Establishing the right pricing strategy for your enterprise software product is an essential step in scaling your revenue.
View all the posts in this series on Enterprise Pricing Strategy:
- An Essential Lever of Growth for Expansion-Stage Companies
- Optimize Your Prices to Power Growth
- Develop a Long-Term View
- Focus on Value
In my previous post, I highlighted the costs of acquiring and serving a customer, some of which are quite elusive and hard to quantify. What I hoped to make clear is that having large enterprise customers can put extreme stress on the company’s P&L in unanticipated ways.
One effective way to counter the unpredictable costs of serving enterprise customers is to have a rational, evolving, and effective pricing structure and licensing model. The price list is a powerful revenue management device that expansion-stage companies have to learn to master in their quest for growth.
In this current post and subsequent posts, I will discuss the main considerations around establishing an enterprise pricing strategy and the different perspectives that inform this decision.
First, let’s discuss the most basic aspects of a pricing model.
Discriminating Price Levels and Communicating the Pricing Model
The fundamental characteristic of Enterprise-level pricing strategy is that the vendor has to price discriminate its customers in some ways, because of the vast diversity of businesses types, scales, and usage needs that exist in the enterprise market. This is usually accomplished using one or more of the following devices:
Establishing a Variable Component of the Price
This establishes the rate of growth of the price based on the scale of the license. Most often, this is based on the number of users (for business applications like CRM, HRM software), volume of usage (number of transactions, number of message, volume of storage), number of process/servers, or number of accesses to a network.
Bundling/Unbundling of Modules
Another distinct feature of business software is that they typically come in stand-alone capable modules that offer different functionality or address different needs, even if they are all related to a common platform. Different customers will require different “bundles,” and having tightly integrated bundles allow the vendors to offer more than just a collection of disparate tools and price differently for the sum of the parts.
Bundling/Unbundling of Services
Another way to differentiate the prices is to allow customers to choose or customize the level of service and support they enjoy. The vendor is possibly the best placed organization to provide the highest quality support and services, and pricing for different levels of specialized service and support separately from the right to use/access the software help unlock that value.
Special prices / pricing tiers
There are also differentiated pricing levels that do not fall under those described above. They arise due to special circumstances (for example, a young company needs to acquire a major customer, or strikes a special deal with a potential acquirer), or the unique business model or sector a company sells to.
- Unlimited, all-you-can-eat licenses: for customers that are so large that they would pay an unreasonably high amount if the variable pricing model is applied
- Umbrella licensing: striking a special deal with a parent organization that in turn distributes its access to its subsidiaries or affiliates
- Revenue share: really a special case of usage-based pricing, but instead of usage, it is revenue-based pricing
Communicating the pricing structure to the customers and the market is just as important as setting the pricing structure, itself. Here, a vendor in a competitive market faces some difficult questions:
1. How Much Detail to Make Public
Does the company publish the whole price list or pricing structure, or should it just explain the structure without giving actual number? Should it only disclose pricing at the lower tiers (where competition and commoditization have made the pricing among competitors to be almost equivalent) and require enterprise customers to “call for details”?
Having fully disclosed pricing will definitely reduce sales and marketing costs dramatically, yet few vendors are willing to do so.
One might think that a vendor chooses not to disclose its pricing solely for rent-seeking behavior. Without publicly available prices, a customer is at a disadvantage in negotiation.
However, price disclosure is also linked to the price discrimination techniques we discussed above. If a company develops very tailored, specific pricing tiers for distinct group of customers, then disclosing such a complex model might confuse the buyers more than help them.
2. Disclosing Discounting and Negotiation Policies
The company has to also disclose whether its prices — if public — are going to be negotiable in anyway, and if so, how much is negotiable.
Many companies do not do this, but others are very clear about their negotiation and discounting policies. Again, there are pros and cons for each stance.
Having stated negotiation policies may encourage price-sensitive customers but increase costs of sales because customers are more likely to try to get a discount. Stating no negotiation policies allows the company to be disciplined about its pricing model and cause the interested customers to self-select.
3. How Strictly to Enforce Pricing Disclosure
While non-disclosed pricing information can generally be considered proprietary information, the fact of the matter is that customers do talk among themselves and to others in the market, and sooner or later the market will have some level of information about the pricing levels. The challenge for the company is to decide how strongly it wants to protect this information asymmetry to maintain an edge versus a competitor or in negotiation.
These are simply the most basic aspects of structuring pricing — setting and communicating the price. Do you have any comment on these ideas?
In my next post, I will discuss other important considerations for a complete pricing strategy: cash flows, discounting practices, non-monetary benefits, price increases, pricing for partners, refund and reimbursement practices. I will also share a number of online resources from pricing and software experts that touch the same topic to enrich the discussion.