Pricing and packaging makes or breaks a product's success in market. If you don't get it right, even great products fail to gain adoption or get monetized. And for early-stage companies creating categories, there often isn't a blueprint to follow from competitors.
I empathize — this stuff is hard. When there isn't a monetization team in place, pricing and packaging is often driven by product management teams which own P&L for their product lines. Other times, it's the responsibility of product marketing, particularly in companies that have a "PMM-as-the-GM" model. There are times in my career when I've driven pricing and packaging, and times when I haven't.
My approach to this discipline is most influenced by a former colleague (Andrew Koyfman) as well as a research paper on Pricing Strategies of Software Vendors by Sonja Lehmann and Peter Buxmann. Their research provides a framework for creating pricing strategy, based on five levers:
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Price Setting: Methodology to determine price
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Pricing Goal: Profit margin vs. market share
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Packaging: Relationship between capabilities or products in portfolio
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Licensing Unit: Metering unit to calculate pricing
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Billing Model: Perpetual vs. subscription vs. consumption
Let's dig into each of these.
Price Setting
Determining the price is the most consequential decision you'll make when formulating pricing strategy. At a high level, I see three main approaches:
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Cost-based pricing looks at the cost to produce a good and adds a nominal percentage markup (your margin) to determine the price. This approach is more common with retailers and consumer products than B2B or services companies.
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Competition-based pricing focuses on market rates, with price determined based on your goal (see below). For example, a new entrant to an existing market may set their price below market rates to gain share and attract customers away from established competition. A premium brand entering a new market may set prices above market rates to capitalize on their brand equity. You often see multi-product companies selling individual products as a loss leader to get customers in the door, encourage the sale of higher-margin products or services, or drive up market share vs. competitors. For example, consumer products Amazon sells are sold at a minimum profit margin, subsidized by the higher-margin AWS business unit.
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Value-based pricing favors setting the price based on customer demand or the perceived value of your products. This approach works well for premium brands that want to create the perception of quality, which is part of the reason why Haagen-Dazs can charge 3x more than Breyers for ice cream (both are great; but try the Oreo & Chips Ahoy 2 in 1 if you haven't already; you won't regret it). Value-based pricing is also the preferred approach for hotels, airlines, and rideshare companies that deal with fluctuating demand. For B2B companies, success with value-based pricing requires a deep understanding of your customers' world, the problems they face, their alternatives, and the outcome of using your product, so you can accurately quantify value and determine customer willingness to pay.
Pricing Goal
This is one of the most important strategic questions to answer. Some companies can employ price skimming for a finite period of time when demand is high and competition is low — for example, targeting early-adopters who are willing to pay a premium for a new-to-the-world product. You see this with a lot of consumer tech products like smartphones and wearables. But from my experience in emerging markets, too many B2B companies prioritize revenue and profit margin early on ahead of adoption and market share.
An example that's close to home for me is the Application Release Automation space. This category of technology emerged in the early-2010s to help IT Operations and DevOps teams automate the process of deploying software to production. Vendors like CA Release Automation (via acquisitions of Nolio and then Automic), XebiaLabs, Electric Cloud and IBM UrbanCode emerged as early leaders, but all failed to achieve mass market adoption, and the total addressable market (TAM) capped out at around $300M as of 2018, per Gartner data.
Why is that the case? In addition to getting disrupted by cloud native technologies and more modern software delivery practices (i.e. continuous delivery), It's because they priced themselves out of demand, with prohibitive pricing levels as well as licensing units that weren't aligned to value.
A few years later, a newer category of Continuous Delivery vendors and tools (CodeFresh, Harness, Spinnaker, and WeaveWorks, to name a few) emerged that were more developer-friendly, and offered generous free tiers and less expensive up-front pricing. In other words, they prioritized adoption and market share ahead of short-term profit margin.
Harness is now worth $1.7B. By contrast, Electric Cloud was eventually acquired by CloudBees for an undisclosed price after years of flat growth. Xebia Labs merged with two other companies to form digital.ai after similarly declining year-over-year growth rates, and its product was essentially deprecated and reimagined as part of a Value Stream Management solution. CA Release Automation and IBM UrbanCode are perceived as legacy product lines, with only 2% year-over-year growth, according to Gartner.
Maximizing market share is the play run by some of the world's most valuable consumer tech companies, like Google, Twitter and Facebook. The core idea is that if you prioritize mass market adoption and growing the category up front, revenue and profit will follow.
Packaging
Packaging is the relationship between products or capabilities your company provides. It determines how customers access and consume your product(s). Virtually every B2B software company likes to call themselves a "platform", but very few actually are. Companies that expand their addressable market via new product development or acquisition often try to stitch multiple products together to create the perception of cohesion. But that perception doesn't always match reality.
If you have multiple products with different pricing units and user experiences that aren't seamlessly integrated with each other, then you don't have a platform. You have a collection of products.
Too many large companies that grow via acquisition struggle to integrate the UX across disparate product lines. And they throw up artificial barriers to adoption by nickel-and-diming customers that want to expand usage across those product lines.
If you're a portfolio company (with multiple products) and each product shares the same target audience or buying center, you're typically better off integrating those products into a single platform or bundling them. When it comes to packaging, my goal is to make it frictionless for customers to expand use cases for my products and adopt new capabilities. Expansion leads to more value, and value leads to more stickiness.
Licensing Unit
This is a lever that a lot of B2B software vendors get wrong. Many companies choose a metering unit that doesn't closely align with the value customers get from their product. This can make it hard for customers to justify ROI when the time comes to renew a subscription or decide whether to expand usage. It also opens up the risk of leaving money on the table if customers use your product in ways you hadn't anticipated.
In both the marketing technology and software delivery spaces, many vendors are moving to user-based pricing, because it's simple, predictable, and tightly linked to usage. Companies can't always predict how many servers they'll have, how much data they'll need to store, how much web traffic they'll receive, how many emails they'll want to send, or the size of their prospect database, but most have a good idea of how many people in their organization will need access to the product they're buying.
Another factor that companies can't always predict is how exogenous market forces will impact the value of their licensing unit. For example, what happens to the value of a server running in a data center when cloud native technology comes around and obviates the need for running software on servers? What happens to the value of an email sent when people get email fatigue and stop opening marketing emails? What happens to the value of a lead in your database when B2B buying behaviors change and product-led growth becomes the new way to "sell". If your licensing is tied to something that decreases in value over time (due to circumstances outside your control), you accelerate the pace at which your product becomes commoditized and obsolete.
Billing Model
This lever has seen the biggest tectonic shifts during the past decade. Starting in the mid-2000s, companies like Salesforce changed the economics of B2B software. They spurned perpetual licenses for software you deploy and manage in your own data center, in favor of software-as-a-service (SaaS) that's fully managed and delivered via the cloud, coupled with an annual, recurring subscription billing model. This ushered in a new era of SaaS, with subscription businesses becoming the new normal.
If the shift from perpetual to subscription was the sea change of the 2010s, subscription to consumption billing will define the 2020s. AWS pioneered this model, introducing pay-as-you-go billing that ensures customers only pay for what they need and use. Consumption billing has become popular as a reaction to B2B vendors forcing customers to commit up front to expensive subscriptions for shelfware products that were never fully adopted.
The magic of a consumption model is that it aligns a vendor's incentives with their customers' incentives — when customers grow with your software and get more value from it, you grow too. This may come at the expense of predictable revenue, but it's a bold bet that I expect to see more companies take.
