Pricing strategy for subscription businesses

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  • This typically involves tiering based on features / modules – on a per seat basisOn the y axis, I see the number of users while on the x axis, we see the depth of usage
  • It’s one of the most common SaaS pricing models in both consumer and enterprise spaceUsing your engineering resources for sales and marketingLower barriers for adoptionProducts that are experiential in nature – document is available across devices – so ? – Experience is just fantastic and you wish to pay for it
  • You grow with the business – if the underlying business that you are serving needs to grow – stagnant business wont work for youFlexibility is typically valuable for companies at an early stage of ramping up their need for a particular product, and who anticipate greater future usage
  • Initially, customers will pay two cents per minute for outbound calls and 1 cent per minute for inbound calls with a $1 per month fee for the phone number. It charges under a similar structure for its SMS product.
  • Exactly opposite of our freemium model
  • Similar mixed models also exist with pay-per-use regimes coupled with perpetual licenses
  • Discover the value proposition and source of value for the consumer
  • Companies experiment with their pricing strategies A perfectly normal and a necessary process to understand the optimal way to price and collect from customersWhile experimenting with pricing is a necessary process, it should be guided by a logical framework that systematically leads to the best strategyA great pricing strategy complements the product offering and the company’s marketing and sales strategyGreat pricing strategies begin with the philosophical underpinnings of the business, focus on customer needs, and support the core strengths of the businessHaving internal alignment with all aspects of the business including the pricing strategy is extremely importantThe pricing model should be simple for customers to understand and evaluateMinimizing churn is about ensuring customers continue to perceive and obtain value from the offering The best companies tie their data monitoring to metrics that show their customers are succeeding by using their offering They also proactively reach out to customers when they’re not getting value out of the offeringParticipation in the developer communityParticipation in the developer community appears to be an industry-standard practice as a means of active engagement and seeding viral adoptionIt is also another means of engaging with customers in a rich and qualitative way to complement any data collection effortsBalance growth goals and customer acquisition with practical realities of pricingCompanies need to balance aggressive goals of hyper growth and frictionless customer acquisition with the practical realities of keeping prices high enough to support the ultimate cash needs of the businessOver time, companies may choose to further reduce pricing in order to bring up market share and lock out competitors, or increase prices to begin to harvest a strong customer base for cash flow A great pricing strategy will be somewhat unique for each great companyData collection and analysis are more important than ever for understanding customers and making critical decisions quicklyCompanies able to quickly analyze data are at a significant advantage to companies that cannot
  • It faced a challenge common to companies offering Tiered, Bundled and Packaged offerings wherein moving to a higher tier led to an unequal utilization of some features among some users – leading to a perception that customers are overpaying for features not needed by all its users
  • Hubspot uses a model that is a hybrid of the Freemium, Consumption, and Tiered models
  • Pricing strategy for subscription businesses

    1. 1. Pricing Strategy for subscription businesses Raghav Bahl : raghav@bvp.com 28th October 2013
    2. 2. Agenda 1 2 3 4 Introduction Key Pricing Models Employed by Subscription businesses Decision Framework for Pricing Model Selection Conclusion
    3. 3. Subscription business valuations are a function of growth, scale and leadership
    4. 4. ‘Scalable’ pricing core to business model success • • Premium product positioning Price for category leadership LEADERSHIP SCALABLE PRICING Comprehensive GROWTH • • Add new customers Milk existing customers for MORE! Derive more from existing customers SCALE • • Penetrative pricing in early stages / price sensitive consumers Price for attractive unit economics at scale
    5. 5. 2 Key Pricing Models Employed by Subscription businesses
    6. 6. The Four Key Pricing Models Freemium Consumption Tiered Perpetual License
    7. 7. 1. Tiered Pro Con Neutral What is the Tiered Model? • The general idea is to tie pricing to some driver of value and usage which can often be seats, modules, data volumes, servers, and many other scale factors User’s perspective Provider’s perspective Value - Pricing axes Customer required to make a longer term commitment Customer’s needs met both in the present and in the future through higher tiers that it can “graduate into” over time Number of users Predictable recurring revenues More stable average selling price as less discounts are needed to keep existing customers Modules used Units processed
    8. 8. Case Study 01: Salesforce.com Value – Pricing axes Features used Keeping it simple ! Flexibility for the client
    9. 9. Case Study 02: letsfreckle.com Value – Pricing axes Number of users Same features across plans! Flexibility for the client
    10. 10. Case Study 03: Assistly (now desk.com, part of Salesforce) Value – Pricing axes Number of users Features used Hours consumed Tiered across users, features & hours consumed
    11. 11. Case Study 04: Hubspot Value – Pricing axes Number of users Site visits Features used Contacts used Emails sent Multiple Value metrics & hence pricing axes Complex ?
    12. 12. Tiered – Our suggestions
    13. 13. 2. Freemium Pro Con Neutral What is Freemium? • A business model that offers core services or features for free, and charges a premium for the more sophisticated components User’s perspective Provider’s perspective Minimal barriers – simple signup and startup process (no online payments) Free use of limited features meets user’s immediate needs, with the option to purchase only if needed Potential to acquire large user base quickly Loss of Sales revenue offset by savings in sales and marketing spend “ Provider’s perspective The free offering will meet immediate user needs and entice them to pay for the premium offering after having experienced it ” “Customers tend to underestimate the value of experiential goods. The optimal pricing strategy is to offer a low introductory price to lead the customer to realize the true value of the offering” - Carl Shapiro, Economist
    14. 14. Freemium – Four methods Capacity-based Product usage is free upto a capacity usage or number of users, beyond which it is chargeable. Feature-based Time-based Example Use-case • Upto 2GB storage capacity is free • Incrementally prices 10GB of storage at $10 per month under its “Pro” plan • Enterprise sales of 1TB or more on a negotiated basis
    15. 15. Freemium – Four methods Capacity-based Customers offered a limited version of a product for free, with certain key features locked. Feature-based Time-based Example • Free VOIP calls Use-case • Calls to Mobile or landline are payable Example • Free members have access to 220-million member network • Monthly fee entitles members to contact others outside their network, see who viewed their profile, and advanced search
    16. 16. Freemium – Four methods Capacity-based Feature-based Time-based A typical free-trial that expires after a fixed period. This offers customers a period of time to experience the full value of the product before they decide to buy. Example Use-case • Free 30-day trial for their CRM platform • During the period, users have access to a significant subset of the full functionality
    17. 17. Freemium – Four methods Capacity-based Feature-based Time-based A less common model in which customers can use the offering for free provided they fall under certain specified categories (such as non-commercial use, educational, non-profit, etc.) Example Use-case • Provides products for free to student community with pre-conditions such as “to be used solely for learning, teaching, and training”* *Source: Terms specified on http://students.autodesk.com/
    18. 18. Freemium – Some Important Considerations Network Effects associated with the product Size of the Market Cost to Serve Free Users Customer Targeting To Freemium or Not to Freemium… Creating Value from Free Users Learning from Free Users
    19. 19. Freemium – Some Important Considerations Network Effects associated with the product Size of the Market Customer Targeting Model works well for rapid scale up Creating Value from Free Users Key question Are we attracting the right consumer base ? Cost to Serve Free Users Learning from Free Users
    20. 20. Freemium – Some Important Considerations Network Effects associated with the product Size of the Market Customer Targeting “What value is a free customer adding?” Creating Value from Free Users Alternative monetization via • Advertising • Selling user data Cost to Serve Free Users Learning from Free Users
    21. 21. Freemium – Some Important Considerations Network Effects associated with the product Size of the Market Customer Targeting A large “free” user base presents an opportunity to gain insights into user trends by applying customer analytics Creating Value from Free Users • Conduct Cohort analysis Cost to Serve Free Users • Track viral referrals Learning from Free Users
    22. 22. Freemium – Some Important Considerations Network Effects associated with the product Size of the Market Customer Targeting Understanding cost along with an estimated conversion rate • Minimum viable size of the target market Creating Value from Free Users • X number of Paid users needed to support Y Free users Cost to Serve Free Users Learning from Free Users
    23. 23. Freemium – Some Important Considerations Network Effects associated with the product Size of the Market Cost to Serve Free Users Customer Targeting Freemium adds another conversion step, so having a large market is crucial for this model Creating Value from Free Users Learning from Free Users
    24. 24. Freemium – Some Important Considerations Network Effects associated with the product Customer Targeting Example Size of the Market • Does one user benefit more from having more users of the product or service? Creating Value from Free Users • Does the size of the user base impact referral rates or increase switching costs? Cost to Serve Free Users • Does the value of your product increase with more users? Learning from Free Users
    25. 25. Freemium – Conversion Rate Optimization Will result in too little an incentive for customers to upgrade Offering too much! Will not generate enough customer interest to upgrade to the paid version Offering too little! Creating a Freemium business model is often about striking a balance
    26. 26. Freemium – Our suggestions
    27. 27. 3. Consumption Pro Con Neutral What is the Consumption Model? • A popular pricing model that allows customers to manage their costs by managing the quantum of product usage User’s perspective Flexibility is typically valuable for companies at an early stage Limited future commitment for customers “ Key Metrics for assessing the Consumption Model • User growth rates Provider’s perspective Revenues fluctuate over time, lower revenue predictability • Number of active users Provider grows with their customers! • Average revenue per user A trade-off between unpredictable revenues –and- deep product adoption ”
    28. 28. Case Study 01: Twilio Overview Twilio provides voice, SMS, and other communication services on the cloud Pricing Model: • Discounting tied to usage benchmarks: As customers scale up their business and their usage of Twilio, the company provides ever larger volume discounts above 500,000 minutes per month. These discounts are tied to usage benchmarks. Outcomes: • This pricing makes it very simple for its customers to monitor their usage • Allows use of Twilio on a limited basis as customers gain better understanding of the value of the product to their business • Incentives in form of discounts result in increased usage.
    29. 29. Case Study 02: ZipCar Overview • Paid Members log into a smartphone app or website to reserve a nearby car. • Using an onboard computer with a satellite link, the car can be opened using the ZipCar membership card Pricing Model: • Minimal membership fee payable at signup • Hourly rate for usage Outcomes: • Customers experience benefits similar to ownership without the associated costs • Enables understanding user needs and preferences, selecting convenient locations, intelligent capacity management, and vehicle servicing • ZipCar has created an overall enjoyable experience to its customers that have resulted in greater usage and higher lifetime value per customer
    30. 30. 4. Perpetual License Pro Con Neutral What is the Perpetual License Model? • Structured as a one-time upfront payment with an additional recurring fee for “maintenance and support” plus professional services User’s perspective High upfront cost and long-term buy-in makes adoption more difficult Provider’s perspective High price product – high touch sales – Longer sales cycle Cost of capital is low, then perpetual licencing makes more sense than subscription-based models Great cash flow situation ! Low attrition risk - Customer lock-in secured for a longer term “ An older-world option that’s losing popularity in today’s cloud-based SaaS environment – Yet has some key mutual benefits for both vendor and customer in longerterm projects requiring extended commitments ”
    31. 31. Case Study 01: Oracle Pricing Model: • Operates with two separate pricing models for all of its products as either perpetual or term licenses • Baseline usage covered by the Perpetual License, and incremental usage (such as adding temporary seats) under a Term scheme • Oracle provides licensing credits and upgrades for situations where existing perpetual license customers have their product bundled or discounted with other offerings Outcomes: • Customers enjoy the flexibility of a mixed pricing model • This model enables customers making long-term capital investments in Oracle products to have an optimal mix of fixed payment commitment with ongoing variable spends • By providing licensing credits and upgrades, Oracle ensures that existing long-term customers do not lose out of newly introduced benefits
    32. 32. Case Study 02: Microsoft Software Assurance License Mobility Pricing Model: • In July 2011, Microsoft began to offer License Mobility through Microsoft Software Assurance for on-premise applications. • On-premise applications for which customers had already purchased a perpetual license could be migrated to the cloud through Microsoft Azure (its infrastructure-as-a-service platform) or other providers Outcomes: • Microsoft was moving its legacy customers towards increased flexibility in meeting client cloud computing and accessibility needs Many legacy businesses are in transition and have no alternative but to continue to support their historical perpetual licensing models while attempting to match the subscription approaches by emerging cloud challengers
    33. 33. Pricing Models at scale: Other Options • Build the product as a platform – enable third party developers to build applications – Take a cut of the transaction value – Build more stickiness • Monetize customer base by creating a service marketplace take a cut of the transaction value • Build additional modules that fit in well with the existing product • Extract fees by providing services like payment infrastructure or advertising revenue
    34. 34. 3 Decision Framework for Pricing Model Selection
    35. 35. 6-Step Decision Framework for selecting the right pricing model Based on the lessons from the earlier case studies, a pricing model decision can be arrived at in 6 steps: 1 What is the Customer’s Value of the Product? 2 Is the Customer Aware of this Value? 3 Can the Customer Base be Segmented? 4 Is the Customer’s Demand Variable or Uncertain? 5 Establishing a Floor Price 6 What Value Metrics are Most Important to the Customer?
    36. 36. Decision Framework: Step 01 1 What is the Customer’s Value of the Product? There are several sources of value that a customer can derive from a product time savings increased revenue customer’s price sensitivity reduced errors attribute tradeoffs ROI for Customer resource or cost savings efficiency gains & Exogenous Factors network effects Establish a demonstrable ROI Value for the customer to set the price ceiling
    37. 37. Decision Framework: Step 02 2 Is the Customer Aware of this Value? • Understand if the customer’s perceived value is less than the offering that the firm has calculated “<“ than that arrived at in Step 01 Customer’s perceived value is… “>” than that arrived at in Step 01 Freemium model or a “low introductory price” model In case of new products without available substitutes, customers might need time to understand the value, and may initially not be willing to pay the true value as determined in step 01 Reset price ceiling to this higher perceived value Consider offering a Tiered model
    38. 38. Decision Framework: Step 03 3 Can the Customer Base be Segmented? Look for opportunities to segment the customer base to see if different values can be separated from each other Common Segmentation Criteria Using fewer, or more, product modules Customer’s perceived value… Matches with value arrived at in Step 01 IF YES More number of items are being processed IF YES Fewer, or more, employees are using the product IF YES Tiered Pricing Consumption or Freemium pricing Consumption or Tiered Pricing
    39. 39. Decision Framework: Step 04 4 Is the Customer’s Demand Variable or Uncertain? Variability in demand and other uncertainties (or lack of it) can provide indicators for pricing model selection CUSTOMER TYPE: • Inconsistent demand for product • Requirements on an “as-needed” basis Consumption Pricing model is favorable as it will capture this variable demand • Lack of clarity into future demand CUSTOMER TYPE: • Reasonably certain demand for the offering • Clear perceived value in line with actual value of offering Tiered Pricing model would be ideal if customers are likely to have a long relationship with the company
    40. 40. Decision Framework: Step 05 Establish a Floor Price 5 Calculating a price floor - the purpose is to determine if the business is economically viable if Cost of Customer Acquisition if Cost of Customer Acquisition > Value derived from the customer in terms of payment In this case, optimal decision would be to not produce. < Gross margin earned from customer in Year 1 Invest in consumer acquisition for rapid scale up
    41. 41. Decision Framework: Step 06 6 What Value Metrics are Most Important to the Customer • The final important consideration to make is the value metrics that are important to the customer • With any of the pricing strategies, as the customer grows which metrics will increase? • These metrics could be – Capacity – Usage – Users – A specific time period – Access to certain features – Specific customer segments, etc. Having an understanding of these features will allow the firm to create value through the pricing strategy by setting proper thresholds between pricing tiers
    42. 42. 4 Conclusion
    43. 43. In Conclusion: Points to Consider Companies experiment with their pricing strategies A great pricing strategy is simple complements the product offering and the company’s marketing and sales strategy Data collection and analysis are more important than ever for understanding customers and making critical decisions quickly Minimizing churn is about ensuring customers continue to perceive and obtain value from the offering Participation in the developer community Balance growth goals and customer acquisition with practical realities of pricing
    44. 44. Thank You!
    45. 45. Company A Privately-held Infrastructure-as-a-Service company using a consumption model Selection Objective Company A selected the Consumption model to remove as much friction as possible from the choice that customers faced to try and ultimately adopt its product offering * Pacific Crest survey
    46. 46. Company A Privately-held Infrastructure-as-a-Service company using a consumption model Key Learnings • Ease of signing-up and lack of commitment meant higher chances of churn… However, Company A experienced low churn below benchmark* due to following reasons: – Customers were able to try and use the service without a contract “ consumption was the most customerfriendly model we could adopt since it was “pay for what you use,” and there was no contract lock-in – Customers ramp-up only after having successfully used the service – Customers begin to integrate the service into their own platform and applications - which increased customer stickiness • The “no commitment” revenue model coupled with a sales team that was strongly encouraged to use no pressure tactics had gained the company considerable traction the Company’s pricing model, in addition to being more flexible, is also less expensive than traditional on-premise pricing models CFO, Company A Tactics That Worked for Company A • Due to its consumption model, the company closely tracks customer usage of its offering, average revenues per user, user growth efficiency, and churn • The company spends a lot of marketing resources on engagement with the software developer community – It has created a developer evangelist program which is getting to be an increasingly common phenomenon in the industry ”
    47. 47. Company B Publicly-traded SaaS platform using a Consumption model Pricing Model Selection The company’s pricing strategy was developed through testing the concept with a smaller client base to determine the value proposition and then finalizing prices accordingly
    48. 48. 3 From Theory to Practice Interviews with real-world companies
    49. 49. Company B Publicly-traded SaaS platform using a Consumption model Key Learnings Company initially had a “land and expand” mentality that was very successful • As the number of users increases, the value proposition and the price per user also increases • The company initially experimented with lower price points until it discovered that the product had significant traction and a higher willingness to pay than initially thought • The lower price point allowed customers to try the product and understand its value which eventually led to a higher willingness to pay. “ “The company has a performance-based, customer-centric approach where we are actively tracking metrics that are indicators (sometimes indirect) of our customers’ success” “The Management believes the main reason for churn is decreasing perceived value” Tactics That Worked for Company B • The company uses data to measure if a customer is underperforming • Using data to estimate the value that a customer is getting from its product, the company uses this as an opportunity for account management • A team of product consultants and enterprise support help train its customers to more effectively use its product This represents a significant upselling opportunity • Lastly, and more subtly, this exercise helped the company to obtain intelligence and data to figure out its price point. ”
    50. 50. Company C Privately-held content delivery network using a feature-based Freemium model Pricing Model Selection Company C’s primary objective was to generate scale so as to make its cost structure became more viable and enable it to undercut competition Additionally, scale also has the benefit for the company of offering more value to its customers With this goal in mind, the company wanted to remove as much friction as possible for its customers and deliberately pushed as many features as possible down to its Free plan
    51. 51. Company C Privately-held content delivery network using a feature-based Freemium model Key Learnings • Company realized that it needed to discriminate based on the size of the customer A Method for Analyzing Metrics: • Through this approach, the company has found that pricing has actually helped it to reach higher tiers of customers • Company C looked at all customers that signed up for the product in January. “Price Too Low” • When Company C signed up its first large corporate customer, the customer they felt that the price point was too low for its own peace of mind • Company C created a new pricing tier with dedicated support agents and maximum functionality • Therefore, the price discrimination strategy was as much psychological as it was financial in this case. • Then, moving out 1,2, and 3 months on, it analyzed churn, conversion rates, and average revenue per customer It found this exercise particularly illuminating because of the difficulty of collecting data in such a rapid growth mode and the difficulty of having benchmarks. Tactics That Worked for Company C • The company does not have a dedicated marketing and sales team – Its primary channel is through a network of partners • While the company was in its growth phase, the company took a different approach to looking at its metrics, in particular churn - It used cohorts based on the date of signup to analyze trends. • It uses this data and actively reaches out to customers. This has generally served to keep churn rates low
    52. 52. Company D Privately-held SaaS platform using a capacity- and time-based Freemium model Pricing Model Selection Company D initially had a 30-day free trial of its product. In late 2012, it rolled out a Capacity-based Freemium version of its product and had both models running side-by-side.
    53. 53. Company D Privately-held SaaS platform using a capacity- and time-based Freemium model Key Learnings • Initial uptake on the capacity-based Freemium was moderate, subsequently requiring a greater marketing push • The significant challenge that Company D faced was to familiarize some segments of the market with its product and establish its value proposition accordingly • This implied a need to focus on educating prospects on the value of the product. • As prospects have more complex needs, the product has greater value to them • An ROI model was developed to explicitly demonstrate the value to the prospect and highlight the greater value with increased complexity of prospect needs. “ In enterprise software, products tend to be more technically complex than consumer products. While companies are used to the complexity and have processes in place for evaluating the products (of which ROI is one), the cycle of a technology disrupting the enterprise market is accordingly longer in most cases Enterprise SaaS companies should be aware of this absorption time. Tactics That Worked for Company D ” • With the subsequent marketing push in spring of 2013, Company D revamped its pricing model to be simpler which had the effect of shortening its sales cycles • Additionally, the capacity-based free version was used as a means of extending Company D’s partnership network – Therefore, there was a sales value and a strategic value to this action on its part • The trend of the “consumerization of the enterprise” has been very noticeable in Company D’s space as the UI from it and its competitors have quickly converged to being nearly identical over a span of less than one year
    54. 54. In Conclusion: Points to Consider (cont’d) Minimizing churn is about ensuring customers continue to perceive and obtain value from the offering • The best companies tie their data monitoring to metrics that show their customers are succeeding by using their offering • They also proactively reach out to customers when they’re not getting value out of the offering Participation in the developer community • Participation in the developer community appears to be an industry-standard practice as a means of active engagement and seeding viral adoption • It is also another means of engaging with customers in a rich and qualitative way to complement any data collection efforts Balance growth goals and customer acquisition with practical realities of pricing • Companies need to balance aggressive goals of hyper growth and frictionless customer acquisition with the practical realities of keeping prices high enough to support the ultimate cash needs of the business • Over time, companies may choose to further reduce pricing in order to bring up market share and lock out competitors, or increase prices to begin to harvest a strong customer base for cash flow • A great pricing strategy will be somewhat unique for each great company
    55. 55. Case Study 01: Salesforce.com Overview • Salesforce.com is a global enterprise software company best known for its customer relationship management (CRM) software. • Salesforce.com also has Force.com which is an integrated platform featuring an API for developers to create their own apps for the Salesforce.com platform Pricing Model: • Software is provided through a bundled cloud-based offering featuring five pricing tiers that range from $25 to $260 per user per month. • Access to functionality is also tiered on light and enterprise categories Outcomes: • By creating tiers on multiple product offerings, Salesforce.com allows its customers significant flexibility to structure its offering to the customer’s needs. Providing this flexibility is a key for successful tiered strategies
    56. 56. Case Study 02: Assistly (now desk.com, part of Salesforce) Overview • Assistly provided a cloud-based customer service platform for its clients • This per-user or per-seat usage of assets could lead to a conflict between per-user pricing and tiered pricing, and needed a creative pricing solution Pricing Model: • Tiered - A full-time agent for $29/month (prepaid annually); Limited functionality product priced at $3 per month for 3 agents • Consumption - It could then add a “flex agent” for $1/hour OR • Freemium – free usage for 14 days Outcomes: • The combination of consumption and tiered pricing helped its customers better match seats to actual usage
    57. 57. Case Study 03: Hubspot Overview • HubSpot is an all-in-one marketing software provider that servers more than 10,000 companies in 56 countries to attract leads and convert them into customers • Hubspot offers a number of marketing applications through a SaaS platform. Pricing Model: • Tiered - Firstly, the platform’s functionality is divided into three service levels (basic, pro, and enterprise) that offer progressively more features. • Consumption - Users can then select the number of contacts and leads that they want access to through the platform which are charged on a per month basis • Freemium - A 30-day free trial is offered to first-time users Outcomes: • This hybrid model combines elements of the consumption and tiered models which allows the customer to select their optimal service level • The Free trial encourages new customers to experience the product and has led to rapid expansion of its user base globally.
    58. 58. Case Study 02: Amazon Web Services Overview • Amazon Web Services (AWS) is an Infrastructure-as-a-Service platform for webbased companies. • AWS’ primary products allow customers to have access to Amazon’s large-scale, reliable, and efficient IT infrastructure Pricing Model: Amazon prices the various products on a per-use basis and touts the flexibility, cost-effectiveness, scalability, and security of AWS as an infrastructure solution Outcomes: • Allows Amazon to effectively match pricing to customer need • Presents opportunities to upsell new and existing products • Creates fairly significant switching costs as users pay for more services.

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