THE TABER REPORT
The Voice of Effective Marketing
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April 2004
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Pricing and Licensing I'm going to start this section with a bit of heresy: don't be too creative or spend a bunch of time on pricing or licensing. It's the wrong side of the equation to solve: it's more important to focus on value -- what you give to customers -- and on increasing the uniqueness of the value you provide. Learn from luxury items like Dom Perignon or deBeers or Sony. Sustainable value-add, differentiation, and reputation will do more to make you profitable than any pricing scheme. (Unless, of course, you're a Redmond-based ISV with monopoly power.) That said, pricing is a signal you send to the market, and an indication of your value, and that goes double for services. So it pays -- literally -- to set your pricing right. There
are three basic mechanisms for pricing: cost plus, channel driven, and
value based. Cost-plus pricing makes the most sense with commodities, and
bases the price on your underlying costs plus a fixed percentage.
Channel-driven pricing starts with the needs of your channel (whether retailers
or direct sales reps) and determines price points from there (whether
"shelf space means a $49.95 price" or "a rep can't make
money with $25 K deals"). Neither of these mechanisms puts much
emphasis on the customer or perceived value. In contrast, for software, pharmaceuticals, medical
equipment, services, and non-commodity hardware, value-based pricing is most appropriate because it
starts with the customer's perceptions, and how much a
solution to their problems ought to be worth. Auction-based pricing is the
latest twist in value-based deals. ValueFirst™ Methodology It's a common mistake to choose price points too early. Of course, you'll need an "average selling price" for your business case (whether for VCs or your own executives), but this average price is purely theoretical and must never be thought of as a price point. My pricing methodology starts by quantifying the size of the customer's economic problem, and understanding which of their cost elements a product will resolve. I pay attention to the customer's decision horizon -- only the elements of value that are within their timeframe or "field of view" will be relevant to their willingness to pay. Ironically, some of the hardest work in the ValueFirst methodology is figuring out who the customer is. Remember, a customer is someone who pays you money and receives the economic benefit, not necessarily the user of your product or service. Get this right, or you have to start over. When you are creating a new product (unless it's a commodity item), you don't know what a reasonable price is, and neither does your customer. So don't ask them yet. Until the customer has actually used a product mock-up, you can't measure benefits and they can't estimate value. The next step is to determine the pricing objective. "To make a bunch of money real fast..." is not a usable pricing objective. You need to identify the one thing from the list below that will be the most important driver for your business:
These items are interrelated, but each yields a different set of priorities and weighting factors for evaluating pricing models and price points. The next step is to choose a pricing model. Build on your understanding of the customer's perspective of your value to choose the metrics of how you will charge. Pricing models are actually more important (and harder to change) than price points. Pricing models are often intimately linked to business models, and your firm may use a combination of such models as:
It's OK to have more than one pricing model, but this will add operational complexity. The most interesting pricing models (read: shared-benefit, the ultimate value-based price) are devilishly complicated to administer even in a direct channel and impossible through channels. Unless you are in a really new product category, it is not a good idea to make up a completely new pricing model (it's too hard for your channel and just confuses the customer). There are a couple of pricing models that are essentially off-limits: enterprise-wide licenses ("site deals") or all-you-can-eat licenses cause far more trouble than they are worth (just ask your CFO!). Instead, create volume discounts ("5000 seats") with specific timeouts and thresholds that automatically trigger "recognizable revenue".
Don't fall into analysis paralysis: avoid the trap of academic or economist thinking. Customers make irrational purchase decisions all the time, and even the best pricing has its share of emotional / intuitive / impressionistic "logic." In fact, the price the customer is willing to pay may depend on the individual sales rep involved. Do check with customers about prospective prices, but it's even more important that your channel -- whether direct sales or distributors -- be happy with the pricing model and price points. Channel partners and sales management can shoot down pricing in very dramatic ways. Discounting - whether permanent volume schedules, upgrade / competitive offers, or temporary promotions - must be carefully designed to achieve specific behaviors. The incentives must work equally well for the channel and the customer. For promotions, think through the mechanics of your "coupon" and make sure to print an expiration date on all offers! The
final sanity check: pricing must be simple to work. A common
mistake is to make price lists and enforcement mechanisms too complicated. Price points should not be
changed more often than once a year unless you are in a commodity
market...and pricing models should last at least twice that long. So
get everyone to review the pricing for practicality and longevity before
you launch any change. Changing prices too often limits your
credibility. Product Licensing Licensing -- the terms and conditions of your contract (or EULA) and any enforcement mechanism you build into the product -- is required to protect your intellectual property and your revenue stream. Mistakes can be costly and long-lasting, so lawyers and even marketing consultants are a bargain here. The licensing terms, conditions, and enforcement should be designed in conjunction with your pricing. The units of pricing (e.g., $/CPU or $/use) and the pricing model need to match what your license and enforcement mechanism. Think through how your license will get to the customer, how you will validate that the license has been accepted, and how you will authorize the user to continue using the product. A lot of good work has been done by Microsoft on leveraging the web for this -- learn and even copy them. Pay a lot of attention to indirect channels -- how the partner will get license confirmations back to you -- and make sure that your license will work properly through distributors and international transactions. Make sure to allow for free demos, limited time trials, and other "try then buy" mechanisms. Generally speaking, "floating keys" for software license enforcement do not work. In some cases, you may be able to build gag orders into the license (e.g., "no benchmarking" or "no public comments about the product without company approval"), but these imply that you once worked for Oracle or otherwise have something to hide. The biggest
mistake is to make your licensing so complex that it slows down the sales cycle,
causes friction in your channel, or
creates customer objections. The KISS principle applies here.
Does Your Marketing Scale? -- coming in May
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after all this is it time to come up with price points. Look at competitors and
substitutes, but know that customers rarely evaluate competitive prices the way you
do. First, they have different perceptions and understandings
about the details of your
product differentiation. Second, they will prioritize
elements of value differently than you. Spend less time talking
to your executive staff about price points, and more time talking with your
sales rep, channel and customer.
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