Pricing – Wanted and Unwanted Consequences
Are you using the right pricing style for your software?
Most businesses have amazing software solutions. But, how they’re priced can be the difference between scaling and failing.
You might ask: why does it matter so much?
The way products and services are priced has a material effect on the quantity of sales and retention of clients. Furthermore, some pricing strategies offer more growth potential than others.
Based on the countless conversations we’ve had with businesses, and the experience we have gained from operating software units ourselves, we’ve summarised 6 pricing styles and their wanted / unwanted consequences.
1. Flat-Rate Pricing
Definition:
The simplest pricing strategy – you give them something, they pay you a flat fee in return.
Example: Basecamp
Analysis:
✔ Simple for existing and new customers to understand
✔ Shorter sales cycle
✔ Decentralised/Virtual sales process (e.g. click and buy)
✘ Revenues don’t scale with customers
✘ Revenues don’t scale with development costs
✘ Cost of acquisition will converge to life time value for customers
Conclusion:
We see the main advantages of this strategy for companies starting out. The pricing strategy has long-term disadvantages when it comes to extracting value out of the software.
2. Usage-Based Pricing
Definition:
A dynamic pricing model subject to the volume of usage (emails sent, leads generated etc.)
Example: Chargebee
Analysis:
✔ Revenues scale with customers’ business needs/usage
✔ Appeals to multiple customer profiles (low and high usage customers)
✘ Requires ability to measure usage
✘ Potential cyclicality of revenues depending on industry served
Conclusion:
A good strategy if you can track usage. Optionality of growth engine within customer base. However, more sensitive to economic downturns as usage often declines, depending on the industry served.
3. Tiered Pricing
Definition:
Buckets of pricing depending on functionality of solution
Example: Zendesk
Analysis:
✔ Upselling opportunities within existing customer base
✔ Optionality appeals to multiple customer profiles (small, medium and large businesses)
✔ Highest priced (highest margin) solution can seem most attractive (by applying specific marketing techniques)
✘ Harder for new customers to understand (clarity in marketing is critical)
✘ Longer sales cycle
✘ Sales process may involve more elaboration/explanation
Conclusion:
An interesting strategy, subject to modular software, which appeals to multiple customers. Upselling is an opportunity as well as a challenge (communication is key).
4. Per User Pricing
Definition:
Same as Flat-Rate Pricing, but possibility to pay for multiple users under one account.
Example: ProductPlan
Analysis:
✔ Simple for existing and new customers to understand
✔ Shorter sales cycles
✔ Decentralised/Virtual sales process (e.g. click and buy)
✔ Revenues scale with customers
✘ Requires multi-user software
✘ Revenues don’t scale with development costs
✘ Customer concentration (i.e. customer churn can be more significant – 10 users churn at once)
Conclusion:
Good strategy for multi-user software solutions. Revenues scale with customers (decentralised sales cycle). But you need a broad customer base with approximately equal number of users to avoid customer concentration.
5. Per Active User Pricing
Definition:
Customers only pay for the number of active users. If a user does not use a feature, they don’t pay.
Example: Slack
Analysis:
✔ Simple for existing and new customers to understand
✔ Shorter sales cycle
✔ Decentralised/Virtual sales process (e.g. click and buy)
✔ Revenues scale with customers’ business
✔ Customer proposition is more fair
✘ Requires multi-user software and ability to track activity
✘ Higher economic sensitivity
Conclusion:
Good strategy for multi-user software solutions. Offer might be more fair than a simple user-based pricing model, but requires the ability to track activity and increases exposure to economic cycles.
6. Per Location Pricing
Definition:
Customers pay for the number of locations they operate (offices/ stores) regardless of number of users.
Example: Spacio
Analysis:
✔ Simple for existing and new customers to understand
✔ Shorter sales cycle
✔ Decentralised/Virtual sales process (e.g. click and buy)
✔ Revenues scale with customers
✔ Revenues are not affected by customers’ employee turnover
✘ Similar pricing for customers with a similar number of locations, even though the number of users and activity levels might vary significantly
✘ Revenues don’t scale with development costs
✘ Customer concentration (i.e. customer churn can be more significant – multiple locations at once)
✘ Revenues might be affected by real estate prices
Conclusion:
Good strategy for software solutions for customers that operate multiple stores/offices and for customers whose businesses suffer from high employee turnover. Disadvantages are mostly similar to the per-user pricing strategy.
In conclusion
How to price software always depends on the solution at hand. It also depends on the industry, the types of customer one wants to attract and the growth ambitions. Ultimately, pricing will not just affect the profitability of the business, it will affect churn rates, volatility in earnings, duration of sales cycles and scalability.
As mentioned in our previous whitepaper on Sales Strategies an owner needs to know what they want before initiating a particular pricing model. This will make them more aware of the KPIs to track, measure and optimise. All this, so that the effectiveness of the strategy can be assessed and adjusted, if needed.
You need to know:
- What you want
- What to measure and why
- How to consistently measure and improve
All companies have a different pricing strategy and maybe your business employs one of the above. As always we hope to have provided you with some food for thought. If you have had any great or terrible experiences with pricing strategies, please let us know.
We would be more than happy if the time we invested into putting these ideas together yielded some returns for your business!
About Software Circle
Software Circle is a UK publicly listed company with a long history of providing software solutions to various SMEs across the world. We introduced a new corporate strategy in 2021 with the aim of building a Group of independent software companies, servicing different industries and benefiting from a shared pool of resources in terms of talent, knowledge, and capital. Software Circle wishes to be a permanent home for software businesses, continue the legacy of its owners and capitalise on both organic and inorganic growth opportunities that may present themselves.