Ahhhhh, the good old days. No, I am not talking about the Obama presidency. I am talking about setting objectives for technology services pricing. Let’s reminisce, shall we? Here is an excerpt from my book published in 2013.
“At some point in the distant past a manager inside a software company made an absolutely brilliant decision. The name of the individual is lost to history, but the brilliance cannot be denied. It was simple really, and necessary. When we install our software onto the company’s hardware, he reasoned, the software will work perfectly. From there, it’s all downhill. Over time, the company will change their requirements. They will upgrade their hardware and expect our software to continue working. They will want our software to talk to other software. They will change processes, and new best practices will emerge. The user base will evolve. Each of these changes will decrease the usefulness of our software to the customer.
Of necessity we need to continually upgrade and maintain our software so it continues to deliver the value promised, but how do we pay for it? He made the decision to charge customers 20% per year of the initial license price to cover these costs. In this moment, this manager gave birth to maintenance revenues. The rest is history.”
In sum, setting objectives for services pricing was simple. Sell the product for its value, charge 20% of the product price for maintenance, and fight like hell to keep it. With high switching costs driving 20 year consumption life cycles, recurring service revenues were a gold mine and the heart of the business model.
A New Customer Engagement Model
Today, however, a new XaaS customer engagement model is emerging with significant service and pricing implications: the Land, Adopt, Expand and Renew (LAER) model. Essential services are no longer the heart of the model. In fact, you are unlikely to be paid at all for simple maintenance and upgrades. That said, services are more vital than ever for getting paid. In the XaaS world, if you want to get paid at all, and keep getting paid, you had better at minimum get uptake and demonstrate utilization value. Sales must be made throughout the customer life cycle, and service personnel are becoming a new sales channel.
The implications for pricing are obvious
- Provide us with your solution at a small fraction of the price we would have paid for a traditional software license. Maintenance is largely on you, and don’t expect a long contract.
- Switching costs are relatively low. Demonstrate utilization value in a meaningfully differentiated way or we can switch suppliers.
- We might be willing to pay for value added services, but you need to market and sell those services to us at a price we are willing to pay for value received.
The LAER Framework Demands Dynamic Pricing
The following graphic illustrates the myriad of pricing challenges that need to be addressed throughout the customer engagement life cycle. In the XaaS world, customer price sensitivity will change over the life of the engagement. As a result, effective pricing will require the ability to experiment and dynamically adapt to customer and situational requirements in order to capture a fair share of value created.
New Pricing Questions
In considering pricing goals for the business, there are three new questions to be asked
- How does your pricing dynamically adapt to changes in the customer’s price sensitivity and your evolving pricing power through the engagement life cycle?
- Can sales dynamically tradeoff highly price sensitive offerings with less sensitive ones, at healthy margins, at scale?
- Does your CPQ system enable you to experiment with different forms of monetizing efforts?
The good news is this is a win-win situation. Successful suppliers will be best at delivering and communicating value delivered, or outcomes. Successful suppliers are part of the customer’s value stream, i.e. investments to be maximized, rather than being part of the customer’s cost stream to be minimized. Successful suppliers know their customers’ businesses, and customers pay a premium for their value and knowledge. Your customers win and you win.
Happy days are here again!