Pricing is always an interesting topic, but even more so in the Hardware and Software worlds. In the consumer products business, if there is a package of frozen peas from Green Giant priced at $3.99, you’re not likely to see someone else offering the same-size package of peas at $19.99. But it’s different for SaaS pricing strategy as well as other hardware and software markets.
Things move fast in software and hardware markets
The pace of innovation in the Tech world leads to pricing that’s all over the map. It’s not unusual for a brand new competitor to come out at a higher price than the current established market leader. This can happen if their product is based on market-changing advances in product functionality due to new technology. This is almost unheard of in most other industries. Then there is the PC business, where rapid technological advancement over a long period of time has led to continuously lower prices for the same level of functionality. This has been a great benefit to consumers and businesses using PCs but has squeezed a great deal of margin (and indeed many competitors) out of the market.
Again, things move fast in Tech. Sometimes a new competitor might start out at a high initial price to harvest profits with a major feature advantage. Another competitor might aggressively discount to gain market share, based upon a lower cost structure. Whatever the case, you can count on pricing moves to be dramatic and to have a profound effect on most technology market segments.
Value-based hardware, mobile software, and SaaS pricing
So what’s the best way to price software and hardware-based products? Is it best to add up your fixed costs and allocate them to a forecasted number of units to ensure you are recovering your investment? Or is it better to use your variable product costs and a standard multiplier derived from history to set your prices? Maybe you just set your pricing based on the prices of your competitors. Or let your customers tell you what they’re willing to pay.
While all of these approaches have merit and a place in pricing policy, none of them should be the overriding factor in your pricing strategy.
And the most important factor to consider in Pricing? The most important thing to focus on in setting prices is VALUE. What is the value of your product to your customer as an economic, functional, or emotional return? And how does the customer value the benefits of your product relative to your competitors?
Market segmentation and value pricing
Value can be a squishy concept to some folks, so let’s talk about the nature of Value:
Value is a measurement scale of the underlying needs or wants that drive a customer to purchase a High Tech product. If the benefit that the product provides closely fulfills that want or need at an attractive or at least acceptable price, you usually have a sale! This is what is meant by HIGH VALUE.
Maybe the most important consideration in value-based pricing is to SEGMENT your market properly prior to the pricing decision. Segmentation, by definition, is the process of separating the total addressable market for your product into “buckets”, or segments of potential customers who have similar needs and wants and therefore will react similarly to a specific offer. What this means is that once you have divided your marketplace into appropriate market segments, you may be able to charge individual segments different prices that are based upon the perceived value the product provides them.
A SaaS pricing example
Let’s look at an example of a segmentation approach; marketing a security software (SaaS) product to corporate IT departments. Through your market research, you have concluded that the potential customer set with the highest pain threshold for the particular security problem you are solving happens to be banks. By adding a few important banking-specific features to build a “fence” around this market segment, you may be able to charge a price for a banking-specific version of your product that exceeds what other segments might pay. That’s because banks have plenty of money for things that they really need, and good security software is near the top of the list.
The Importance of value
In other segments it might be important to have a product at a LOWER price (with fewer features for differentiation), leading to greater segment penetration resulting in higher overall revenue. If you extend this model to multiple segments and differentiate the products properly, this approach will lead to far higher total product line revenue than if you set just one price for the entire market.
Establishing value for each market segment, pricing to that full value, and communicating this value to the marketplace is the essence of Value-based pricing. However, I don’t want to understate the difficulty of doing this precisely. This is because the concept of value to a specific customer segment may be hard to quantify. Therefore there is a subjective component to this exercise, which leaves it open to error which can only be reduced by experience and pricing expertise.
Don’t price in a vacuum
Finally, it’s important also to remember that pricing actions should not be done in a vacuum. First of all, it’s important to remember that pricing doesn’t exist in a vacuum, but in relation to potential “substitutes”. By substitutes I mean other products that compete with yours either directly or indirectly, manual methods for completing a task, or maybe even not completing the task at all. A prospect will internally assign “value” or “cost” (a negative value) to each one of these potential substitutes. The art of value-based product pricing is to estimate these customer-driven product valuations as closely as possible to allow you to price your price/product value for success in the marketplace.
It’s also important to remember that pricing is just one of the 4Ps of marketing (Price, Product, promotion & place(distribution). All four of the Ps are interrelated and must be considered together in your overall go-to-market planning.
Promotion & distribution are equally important to pricing strategy
You cannot properly price a product without at the same time considering the features and benefits of your product versus the competition. It is equally important to consider how it will be promoted and distributed. Self-service SaaS pricing for a product sold directly will almost certainly be in a lower range compared to an enterprise software product sold via an expensive, sophisticated direct sales force or a VAR channel. If you aren’t going to have much of a promotional budget, you may want to be a price leader to maximize your chance of being successful. Similarly, if your product is at a perceived value deficit, your price relative to the market leader will probably need to be very aggressive. So consider all 4 Ps carefully in your marketing plan.
Quick introduction to a complex topic
Hardware and SaaS pricing strategy is a complex topic that many books have been written about. This post is meant to be only a quick introduction to pricing in the software and hardware world. Hopefully, it gets you thinking a bit more expansively about pricing tactics. So when your next new product comes out, you’ll look harder before quickly pulling a price out of the air. I’d love to hear your own pricing observations and experiences, so please leave a comment below!
Follow Phil Morettini and Morettini on Management via Twitter, Facebook, LinkedIn, RSS, or Subscribe to the Morettini on Management Newsletter hosted by LinkedIn. Contact Phil directly at firstname.lastname@example.org