Channel Pricing Strategy for Software and Hardware Products

Pricing software products and SaaS offerings is always a difficult exercise. With high product development costs, but very low costs of goods sold, there are many different pricing strategies that people have followed successfully (and not so successfully!) over time. Somewhat surprisingly, pricing hardware products is a bit simpler. A hardware business is much more complicated to run, in general.  However because hardware has a significant cost of goods sold, that acts somewhat as a governor on market pricing behavior. But even hardware technology markets are dynamic and fast-moving. Pricing is a complex enough topic when all sales are going direct. Once you bring channels into the picture, it only gets even more muddled. Today we’ll focus on channel pricing strategies.

PRICING AND CHANNEL CONFLICT

The biggest concern most companies have when pricing for multiple distribution channels is channel conflict. If it isn’t, it probably should be. I have seen many companies who actually AVOID selling through channels for fear of the channel conflict implications it brings. They are afraid of a channel undercutting their direct sales force in price and channel conflict in general. This arises as a result of different prices being presented to customers by representatives of different channels. But this fear isn’t necessary with a savvy understanding of the implications of pricing actions. This understanding comes from experience. The specific experience of “paying attention to what actually HAPPENS in the marketplace”. Price properly and run your channel programs well and you can sell successfully via multiple channels. With all of those channels living in relative harmony.

VALUE-BASE CHANNEL PRICING STRATEGIES

I’ve written about value-based pricing a number of times before. In the context of the perceived value of a product – as seen by the end-user – being the guidepost for pricing actions. A similar concept exists for channel pricing strategies, specifically for discounts. Don’t take a simplistic approach and give the greatest discount to the channel players that move the most product. This is a common but often destructive strategy; more on that later. Before setting channel prices, it’s important to measure how much “value” each channel provides both to you and your end-user customers. Depending upon the channel you should evaluate things like 24/7 support, inventory & product availability, technical/customization expertise, credit services, and the like. It is often helpful to let the cost of delivery of each of these attributes be your guide to the value they provide. Don’t forget to include your own direct sales force as a “channel” in this exercise.

VALUE-BASED CHANNEL DISCOUNT STRUCTURE

Here’s an example. You may figure that the cost of a VAR providing 24/7 support to end users is equal to 5% of the list price of the product. Because the VAR is providing that support,  YOUR company doesn’t have to, saving resources and money. Another example might be the inventory held by a retailer is equal to 2% of the product list price. Again, that means that YOUR company doesn’t have to hold it, saving that cost. And so on and so forth. Using this value-based method, you can estimate the actual costs borne by your partners in delivering marketplace value. Use this as a guide in building your channel discount schedules for various types of channel partners.

This value-based channel pricing approach is not well-known and seldom considered. Most tech executives seem to believe the only value-add that is worth extra discount points is sales volume! If you use a value-based pricing approach, you can build a multi-channel strategy that “clicks on all cylinders”. By providing discount structures that are equitable and based upon costs borne and value delivered, you establish a “level playing field” for each channel partner type.

LIMIT CHANNEL VOLUME DISCOUNTS

If you choose the typical “more volume=greater discount approach”, your multi-channel pricing strategy is a house of cards that will likely collapse around you. One channel will quickly grow to dominate and the other channel types will soon quit actively selling on your behalf. They will eventually wither away as a useful sales and marketing entity. Unfortunately, this is a common scenario CREATED in the marketplace by first-time vendors using the channel. Remarkably, a lot of experienced practitioners do this as well.

THE GOAL IS TO MAXIMIZE SALES AND PROFITS THROUGH ALL CHANNELS

Again, the key to multi-channel success is not letting one channel dominate. Ideally, you would like all channels to be presenting deal prices to the end customer that are roughly equal in “value”. In reality, that pretty much can’t happen without price fixing. Some folks may be able to get away with it, but that’s another story… However, I maintain you should strive as much as possible to have end-user pricing equity for all channels. This is where the counter-intuitive part of this discussion comes into play. As discussed above, most tech product channel pricing strategies are usually based on the volume of product a particular channel player can move. It seems very logical–why wouldn’t you want to incentivize and reward a partner with better margins, if they are selling more products?

While this appears logical, it is actually penny-wise and pound-foolish. In fact, it is often catastrophic with respect to your plans to maximize sales through multiple channels. Let’s look at a simple case of how this often “breaks” a multi-channel strategy for a common case: a vendor selling through both retailers and VARs.

A SIMPLE CHANNEL PRICING STRATEGY EXAMPLE

Retailers provide a vendor with a point of purchase by holding inventory, where their customers can go to immediately purchase a product. On the other hand, VARs often don’t hold much inventory, but provide other services important to the vendor and many end-user customers. Examples are tech support, training, customization, and integration with other software and hardware products. Both of these channels may have an important role to play in the overall strategy to maximize vendor sales to customers with different needs.

DON’T LET RETAIL DESTROY YOUR CHANNEL STRATEGY

Retailers are usually high-volume partners, with the individual VAR less likely to be a volume outlet. It’s important to note that the VAR CHANNEL in aggregate may hold even greater promise to move volume. If you structure your pricing by volume only, the retailer will get better discounts. However individual VARs generally have higher costs spread over lower product volumes. So they actually need HIGHER discounts to stay close in deal pricing vs. the Retailer. This situation is exacerbated by the fact that retailers tend to be volume-oriented. They often accept a relatively small, fixed margin applied blindly to everything they sell to drive volume. If you provide discounts based on the volume that a partner moves, what will happen is inevitable.

The retailer will take over your channel business because the VARs will be “squeezed out” by the relatively low prices charged by the retailer. They won’t be able to make a profit on your products, so they will ignore the business. You will lose the opportunity to realize significant sales through the large (in aggregate) VAR channel. This will hurt your business, especially with those customers who desire the service and support VARs supply.

I am oversimplifying this situation, of course. That’s because VARs are more interested in the service revenue that a product can pull than they are in product margins. But I have seen this scenario play out many times. It can kill product sales through a VAR channel that might otherwise generate healthy sales. This can be a heavy penalty for naive technology product managers, sales managers, and senior executives who are charged with pricing their products and moving them through multiple channels. Unfortunately, these executives don’t fully realize the consequences of their actions.

SUMMARY

Pricing seems pretty simple on the surface. It really isn’t ever simple and when channels are involved, it becomes anything but. It’s important to think through completely the downstream effects of your channel pricing policies when multiple distribution channels are involved. Let me know if you have questions, or post a comment with your own preferred channel pricing strategies or stories that you’d like to share.

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