Software pricing has always been more art than science, but there is improving methodology on how to do it. Value-based pricing is becoming a preferred method for many software teams, since it bases price on the value your product brings to end users.
How can you implement value-based pricing for your software? In an on-demand webinar with Logi Analytics, Hans-Bernd Kittlaus, Chairman of the International Software Product Management Association and CEO of a training and consulting company called InnoTivum, recently answered this question and discussed how embedded analytics can add value to applications.
What is value-based pricing?
Hans-Bernd Kittlaus: What we tend to use for standard software products is a value-based approach where we do not look at the cost first, but we start by looking at the customer value our product generates when a customer uses our product. Once we have figured out how customer value is generated, which parameters drive that customer value, then we can define our price approach by using pretty much the same parameters that drive the value in our price structure—and thereby making sure our price reflects the value the customer gets from our product. That’s the principle of value-based pricing. You can also apply value-based pricing to physical products, in particular in B2B environments, but it is still fairly uncommon. The common pricing approach for physical products is still the cost-based approach.
What’s an example of value-based pricing?
Imagine you are the vendor of an airline reservation system and you want to sell the system to airlines. When you want to apply value-based pricing, first you have to figure out the value for the airline when they make use of our product, our reservation system. Since such a reservation system is a transaction-based system, it’s quite typical that the value is generated through the transactions. You can use the number of transactions—in this case, the flight reservations—as the parameter that drives customer value. You can then multiply that parameter by a base value factor and that gives you quantified customer value.
How do you determine that customer value?
One approach that can help us in that analysis is known as the business model canvas. In the center of this canvas, you see value propositions; that is exactly where you need to analyze the value that we provide to our customers. That is related to what you see on the right side, which is called customer segments. If you come to the conclusion that the value your product provides is different for different customer segments, then that is what you can show here with this business model canvas.
The term “business model” has traditionally been used for companies. How does a company provide value to customers and generate revenue and profit from that value? That is exactly what you can show in this canvas. The idea is, with a canvas on one piece of paper, you can explain what your business model is in terms of market side—that is the right side of the canvas—customer segments, channels. And on the left side—the product side—what do we need to do in order to provide that value? The activities result in cost on the bottom left side. On the market side, we hopefully generate revenues, and you see that on the bottom right side.
What special value does embedded analytics add to software?
The additional value that comes with embedded analytics is dependent on the customer segment. We need to understand the value creation for customers, and in a lot of cases we need to do some segmentation because the value may be different for different customer segments. Then we have to reflect that value creation in our pricing approach so the customer value is always connected with the price. When we talk about a tiered pricing approach here, that means we offer the product at different price points for different customer segments that correspond to our value creation.
In order to implement such a tiered pricing approach, it is helpful when the embedded analytics functionality you implement in a software product allows you to switch certain functions on-off depending on what the customer has really bought and what provides value. When you are able to do that, then it becomes easier to implement the tiered pricing approach.
If you add embedded analytics functionality to your product that makes your product unique in your market, then this functionality is a prime candidate for premium pricing. Because if a customer really sees a lot of value in this functionality, there is no other choice.