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The Art and Science of Value-Based Pricing for Enterprise Software

In a world where software is omnipresent, Value-Based Pricing stands as a beacon for enterprises, guiding them towards mutual value realization. When executed adeptly, VBP not only ensures enterprise software vendors are aptly rewarded for their innovations but also that customers achieve their digital aspirations. Ashish Nayyar explains

The Art and Science of Value-Based Pricing for Enterprise Software
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First Published Nov 29, 2023, 6:30 PM IST

In the sprawling metropolis of modern business, nestled between towering skyscrapers of technological innovation, lies the bustling marketplace of enterprise software products. As businesses jostle and hustle in this market, which is projected to reach over $1 trillion by 2024, one question remains paramount: How should enterprise software products be priced?

In the golden age of digital transformation, on the other side enterprises clamor for software products that revolutionize their processes. Yet, the question that often echoes in boardrooms is not about which tool to choose, but how much to pay for it. Into this conversation enters a new protagonist, Value-Based Pricing (VBP).

Now, imagine a world where the price of a product isn't determined by the cost to make it, nor by the whims of competition, but by the value, it offers to its users. That's the philosophy behind VBP. Instead of asking, "How much did it cost to develop?" or "What are our competitors charging?", businesses adopting VBP ask, "What is this worth to our customers?" Enter the world of Value-Based Pricing (VBP), where the software’s price tag isn’t tethered to its development cost, but the value it promises to deliver.

In the realm of enterprise software products, the VBP approach is particularly apt. Software isn't a tangible good; its value isn't in its physical presence but in the solutions it provides. Enterprise software often delivers intangible benefits such as improved efficiency, data insights, or streamlined workflows. While these benefits can be hard to quantify, but they can significantly lead to tangible benefits like influencing a company's bottom line.

Picture this: a company in San Francisco, CloudTech, developed a state-of-the-art data analytics tool. They invested substantial amounts into its development, but when it came to pricing, they diverged from the beaten path of cost-plus pricing. Taking inspiration from trailblazers like Salesforce, which saw its revenue skyrocket to $26.49 billion in 2022, CloudTech embarked on the VBP journey.

Let's delve deeper into the narrative of Salesforce, a trailblazing cloud-based enterprise software company. Salesforce is reputed for offering a comprehensive suite of tools that cater to varying business sizes and needs. Instead of a one-size-fits-all pricing approach, Salesforce's CRM solutions range from the Essentials package priced at $25/user/month to the more advanced Unlimited package at $300/user/month. What justifies this pricing disparity? The underlying philosophy of VBP. 

Salesforce recognized that a larger corporation, with its complex workflows, will derive substantially more value from the premium features and support offered in the unlimited package compared to a small start-up. By mapping prices to the varying needs and derived values of different businesses, Salesforce ensures its customers feel the software's worth in tangible returns.

Implementing Value-Based Pricing

But how does a company go about implementing VBP? It's a journey that begins with rigorous customer research. A company must deeply understand what its customers value in the product. Before setting a price, one needs to gauge the customers' willingness to pay and understand the key features or benefits they value most. This understanding is the foundation upon which VBP is built.

Once the research phase concludes, the next step is segmentation -- grouping customers by similar value perceptions and willingness to pay. Companies also need to regularly revisit their pricing structures, ensuring they remain aligned with evolving customer values.

However, it's not enough to just set a value-based price. For VBP to succeed, clear communication of the product's value proposition is essential, which can make businesses shine. In the face of free alternatives, companies need to constantly enhance their features, integrate with third-party applications, and effectively communicate the value of their premium offerings. By doing so, VBP can be justified, ensuring customers understand and appreciate the added benefits they are receiving.

Take Adobe, for instance. Their bold move from a perpetual license model to the Creative Cloud subscription service initially met with scepticism. However, by continuously updating their software suite and offering a range of price points based on the value offered, they recorded a stellar revenue of $11.6 billion in 2022 from Adobe Creative Cloud.

Another important factor essential for the successful execution of this pricing strategy is choosing the right pricing metrics, as they help align the price of a product or service with the perceived value it delivers to customers. For instance, the ERP giant, SAP, launched its "S/4HANA" platform, positioning it as a next-gen business suite. SAP's pricing isn't solely based on the number of users or the amount of data processed but also on the document count, a metric that aligns with the value businesses derive from process automation.

Such a strategy ensures businesses only pay in proportion to the utility they extract from the software. In sum, implementing value-based pricing for enterprise software products requires a deep understanding of customer needs, adept metric selection, effective communication, and a commitment to delivering demonstrable value in a dynamic and competitive landscape.

The Foundational Pillars

* Understanding Customer Value: It's the intersection of tangible (RoI, efficiency gains) and intangible benefits (brand value, innovation) the software offers.

* Segmentation: Acknowledging the diverse value perceptions across customer segments. 

* Dynamic Engagement: Continuously updating the value proposition in sync with market and technological changes.

Challenges

Transitioning to VBP, however, isn't a cakewalk. One of the key challengesis the intricacy of accurately assessing and quantifying the perceived value of enterprise software to diverse customer segments. Understanding how different customers derive value from the same software can be complex, as value is often subjective and context-dependent.

Additionally, communicating the software's value proposition effectively to enterprise customers who are accustomed to traditional pricing models can be challenging. In a competitive landscape, where multiple enterprise software solutions often offer similar features, differentiation based on value becomes crucial.

Selecting the right pricing metrics is another hurdle, as it requires finding a balance between a metric that aligns with the software's value and one that customers can readily understand and accept.

Finally, transitioning existing customers to new value-based pricing models may face resistance, as they might be accustomed to legacy pricing structures. 

Many companies stumble, facing pushback from enterprise customers used to older models. But as Adobe’s journey from a perpetual license to a cloud-based subscription model demonstrates, with a relentless focus on delivering unmatched value and a pricing model to match, the sky's the limit.

Overcoming these challenges requires careful research, innovative marketing, and ongoing customer education to demonstrate the tangible benefits and sustained value of the software.

In conclusion, as the enterprise software sector continues its meteoric ascent, VBP is not just a trend but an essential pivot, placing the customer and value at the epicentre of pricing strategies. The success stories of Salesforce, Adobe and SAP underscore a fundamental truth: in the age of digital transformation, understanding and delivering value holds the key to sustainable growth and profitability.

Implementing VBP necessitates understanding customer needs, continuously gauging software product’s perceived value, and adjusting pricing accordingly. And as the success stories show, when value becomes the guiding light, growth inevitably follows.

Ashish Nayyar is a seasoned professional with a wealth of expertise spanning more than thirty years in the dynamic realms of Enterprise Software Products and ICT sectors. His niche lies in the domain of Value-Based Pricing and commercial leadership, where his insights and strategies have made a significant impact. Ashish serves as a trusted advisor to business, sales, and product leaders, offering invaluable insights and guidance from a pricing performance perspective. Email: ashish.nayyar@gmail.com

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