Pricing strategy for subscription businesses

Pricing Strategy for subscription businesses

28th October 2013

Raghav Bahl : [email protected]

Agenda

Introduction

Key Pricing Models Employed by Subscription businesses

Decision Framework for Pricing Model Selection

Conclusion

1

23

4

Subscription business valuations are a function of growth, scale and leadership

‘Scalable’ pricing core to business model success

SCALABLE PRICING

SCALEGROWTH

LEADERSHIP

• Penetrative pricing in early stages / price sensitive consumers

• Price for attractive unit economics at scale

• Add new customers• Milk existing customers

for MORE!

• Premium product positioning• Price for category leadership

Comprehensive

Derive more from

existing customers

Key Pricing Models Employed by Subscription businesses

2

The Four Key Pricing Models

Freemium Consumption

Tiered Perpetual License

1. Tiered

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

Provider’s perspectiv

e

Predictable recurring revenues

More stable average selling price as less discounts are needed to keep existing customers

User’s perspectiv

e

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

Pro

Con Neutral

Number of users

Modules used

Value - Pricing axes

Units processed

Case Study 01: Salesforce.com

Features used

Value – Pricing axes

Flexibility for the client

Keeping it simple !

Case Study 02: letsfreckle.com

Number of users


Flexibility for the client

Same features across plans!

Case Study 03: Assistly (now desk.com, part of Salesforce)

Features used

Tiered across users, features & hours consumed

Number of users

Hours consumed


Case Study 04: Hubspot

Features used

Multiple Value metrics & hence pricing axes

Complex ?

Number of users

Contacts used


Emails sent

Site visits

Tiered – Our suggestions

“Prepare a comprehensive

list of value drivers for the

client”

“Rank value drivers on importance

to client based on consumer usage /

feedback”

“Number of pricing axes to be

determined by value proposition &

consumer sophistication ”

2. Freemium

What is Freemium?• A business model that offers core services or features for free, and charges a premium for the more

sophisticated components

“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

Provider’s perspective The free offering will meet immediate user needs and entice them to pay for the premium offering after having experienced it

“

”Provider’s perspectiv

e

Potential to acquire large user base quickly

Loss of Sales revenue offset by savings in sales and marketing spend

User’s perspectiv

e

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

Pro

Con Neutral

Use-case

Time-based

Feature-based

Freemium – Four methods

Capacity-based Product usage is free upto a capacity usage or number of users, beyond which it is chargeable.

• 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

Example

Capacity-based

Use-case

Time-based


Customers offered a limited version of a product for free, with certain key features locked.

• Free VOIP calls

• Calls to Mobile or landline are payable

Example

Feature-based

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

Capacity-based

Use-case

Feature-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.

• Free 30-day trial for their CRM platform

• During the period, users have access to a significant subset of the full functionality

ExampleTime-based

Capacity-based

Time-based

Feature-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.)

• Provides products for free to student community with pre-conditions such as “to be used solely for learning, teaching, and training”*

Example

Use-case

*Source: Terms specified on http://students.autodesk.com/

http://students.autodesk.com/

Freemium – Some Important Considerations

Creating Value from Free Users

Learning from Free Users

Cost to Serve Free Users

Size of the Market

Network Effects associated with the product

Customer Targeting

To Freemium or Not to Freemium

…



Size of the Market


Customer Targeting

Model works well for rapid scale up

Key question Are we attracting the right consumer base ?





Size of the Market


Customer Targeting



“What value is a free customer adding?”

Alternative monetization via• Advertising

• Selling user data



Size of the Market


Customer Targeting



A large “free” user base presents an opportunity to gain insights into user trends

by applying customer analytics

• Conduct Cohort analysis

• Track viral referrals



Size of the Market


Customer Targeting



Understanding cost along with an estimated conversion rate -

• Minimum viable size of the target market

• X number of Paid users needed to support Y Free

users



Size of the Market


Customer Targeting



Freemium adds another conversion step, so

having a large market is crucial for this model



Size of the Market


Customer Targeting



• Does one user benefit more from having more users of the product or

service?

• Does the size of the user base impact referral rates

or increase switching costs?

• Does the value of your product increase with

more users?

Example

Freemium – Conversion Rate Optimization

Creating a Freemium business model is often about striking a balance

Offering too little!

Will not generate enough customer interest to upgrade to the paid version

Offering too much!

Will result in too little an incentive for customers to upgrade

Freemium – Our suggestions

“Give enough away for free

to gain customer insights”

“Understand that conversions take

time”

3. Consumption

What is the Consumption Model?• A popular pricing model that allows customers to manage their costs by managing the quantum of

product usage

Key Metrics for assessing the Consumption Model• User growth rates

• Number of active users

• Average revenue per user

“

”

User’s perspectiv

e

Flexibility is typically valuable for companies at an early stage

Limited future commitment for customers

Pro

Con Neutral


e

Revenues fluctuate over time, lower revenue predictability

Provider grows with their customers!

A trade-off between unpredictable revenues –and- deep product adoption

Case Study 01: Twilio

OverviewTwilio 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.

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

4. Perpetual License

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

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 longer-term projects requiring extended commitments

“

”

User’s perspectiv

e

High upfront cost and long-term buy-in makes adoption more difficultCost of capital is low, then perpetual licencing makes more sense than subscription-based models

Pro

Con Neutral


e

High price product – high touch sales – Longer sales cycle

Great cash flow situation !

Low attrition risk - Customer lock-in secured for a longer term

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

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

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 marketplacetake 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

Decision Framework for Pricing Model Selection3

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:

What is the Customer’s Value of the Product?1

2

3

4

5

6

Is the Customer Aware of this Value?

Can the Customer Base be Segmented?

Is the Customer’s Demand Variable or Uncertain?

Establishing a Floor Price

What Value Metrics are Most Important to the Customer?

Decision Framework: Step 01

What is the Customer’s Value of the Product?

1 There are several sources of value that a customer can derive from a product

ROI for Customer

Exogenous Factors& Establish a

demonstrable ROI Value for the customer to set the price ceiling

customer’s price sensitivity

attribute tradeoffs

network effects

time savings

increased revenue

reduced errors

resource or cost savings

efficiency gains


Is the Customer Aware of this Value?

2 • Understand if the customer’s perceived value is less than the offering that the firm has calculated

Customer’s

perceived value is…

“<“ than that arrived at in Step 01

“>” 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 valueConsider offering a Tiered model


Can the Customer Base be Segmented?

3 Look for opportunities to segment the customer base to see if different values can be separated from each other

Matches with value arrived at in Step 01

Using fewer, or more, product modules

More number of items are being processed

Fewer, or more, employees are using the product

IF YES Tiered Pricing

Consumption or Freemium pricing

Consumption or Tiered Pricing

Common Segmentation Criteria

Customer’s

perceived value…

IF YES

IF YES


Is the Customer’s Demand Variable or Uncertain?

4 Variability in demand and other uncertainties (or lack of it) can provide indicators for pricing model selection

• Inconsistent demand for product

• Requirements on an “as-needed” basis

• Lack of clarity into future demand

CUSTOMER TYPE:

• Reasonably certain demand for the offering

• Clear perceived value in line with actual value of offering

CUSTOMER TYPE:

Consumption Pricing model is favorable as it will capture this variable demand

Tiered Pricing model would be ideal if customers are likely to have a long relationship with the company


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

Value derived from the customer in terms of

payment

> In this case, optimal decision would be to not

produce.

if Cost of Customer

Acquisition

Gross margin earned from customer in Year 1< Invest in

consumer acquisition for rapid scale up


What Value Metrics are Most Important to the Customer

6 • 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

Conclusion4

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

Thank You!

Company APrivately-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

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

– 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

consumption was the most customer-friendly model we could adopt since it was “pay for what

you use,” and there was no contract lock-in

CFO, Company A

Company APrivately-held Infrastructure-as-a-Service company using a consumption model

the Company’s pricing model, in addition to being more flexible, is

also less expensive than traditional on-premise pricing models

“

”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

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

From Theory to PracticeInterviews with real-world companies

3

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”

Company BPublicly-traded SaaS platform using a Consumption model

“

”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.

“The Management believes the main reason for churn is

decreasing perceived value”

Company CPrivately-held content delivery network using a feature-based Freemium model


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 pushedas many features as possible down to its Free plan

Key Learnings

• Company realized that it needed to discriminate based on the size of the customer

• Through this approach, the company has found that pricing has actually helped it to reach higher tiers of customers

A Method for Analyzing Metrics:

Company CPrivately-held content delivery network using a feature-based Freemium model

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

• Company C looked at all customers that signed up for the product in January.

• Then, moving out 1,2, and 3 months on, it analyzed churn, conversion rates, and average revenue per customer

“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.

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.

Company DPrivately-held SaaS platform using a capacity- and time-based Freemium model


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.

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.

Company DPrivately-held SaaS platform using a capacity- and time-based Freemium model

“

”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

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

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

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

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.

Case Study 02: Amazon Web Services

Overview• Amazon Web Services (AWS) is an Infrastructure-as-a-Service platform

for web-based 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.

Pricing strategy for subscription businesses

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