Pricing

Importance of pricing
Review and compare your pricing model
Align your pricing (and packaging) to buyer personas
Building expansion into your pricing model
Low-cost upfront offer
Factor price escalators
Avoid unchecked and excessive discounts
Licensing modules
Revenue leakage from contract breaches

Importance of pricing

Price your offering right. It is easier said than done. Getting it right is often the result of a good pricing strategy. Prices reflect the perceived value of a product, thereby shaping the customer’s perception and decision-making process. Moreover, it is a vital component in revenue generation and profitability, with a direct impact on the bottom line. A strategic pricing model can cater to diverse customer segments, maximising market reach (if one is aiming for it) and serving as a key differentiator in competitive markets. Unique value propositions can justify premium pricing, setting a company apart from its competitors.

As owner-managers of small and medium-sized B2B software companies, you must continuously review and adjust your pricing strategy in response to business objectives and market dynamics.

This article focuses on all you need to craft the right pricing strategy.

Review and compare your pricing model

As with most things, the best way to start is to review your current model. What model are you currently using? Is pricing based on a cost-plus model or simply arbitrary pricing based on market conditions? You should ideally compare your model with your competitors’ to know how your pricing compares with theirs. This informs you and empowers you. If your pricing is more than theirs, ensure that you are effectively communicating the added value your company is providing. If your prices are less than competitors’ check to see if there is room to increase prices especially if you are offering similar services as your higher-charging competitors.

Align your pricing (and packaging) to buyer personas

Willingness to pay for your offering differs from one customer to another depending on their specific needs and expectations. Although you should try to keep the model simple, a one-size-fits-all approach will not work.

When you research the ideal customer profiles (see here for details), you will notice distinct preferences and priorities possessed by each buyer persona. Each persona values features differently, leading to a varying willingness to pay based on the perceived value derived from these features. Understanding these nuances is essential for harmonising pricing and packaging strategies effectively.

Optimising pricing involves considering how features are bundled to appeal to different buyer types. To achieve the goal of providing tailored solutions at acceptable price points, several approaches are commonly used. One prevalent strategy is the "Good-Better-Best" packaging model, offering tiered plans with escalating functionality and pricing at each level. For instance, Wordpress’s Personal, Premium, and Business plans cater to different personas with varying functionalities, providing a natural upsell path.

Another strategy is case-based packaging, bundling features to align with distinct use cases of customers. This is applicable in the case of large B2B customers with clear use cases.

By understanding the unique needs and value perceptions of each persona, businesses can tailor their pricing and packaging strategies to offer the right features at compelling price points, fostering customer satisfaction and potentially driving up-sell opportunities.

💡

While it is alright to pivot/package the product to buyer personas, in our experience, it is a lot of software development work to cater to each buyer group. For example, one of our portfolio companies that enables efficient document management primarily in the healthcare ecosystem, could be extended to work in other public/private sector ecosystems. However, this would come with different functionalities and features that would require a lot of development work. There are other products we would compete within these sectors. Although our solution and the other document management software products in the market have similarities, their use cases are different and aligning them would involve cost and resources.

Building expansion into your pricing model

Integrating expansion into the pricing model can be a significant driver of revenue growth for small to medium-sized B2B software companies. By anchoring pricing to a value metric linked to the customer's usage, businesses can naturally increase revenue as the customer expands their utilisation. Two common pricing models align price with value to capture expansion: per-user pricing and per-usage pricing. The former, commonly used in software companies, ties pricing to the number of users or seats, while the latter links pricing to the actual usage of the product or service, like the number of transactions processed or storage space used. Both models effectively align pricing with the customer's increasing value, capturing growth in revenue as the customer's usage and derived value expand.

The obvious question that follows is, which value metric should one pick? While it depends on the customer’s experience. If you had a change, you should pick a value metric that fulfils these three key criteria.

Firstly, it must align with what customers value the most. If you take the example of a B2B email marketing solutions provider, the customers prioritise growing their email lists, thus the pricing model could be aligned to the number of contacts to which a customer sends marketing emails.
Secondly, the chosen value metric should grow in line with customers' growth and increase the value derived from the product or service. For instance, in the realm of B2B asset management services, 401(k) administrators bill based on a percentage of plan assets, allowing their revenue to increase as their customers' plans expand.
Lastly, the selected value metric should be easily comprehensible for customers, emphasising the connection between the price paid and the value received. This brings transparency to the whole model.

💡

One of our portfolio companies provides solutions that assist in planning retail spaces for grocery stores, departmental stores and other retailers. It prices the software based on # of users. For the segment in which it operates, what matters more is the size of the stores than the number of users that are modelling. This is mainly because super stores / mega stores are different from small stores and the layout challenges are varied in nature. The right metric should be square footage. The loss of revenue due to the incorrect choice of metric is quite evident, particularly in the case of one of the multinational companies that implemented new retail stores over the past six years. During this time the customer expanded into 18 countries. If the price had been based on square footage we would have generated a lot more revenue vs. its current user-based pricing model. Value-based pricing that captures expansion is hard to achieve as a small business selling to large businesses particularly early on as you need a foot in the door with customers. However, once a certain level of stability is achieved, you need to try and push it with your customers.

Low-cost upfront offer

Implementing a low-cost, upfront offer strategy stands as a powerful tactic for small to medium-sized B2B software companies. It mirrors the age-old concept of drawing customers in with an enticing, low-priced offering and subsequently capitalising on higher-margin follow-on sales. vertical software companies often entice users with Free or Basic plans, subsequently up-selling them to more feature-rich packages like Plus or Enterprise offerings after they've experienced the product's value.

In the B2B software business scenario, this strategy is equally effective. Introducing a low-cost, entry-level offer, such as an assessment in consulting or a basic software package, significantly reduces the barrier to entry. This initial interaction not only builds trust and delivers value but also positions the company to transition customers to higher-priced, comprehensive solutions over time.

💡

At one of our portfolio companies, we make a low-cost audit offer to customers, typically priced between 15-20k. This helps build rapport with the customer and allows us to show the customer the value we create in delivering the customer clean Metadata. This project paves the way for the 100k comprehensive solution that we provide them to fix their metadata issues. We think that the low-cost offer is a good way to set you up for real work.

Factor price escalators

In the current landscape, where price inflation is a common occurrence, B2B software companies, particularly those with recurring revenue models, face the challenge of balancing revenue growth with increasing costs. Implementing price escalators within customer contracts could be a strategic move to counteract inflationary pressures and secure revenue expansion over time.

The inclusion of a price escalator in contractual agreements automatically adjusts the pricing structure gradually over the contract duration. There are some compelling reasons to consider price escalators within contracts. Firstly, small incremental increases compound over time, contributing to revenue growth without drastic changes. Secondly, these adjustments are less likely to draw competitors' attention compared to infrequent but significant price changes. Moreover, smaller alterations are easier to rectify if needed, reducing potential risks. Lastly, having built-in price increases as a standard term in customer agreements can serve as a valuable negotiating point in securing deals.

Established SaaS products commonly integrate annual price escalators into their contracts, ensuring incremental revenue growth. Surprisingly, despite its potential advantages, this practice remains underutilised among many B2B companies. Apart from just oversight, the reasons for not having price escalators could be the lack of competitive position, product stickiness, and the availability of alternatives. However, you should make every attempt to incorporate escalators in your contract. We typically advise that have increased linked some sort of a metric. An example could be the retail price index. Since salaries in the B2B software industries grow faster than inflation it is advisable to factor in a margin on top of the metric you use e.g., Retail price index + 2-3%

💡

In one of our portfolio companies, we haven’t raised prices in the past seven years. Last year we finally increased prices by more than 10%. Our customers agreed to the upward revision given the visible inflationary environment since the pandemic. However, going forward we plan to implement a standard retail price index + 3% within our standard terms and conditions for renewals. Setting up a process like this will help keep a check on price escalators and make it easy to push price increases forward with customers.

Avoid unchecked and excessive discounts

The absence of a well-defined discounting policy signifies a company's tendency to leave money on the table. Having a clear policy is one thing, but to make it work, you need to educate your sales force. In our experience, the best measure, that can effectively combat this issue is, investing in sales training to emphasise the value of the solution rather than defaulting to discounts. What naturally follows is establishing clear discounting policies with defined guidelines and thresholds. Proper policy training allows us to re-frame the purpose of discounting as a strategic tool rather than a standard practice and helps re-calibrate the team's mindset.

💡

For one of our portfolio companies, a key customer contract was up for renewal. We offered discounts as this involved a key customer with whom we were renewing a long-term contract. The client created enough fears that we might lose the contract. This was a special situation, we caved in. Additionally, in this case, we were negotiating the prices with a senior stakeholder who was our user-customer. That led to a disconnect. Special situations such as this could arise, leading to difficulties in negotiating prices with key, large customers. However, generally, you should consider training the sales and account management teams to not offer discounts to customers unless it is a special situation.

Licensing modules

If a customer asks you to piece of development work your immediate instinct would be to accept and start work. We’d advise you to ask yourself a couple of questions before proceeding:

How many man-days would the development work take?
Is cash/working capital to finance the work an issue? If cash is an issue you could charge upfront implementation charges. But if it is not you could simply charge the users a subscription fee.
Is this a built-in feature that can be strategic to the business? Can it be marketed to other users? As a rule, any bespoke development work you do should be able to be bundled into your existing product. And if it is strategic to the business the development work could be done for for free.

Revenue leakage from contract breaches

Revenue leakage is a common issue with many B2B software businesses. There are several instances where businesses leave money on the table with more users using the product than subscribed for. This is a contract breach. This could be avoided if only one could take stock of all the licenses that customers have purchased and check if this ties back to the contract.

If the pricing model is based on the number of users then it typically works alright. However, if the licensing is based on a range of users, let’s say 1-100 users, you would not know how many users used it and also prominent when the pricing is API-based or transaction-based. In these cases, at the time of renewal, you need to check if they breached it. If you missed it at the time of renewal, it is harder to get customers to pay more during the subscription period. Monitoring breaches is crucial. This is why, at Tern, we typically check for breaches immediately after we acquire a company (first 100 days). We try and correct it immediately before we move along.

💡

Footnotes:

Winning Move