs. It can also include quote-to-cash system changes.
Change management accounts for the remaining 70%. Transition policies, governance, and exception handling are some organizational aspects of the change management effort and they will help the company manage the speed of change. The challenging work lies in getting sales, customer service, and product teams to make lasting changes to their behaviors to support the new products and models. Companies need new KPIs and incentives as well as programs that enable better communication with customers, partners, and employees. Especially with outcome-based models, all parties will need to agree on how to define, measure, and share the incremental value, an ongoing task that can be complex and sometimes contentious. Finally, they need the ability not only to experiment, but also to create rapid feedback loops so that the organization can find, interpret, and absorb the insights from the experiments.
Original article can be found here.