Segment Your Way To Greater Profits

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An examination of how software companies often fail to understand how different customer groups value their products. This leads to firms offering both excessive price discounts and too many licensing vehicles. Companies can develop an integrated approach that targets the right pricing strategy and product offerings to different groups, in this case: "business professionals," "aspriants," and "general users."

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Segment Your Way To Greater Profits

  1. 1. PRICING ADVISOR The 3535 Roswell Road, Suite 59 Marietta, GA 30062 770-509-9933 A Pro f e s s i o n a l P r i c i n g S o c i e t y P u b l i c a t i o n www.pricingsociety.com Segment Your Way to Greater Profits power. Raychem made heat-shrinkable within specific organizations without Bruce La Fetra, Senior Marketing tubing that was used in commercial, au- undercutting the high prices paid by ex- Consultant for Rubicon Consulting, tomotive, industrial and military appli- isting customers. The most problematic cations. While the company had dozens scenario is when the same or similar examines how software companies of chemical formulations, a couple were applications are used by different user often fail to understand how different sold into all of these markets, each at a sets for business-critical and non-criti- different price with a low-to-high range cal tasks. customer groups value their products. of about 3X. While the tubing came off This leads to firms’ offering both ex- the same production line—often the Business-critical users (Business Profes- same run—each run was only tested to sionals) are willing to pay top dollar. cessive price discounts and too many the relevant specification for the intended They may not be happy about it, but in licensing vehicles. La Fetra shows how market. Since applications ran the gamut the absence of close competitors, they from exposure to hydraulic fluid in a M1 have few alternatives. At the same time, companies can develop an integrated Abrams tank to strain relief in consumer there may be untapped, broader market approach that targets the right pricing electronics, the QA certification was im- opportunities with users who are will- portant. This gave the company total pro- ing to pay only a fraction of the amounts strategy and product offerings to the tection against customers buying a lower paid by Business Professionals. How groups he defines as “Business Profes- grade product even though some knew it does the vendor aim high and low at the came off the same production run as “the same time? sionals,” “Aspirants” and “General good stuff” that went into military and Users.” For more information, you space hardware. The varying usages drove Most sellers respond to this situation by different pricing for the same product. creating an entry-level or “light” version can reach Bruce at: 408-395-3910. of their application that they can feature, What’s at Stake and functionally differentiate, from the W Many vendors face a similar premium version. With only two user hy do software vendors problem: they have multiple volume sets, this solution works well and gener- offer so many buying ve- licensing vehicles, but target them ally is advisable. The situation gets more hicles? indiscriminately at the entire user base complicated when there is a mid-market with the well-meaning intent of giving set of price aware users. These purchas- Most companies say they customers more buying options. There is ers are eager to use the high-end appli- want to give customers multiple options, nothing unusual cations, but are or they do it simply because “everyone about these often unable to else” does. The actual strategic rationale vendors’ justify paying top for offering a menu of different vehicles licensing Business-critical users dollar for occa- and discounts is poorly understood or vehicles; they (Business Professionals) sional use. forgotten within many vendors; yet it are the same are willing to pay top dollar. represents the difference between ad- ones most Some vendors call equate and great pricing. Great pric- sellers have: They may not be happy these users “pro- ing allows a vendor to tailor its offers to contractual, about it, but in the absence sumers,” but in various buying groups. This is not illegal transactional, an organizational discrimination. Rather it merely reflects site and of close competitors, they context we refer sellers’ taking advantage of differences concurrent have few alternatives. to them here as between users in how they value—and licensing. “Aspirants.” Typi- how much they are willing to pay for— Customers like cally, if the ven- products. Understanding this (and suc- these hydra- dor sells a suite cessfully putting it all into practice) is headed programs because they give them of applications, this often results in the fundamental to price optimization. But lots of options (…to game the system Aspirants buying some (but not all) of if it’s so essential, why don’t more ven- and to try to find the cheapest way to the premium offerings at a price lower dors do it well? buy the products). than what Business Professionals are willing to pay, but far above that which Raychem Corporation provides a text- The dilemma faced by all these ven- lures General users. This makes Aspi- book example of price discrimination’s dors is how to proliferate for broad use rants an important growth source, so 4 January 008
  2. 2. PRICING ADVISOR The 3535 Roswell Road, Suite 59 Marietta, GA 30062 770-509-9933 A Pro f e s s i o n a l P r i c i n g S o c i e t y P u b l i c a t i o n www.pricingsociety.com the failure to price optimize is a strategic many vehicles and an opportunity exists the vendor’s advantage. It is a “push” oversight. to simplify the set of offerings. Here vehicle created to generate demand and are typical options and their distinct should be used to support a prolifera- In short, charge too much and the ven- objectives: tion strategy. dor is unable to penetrate the Aspirant • Contractual Licensing offers volume • Concurrent Licensing is an attractive, and General user segments. Charge too discounts to the vendor’s best customers. but often underutilized way to expand little and the vendor risks seeing its lu- Buyers are required to enter into a con- the vendor’s reach to a large number crative Business Professionals trade down tract committing them to a minimum of users who are not doing business to a lower price band. This is a loss of purchasing volume during the con- critical work (i.e. if the license server real, not potential revenue. Because they tracted period. This is a “pull” vehicle, is occasionally oversubscribed, it’s not fear undermining their existing business, which addresses customers that already a disaster). Concurrency should be many sellers fail to act on the Aspirant want to buy the vendor’s products. priced so it is attractive when only low opportunity. It contrasts with “push” vehicles (see availability levels are required. (The application may not be In this situation, vendors immediately accessible will often pursue a Gold- at all times.) But at high Silver-Bronze type prod- availability levels (imme- uct assortment. Not only diate access is required), does this complicate the it is more expensive than development process, but the corresponding con- also it muddies the mes- tractual vehicle. Many saging and buying pro- vendors discourage cesses as well. Customers concurrent licensing, feel encouraged to base seeing it as simply a their buying decisions on way for customers to an analysis of their actual reduce the number of use rather than on their licenses they buy. This aspirational intent. reflects a problem with the underlying pricing, In a licensing situation, not with the vehicle it- the solution is to vary self. Many vendors use the vehicles and offers transactional licensing by user set, so vendors to address this need, but can direct customers to concurrency offers addi- the preferred option. Like water that below) which service situations where tional flexibility and often represents always flows downhill, corporate buy- the vendor must generate end-user de- a better choice. It is a “pull” vehicle so ers are good at finding the cheapest way mand before users will buy a product. vendors should price to value. Con- to purchase a given product, so it is best current licenses are usually offered at when the seller can get them to self-se- A common error for vendors is to pres- a premium over a similar number of lect the desired vehicle. Done correctly, ent too many offerings with excessive contractual licenses, but they don’t the vendor will be able to price optimize discounts because they are trying to have to be. for each user set without the customer’s serve both high- and low-end user seg- feeling manipulated. It’s the proverbial ments. Discounts don’t really encour- Mapping User Sets to having one’s cake and eating it too. age Business Professionals to buy more Preferred Vehicles (see below), but they are demanded by The next section lays out the preferred Mapping Licensing Vehicles corporate buyers because that is how licensing vehicle by user set from to Objectives software is sold. Sellers should under- the vendor’s point of view. Product The first step is to think strategically stand the discount levels required for a selection is used to steer customers to about the objectives for each offering. given industry, and resist the urge to add the desired licensing vehicle. In our Licensing vehicles should be driven by a costly extra tier or two for a vendor’s example, all products are available via strategy, not the other way around. For “really good customers.” contractual licensing, and all or most example, without considering products, • Site Licensing is designed for large by concurrent licensing. But only basic are there different price points or sites with casual usage where the ven- products can be purchased via a site buying behaviors the vendor needs to dor wants to drive broad proliferation. license. The view from each user set is address? If the objectives overlap too If the customer is likely to buy via as follows: much, then the vendor probably has too another vehicle, site licensing is not to • Business Professionals are interested in January 008 5
  3. 3. PRICING ADVISOR The 3535 Roswell Road, Suite 59 Marietta, GA 30062 770-509-9933 A Pro f e s s i o n a l P r i c i n g S o c i e t y P u b l i c a t i o n www.pricingsociety.com the professional versions and premium Figure 1 suites. Since these users have no interest in using the basic versions, site licensing More expensive All products, Loyalist is not attractive. Because their usage is Premium products than Contractual in business critical, concurrent licensing including high-use not available via does not meet their requirement for Master Suite Site License environments high availability (access at all times). Thus, the contractual licensing program Customer Type is the clear choice. More expensive Standard and Insufficient volume Aspirant • Aspirants are primarily interested in than Concurrency the professional products, but buying a for moderate use Premium to qualify for full license for each person or worksta- products Site License environments tion is much too expensive, especially so if several applications are desired. General Users If forced to buy via contractual li- censing at the same premium prices Too expensive for Too expensive for Basic products as Business Professionals, customer organizations are likely to restrict who occasional use occasional use only can obtain and install the vendor’s applications. This is a missed opportu- nity for the vendor as it makes adding Contractual Concurrent Site License Aspirants to the Business Professional set more difficult. High availability, Licensing Vehicle however, is not needed, so concurrent licensing looks attractive as it provides economical access to the professional no new product variations are needed. General Users is reduced. In general, versions. Aspirants prefer to use the If only a single product offering exists, leaders who have less competition at professional versions—and the vendor a low-end version is needed to isolate the high end of the market also risk should reinforce this in its messaging. the general use market successfully. the greatest opportunity cost from in- But, just in case, minimums for the site Where possible, product and licensing action, or from a poorly thought out license are set high enough to exclude vehicle development should reinforce the broad market pricing and licensing most of this group. buying segmentation process. This will strategy. • General Users will only buy at scan- provide the vendor with more options dalously low per-seat prices—com- and greater clarity from the buyer’s Summary pared to Business Professionals. point of view. Software vendors with a loyal base However, high minimums and lack of of users can use licensing vehicles to access to professional products are not Figure 1 provides an overview of the address the broader market without obstacles in environments where the nine buying possibilities available for cannibalizing premium priced vehicles. vendor is trying to drive broad prolif- three user sets and three licensing vehi- We’ve shown here how to balance not eration. Because basic applications are cles. The gray squares describe the disin- only high-value and low-value users, just fine for this user set, these buyers centives for each user set / licensing com- but also how to include a third, mid- may be successfully isolated from the bination, which help vendors steer buyers market, aspirational customer group rest of the customer base. The result toward the most desirable options—rep- in the mix. Since the aspirational is a low-cost, per-user site license resented by the circles. set represents a large, ripe, and only that opens up heretofore unaddressed partially-tapped, growth opportunity, a markets without undercutting the This methodology works particularly vendor must understand how to direct highly lucrative Business Professional well when the vendor is a leader in its these Aspirants toward the high-end market. field and has a strong base of profes- Business Professional set rather than sional users. In this scenario, vendors the low-end General users. A properly The Keys to Success can skew toward optimized pricing since designed pricing, licensing and product The keys to success are: (a) offering an Business Professionals will be unlike- strategy is able to deliver on the needs of appropriate range of products to create a ly to defect to competitors because of each buying group, while also creating sophisticated assortment across customer high prices. For vendors facing a greater unique disincentives to steer specific sets; and (b) targeting access to specific competitive threat, the same structure customers away from non-optimal licensing vehicles. If an adequate high- holds, but the achievable price premium buying vehicles. to-low range of products are in place, for Business Professionals compared to January 008

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