One thing I often hear partners struggle with is their pricing strategy. It’s easy to see why. The old standards like cost plus margin and perpetual licensing don’t always make sense with cloud-based offers. Newer consumption-based, pay-as-you-go models have taken hold and disrupted the entire industry, but they have low value-add and could make it harder to encourage widespread adoption, logically scale your offers, and realize greater profits.
With offer-based cloud services in today’s marketplace, your price becomes part of your value proposition, something you’ll want to share with customers up front. In today’s blog, I’ll cover some successful value-based pricing models that have literally become competitive sales weapons.
Moving Beyond Standard and Fixed Pricing Models
Before I get into value-based pricing, I’ll quickly dispense with two pricing options that, while still in use, may limit your long-term growth. The first is Standard Pricing, which has defined the mobile app market. Think of this as reference pricing, where customers have seen similar products sold for this amount, so you price your offer so that it is similar for fear of breaking from the accepted standard pricing.
This model does nothing to differentiate your offer, nor does it encourage your customers to add more users or services.
The other model is Fixed Pricing or the one-size-fits-all approach. The main problem with this approach is that it tends to leave a lot of money on the table. Your customers aren’t uniform. They have different needs. They’re segmented differently, and again, fixed pricing produces no incentive for customers to purchase more.
That’s why I like to focus more on value-based pricing strategies. Think of value-based models especially when building managed service offers. Managed services offer incremental value to the customer over time, and likewise deliver incremental revenue to you over time. Selling managed services based on price doesn’t necessarily take into account your true costs, the incremental benefit received, or the savings that your managed service delivers.
The goal of virtuous pricing is to create a virtuous sales cycle, where each sale encourages the next sale within the customer organization. It fosters product adoption and proliferation. A popular virtuous pricing model for customers is Digressive Pricing because it brings the cost per unit down. Think of it as fixed prices per unit of value, but with bulk discounts. In per-user digressive pricing, you have breakpoints where the price per user drops based on the additional number of users (see example below).
© 2016 Lemon Operations for Microsoft
It also works in our partners’ favor in a somewhat counter-intuitive way. While it drives the cost per seat down, it helps them to scale by encouraging more aggressive purchasing. And as we’ve heard before, scale is what it’s all about in cloud-based services. You may start out with a limited number of users in a customer organization, but if another line of business is looking to purchase a similar product, your existing customer has incentive to lobby on your behalf because it will drop their cost per user after reaching new breakpoints.
A variation on this is Step Pricing, which can be significantly more profitable. As with digressive pricing, you have unit ranges (e.g. 10-19 users; 20-49 users, and so on). But in this case, you set your price for each range as the top number of users in each range. You may end up initially with 15 users but the customer pays for 19 users. As more users are added, they jump to the next step of max 49 users. This, in turn, amplifies your virtuous sales cycle because the customers get more value as they get closer to the maximum number of users in each level.
Flat Rating Pricing
A time-tested pricing strategy is Flat Rate Pricing, which provides a certain level of value for a set cost that all customers pay (think of how you pay for bank loans and insurance) and applies the 80/20 rule. The idea here is to identify the average consumption across all your customers and set your price above that, creating a model where more than 80% of your customers use less than average consumption, while fewer than 20% use more than they pay for. This means that 80% of your customers more than cover the cost of your over-consuming customers (your best customers). Pricing models built around flat rate pricing have shown between 1.5 and 3 times as much profit as traditional models.
© 2016 Lemon Operations for Microsoft
Fees and Terms
The question around fees also comes up often. Should you charge upfront fees?
As with anything, the answer depends on your business and your customer. In our recent survey of 1,136 Azure partners, we found that only about half charged an upfront fee for project or managed services. When an upfront fee was requested, it was typically less than 25% of the total project or managed services fee. The reasons for charging fees upfront include generating working capital to kick-start a practice, mitigating risk by ensuring the customer is invested in a project, minimizing financial impact when a customer needs longer payment terms.
When it comes to payment terms, in the Microsoft Cloud Practice Development Study we found that the most common payment terms used was NET 30 (30 days). Many partners offer discounts for prompt payment (e.g. a 2% discount if paid within 10 days), which is added incentive for customers to deliver payment on time.
As the IT services landscape continues to evolve, so too will strategies to effectively price your offers. But the goal should always be to maximize your margins while at the same time driving deeper adoption and growing your practice. For more on financial models, value models, and partner profitability, check out our Cloud Profitability Scenarios.
Share your thoughts around pricing and fees. What has worked for your company? Engage with the Microsoft Partner Community here.