Sales & Marketing

Five Sources of Software Pricing Pressure

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Since 2010 when we began our study series on industry trends and the software CEO / CFO outlook, one aspect of the data hasn’t changed. Each year the survey respondents indicate that their key to long-term business success is meeting customer needs. That objective is a major driver in pricing pressures and implementing new pricing models. Our 2014 study reveals new threats to software businesses because of pricing pressures and also shows a trend for performance-based pricing. 

The study included 76 respondents participating in an online survey of quantitative questions during March and April as well as individual follow-up, in-depth telephone interviews with some of the participants, which included some questions not asked in the online survey. CEOs, presidents and chairmen comprised 57 percent of the online survey respondents; of the remaining participants, 17 percent were CFOs, 10 percent were COOs and 16 percent identified themselves in the “other” category. CEOs comprised 70 percent of those interviewed by phone. 

Pricing pressures 

Participants in the 2014 study revealed five major sources of pricing pressure:

  1. Trying to win the “value” sale
  2. Pricing for the “right” type of customer
  3. Maintaining agility
  4. Selling a “solution”
  5. Enabling an apples-to-apples comparison for true-ups 

Value sale. When we asked the executives interviewed by phone to describe their biggest pricing pressure this year, nearly one-third of them reported pressure coming from competitors lowering their price if they can’t compete on value. Two executives commented that “Our competitors use price as a weapon when they can’t compete on value,” and “It accelerates as they become more desperate.” 

A participant stated that, while this is a typical ploy in the industry, this situation has greatly accelerated since 2013. There are now more players in the market because the cloud makes it inexpensive to start a new company, and this exacerbates selling on price versus value. 

Another executive explained that his company was first to market in its space in 2012 and thus was able to set its own price points. But new competitors are entering the space now with less-robust products at reduced price points. 

One executive said his company’s biggest pricing pressure for integration and product support now comes from offshore competition that recently switched to match his company’s pricing model rather than the model that traditional offshore companies use. Now his company is forced to go head-to-head with offshore pricing even though his company uses only U.S. talent. 

Leaders of several young, innovative, disruptive companies stated pricing pressure exists because they are in markets/industries dominated 70-90 percent by software giants with deep pockets such as IBM and Oracle. 

Pricing for the “right” type of customer. Several executives stated their biggest pricing pressure is trying to optimize products for a particular customer segment. Several stated that enterprise customers are more demanding about user experience than they used to be, even a year ago. A CEO said his company now experiences a lot of customer demand to make products even more simplified for users. 

Another executive explained his company’s pricing pressure is to offer a pricing model that appeals to the largest segment of customers. Along the same line, an executive explained that his company is in a new space and not facing a lot of competition. However, they have pricing pressure associated with trying to optimize for the largest adoption because “when people pay more, they engage more.” 

Maintaining agility. A top executive in a legacy company pointed out that maintaining agility is a big pricing pressure for many legacy companies because it’s much easier for young competitors to launch products today than a year or two ago. 

Selling a “solution.” A study participant reporting on his company’s pricing model said they face challenges because they sell a solution versus a productivity tool. Solutions have a 3X upside, he pointed out; but customers want the pricing associated with today’s SaaS/cloud productivity tools. 

The perception of value and pricing associated with SaaS/cloud models also causes a problem in another area. The newer pricing models are more attractive to customers than paying for professional services to get a software product up and running, and two executives reported challenges in getting paid for these services in today’s cloud world. 

Enabling an apples-to-apples comparison for true-ups. In a follow-up phone interview, an executive explained his company’s biggest pricing pressure is the traditional pricing model of a perpetual license with maintenance fees. “CIOs are used to buying this way, but we don’t want to sell this way,” he stated. “That’s a problem because enterprises want pricing transparency for a true-up at the end of the year, but we don’t have apples-to-apples ways to compare the traditional models with new models.”   

The solution for pricing pressures. When we asked study participants about their tactics to reduce the current pricing pressures, several reported that they are changing their sales and marketing strategies to make their product value proposition clearer so that it will resonate with potential and existing customers. 

Performance-based pricing trends 

For our 2014 study, (“Software CEO / CFO Outlook 2014: The Complications of Change”) we asked the executives participating in phone interviews if their companies currently use any pricing models based on success, value or outcome. As the figure below shows, 29 percent reported that their companies are using performance-based pricing. 

pricing

The study found that some software companies implemented value-based pricing a year ago and another as recently as six months ago. A vice president described his company’s strategy as using value-based pricing when billing for new technologies that customers demand the company implement and also around new technologies that the company pushes out to customers. 

Some software firms are more successful than others at transitioning to performance-based pricing. Outcomes range from a company reporting success in using both a value-based and a success-based pricing model to a company reporting pushback. 

A COO whose company offers vertical industry solutions stated, “Whenever we experienced a pushback on pricing in the past, we tried offering success-based pricing. But in every case the customers chose the traditional pricing model instead of success-based pricing.” He added that since performance-based pricing is becoming more common in the industry today, his company is considering offering it again. 

Status quo dilemmas 

Although our 2014 study revealed high expectations around growth in the industry and in the participants’ companies, the study found strong agreement among participants around the dilemmas they face from the changes in their methods for growing their businesses and in their pricing models. 

Competing interests pull software companies in two different directions. It is difficult to balance the effort to acquire new customers without risking the satisfaction level of existing customers. Newer deployment and pricing models — cloud and subscription-based software — are more cost-effective for the software vendors as well as new customers. Yet vendors still must invest in supporting their existing structure in order to maintain competitiveness with their existing customers. 

Click here to review the contents and buy the report, “Software CEO / CFO Outlook 2014: The Complications of Change.” The report provides insights into the current and future state of the software industry, identifies new trends and tracks evolving trends and assesses the goals and challenges of growing software businesses. 

M. R. Rangaswami is co-founder and CEO of Sand Hill Group and is the publisher of SandHill.com.

 

 

 

 

 

Comments

By Jeff Thull

The five sources of pricing pressure raise an interesting question – “How many software companies have the ability to quantify the true financial impact of their software with an amount that their customer agrees with?” Consider the five sources as symptoms; if so, each would suggest sellers do not or have not. Research we have conducted is showing that the financial impact illustrated in most business case /ROI models accounts for less that 25% the actual financial impact. When customers only comprehend and believe 25% or less of the impact, solutions appear identical in content and capability. When the seller cannot or does not provide the means to create an accurate financial analysis – sellers are “self-commoditizing” their solutions and the five sources of pricing pressure continue to disrupt profitable growth.

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