SoftSummit 2004
Utility-Based Pricing:
How To Make It Profitable
Thomas Nagle, Chairman and CEO
Thomas Lucke, Vice President
STRATEGIC PRICING GROUP INC.
Utility Based Pricing - A Tale of Two Views
“Gone are the days when software providers would
back up a truck to the company's front door and dump
as much software as possible and expect a huge upfront license fee from a customer.”
Louis Blatt, Chief Technology Strategist,
Computer Associates
"For companies that don't experience seasonal
variations in how they use IT infrastructure, a lot of
this doesn't make sense"
John Fowler, Chief Technology Officer
Sun Microsystems
They Are Both Right!
© 2003 Strategic Pricing Group, Inc.
2
Why On-Demand?
•
On-demand is not a better model to replace the existing perpetual
license model
•
On-demand is a different model to reach customers, segments
and applications where the current model is not delivering
enough value
•
The trick is to profitably manage the two models simultaneously
– On-demand pricing can commoditize your business and cannibalize
revenue if managed poorly
– On-demand can drive significant incremental utility revenue from new
customers
– On-demand can the lower risk of trial, driving growth in perpetual license
revenue as well
© 2003 Strategic Pricing Group, Inc.
3
Pricing needs to align with value
What is the biggest challenge with today’s pricing models?
Not in line with our business goals
and metrics for measuring value
Maintenance costs are too high
19%
Too complex
15%
Too rigid
14%
Don’t know
Other
Common pricing models
fail when:
42%
9%
1%
•
High variability in use
•
Uncertain future needs
•
High initial investment
•
High performance risk
(of a new product
or technology)
Source: Forrester Research: 156 North American technology decision makers
© 2003 Strategic Pricing Group, Inc.
4
On-Demand Pricing - How To Get It Right?
Understand
where it
makes sense
Choose the
right price
structure
Set the
price
 Identify
segments
• ID value
differenceS
 Assess value
created
 Understand
value drivers
• Pick price
metrics that
track value
 Set price as
discount from
value
© 2003 Strategic Pricing Group, Inc.
5
On-Demand Pricing - How To Get It Right?
Understand
where it
makes sense
Choose the
right price
structure
Set the
price
 Identify
segments
•ID value
differences
 Assess value
created
 Understand
value drivers
•Pick price
metrics that
track value
 Set price as
discount from
value
© 2003 Strategic Pricing Group, Inc.
6
On-Demand Can Expand the Market Opportunity
Perpetual Model Targets
• Economies of Scale
• Low variability; high certainty about demand
• “Leading Edge” IT
Perpetual license
A
B
C
D
E
Value of License
High
Low
Segments
On-Demand Targets . . .
• Time to benefit too long
• Can’t afford initial up-front perpetual license fee
• High variability in usage –High uncertainty about future need
• Cost of “lock-in” high
• Unwilling to risk purchase of “new” software / technology
© 2003 Strategic Pricing Group, Inc.
7
Value of Use Changes With Each Segment
On-Demand Targets
A
Value of Use
High
B
Use Fee
C
D
E
Low
Segments
Perpetual Model Targets
© 2003 Strategic Pricing Group, Inc.
8
How Is Value Created by “On-Demand” Models?
Value
Benefit
•
$ Value from licenses
saved
Reduce risk associated
with uncertainty of
future needs
•
$ Value from shift of
capitalized asset to
expense
Eliminate “lock-in”
Reduce risk associated
with of “new” software /
technology
•
$ Value of risk
reduction
•
$ Value from speed to
implementation
•
Shorten time to benefit
•
Reduce up-front cost
•
•
© 2003 Strategic Pricing Group, Inc.
9
On-Demand Pricing - How To Get It Right?
Understand
where it
makes sense
Choose the
right price
structure
Set the
price
 Identify
segments
 ID value
differences
 Assess value
created
 Understand
value drivers
 Pick price
metrics that
track value
 Set price as
discount from
value
© 2003 Strategic Pricing Group, Inc.
10
Pick Price Metrics That Align With Value
Value can differ even when customers have similar needs
High
Gamma
Value
Same Offering,
Different Value
Beta
Acme
Low
Customers
Differences in value can be captured with pricing
metrics that are linked to value drivers
© 2003 Strategic Pricing Group, Inc.
11
Case Example – Infrastructure Software
Availability
Productivity
Utilization
Reference
1
2
3
4
Low
Complexity,
High Activity
High
Complexity,
High Activity
Low
Complexity,
Low Activity
High
Complexity,
Low Activity
Activity, not environment complexity, was the critical element of value for
this infrastructure software. Traditional metrics left money on the table.
© 2003 Strategic Pricing Group, Inc.
12
Metrics Need To Work Across Segments, Be Feasible in
the Channel, and Understandable By Customers
Tracks
Value
Segment
Differences
Various
Price
Metrics
© 2003 Strategic Pricing Group, Inc.
Metric Filters
Measurable &
Enforceable
Customer
Buying Habits
& Preferences
Channel
Capabilities
Competition
(Reference)
Recommended
Metric(s)
13
Case Example - Identifying the Right Price Metric
Flat Monthly
Fee
• One-price fits
all
• Easy to
explain and
administer
• But does not
reflect value
created
Size-Based
(Number of
Seats)
Usage Based
(Number of
Minutes)
Usage Based
(Number of
Calls)
• Unique price
based on
number of
seats
• Unique price
based on
volume of
center
• Unique price
based on
calls handled
by system
• Simple
• Common in
telecom
• Nontraditional
• Reflects value
• Tracks value
• But – a poor
comparison,
sets transport
price as the
baseline
• Highlights
agent cost
savings,
which accrue
per call
• Only
imperfectly
reflects value
• Key was understanding how value
was really created – not just how
pricing was traditionally done
• Used the metric to define the
reference – strategically important
© 2003 Strategic Pricing Group, Inc.
14
On-Demand Pricing - How To Get It Right?
Understand
where it
makes sense
Choose the
right price
structure
Set the
price
 Identify
segments
• ID value
differences
 Assess value
created
 Understand
value drivers
• Pick price
metrics that
track value
 Set price as
discount from
value
© 2003 Strategic Pricing Group, Inc.
15
Set Price Based on Economic Value Estimation®
Software Example
Revenuebased
Positive
Differentiation
Value
$32,800
Remote diagnosis and
repair of system failures
$7,800
Training on new system
($20,000)
Negative
Differentiation
Value
Eliminate systems
interoperability problems
$14,500
Cost-based
Remote upgrades and
maintenance
Economic Value
$16,000
$10,400
Cost of alternative
software
Reference
Value
$4,000
Present Value = Cost reductions over two years (discounted at 10%)
© 2003 Strategic Pricing Group, Inc.
16
Once the Differential Value Has Been Established, Set Prices
Based on Strategic Assessment of Price Sensitivity Issues
Economic Value
100%
COMPETITIVE ENVIRONMENT
CUSTOMER EXPECTATIONS
PERFORMANCE RISK
75%
Differential
Value
COMPANY STRATEGY
FAIRNESS
AFFECT
50%
PRICE
25%
Next Best
Competitive
Alternative
0%
© 2003 Strategic Pricing Group, Inc.
17
Revenue
Received
A Simple Pricing Model forces costly tradeoffs
Missed
Volume
Opportunities
Missed
Margin
Opportunities
P
Value Received from Access
© 2003 Strategic Pricing Group, Inc.
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A Complex Pricing Model Can Maximize Market Share and Profit
Revenue
Received
License
Hybrid
Ondemand
P
Value Received from Access
© 2003 Strategic Pricing Group, Inc.
19
SoftSummit 2004
Utility-Based Pricing:
How To Make It Profitable
Thank You
Thomas Nagle, Chairman and CEO
Thomas Lucke, Vice President
STRATEGIC PRICING GROUP INC.