B2B SaaS discounting: Should you discount fixed or variable pricing metrics?
Steven Forth is a Managing Partner at Ibbaka. Connect on LinkedIn
TL:DR Should you discount fixed pricing metrics or usage/consumption metrics?
Discount fixed metrics (the platform) first if
You are confident in the usage projections
The platform price is a barrier to closing the sale but the usage price is not
Usage is the primary driver of value
Discount usage first if
You lack confidence in the usage projections
The usage price is a barrier to closing the sale but the platform price is not
Usage is not the primary driver of value
Continue to see why we make these recommendations.
Discounting is a fact of life in B2B SaaS. There is a movement towards zero discounting (see Can a ‘no discounting’ policy work for enterprise SaaS?), but this is generally only possible for fairly simple solutions. Many of Ibbaka’s customers have more complex solutions, available in various configurations, that need a pricing model that aligns value to customer (V2C) with the configuration and usage, or consumption as this is beginning to be called.
The popular packaging pattern over the past few years has been tiered or Good Better Best (GBB) pricing. Some consulting firms have made a good living pushing companies into this pattern.
GBB is not the only effective packaging pattern though. Two other patterns that can be very effective are having a set of independent modules or having a platform with a set of extensions.
The Independent Modules pattern is common as companies add new products or grow through acquisition. It is often possible to define dependencies or paths between modules to drive cross-sell and modules can be bundled in different ways to support different use cases.
The Platform + Extensions pattern is growing in popularity, especially as companies move to rebuild their entire application suite on a generative AI platform. One of the common evolutionary patterns emerging is to take a generative AI module and make it into a platform on which other modules can be built. We are seeing this with Salesforce and its Einstein platform.
Packaging and Configuration, Usage, Value, and Pricing work together as a system
Value is at the center of this system and acts as the organizing principle. However, configuring a solution will not lead to value unless it is used. And price should be designed to track the value of the use of that configuration.
These interactions lead many companies with complex solutions built on a common set of technology (like generative AI) to move from a pure module-based approach to packaging to platform-plus extensions. In this approach, the common functionality that all modules rely on is gathered together into the platform and then additional modules are built on top of this platform, leveraging its capabilities. In some cases, the platform has value in and of itself and can be purchased on its own without any of the extensions. In other cases, at least one of the modules needs to be purchased in order to get value. As an example of the former, think of a bicycle frame as a platform and the wheels, tires, driver train, seat, seat post, etc. as modules that you need to get a working bike. As an example of the second, think of a database that can do a lot of work on its own but that can be made even more valuable with a variety of modules that execute specific business processes like sales or configuration management.
In either case, one often wants to have a pricing metric for the platform. This metric often combines two or three pricing metrics, a base subscription for the platform, some sort of scaling metric, and a usage or consumption metric.
For example, one of our customers uses the following three metrics:
Base fee - an annual subscription fee for connecting to the platform
Scaling fee - a monthly subscription for connecting devices to the platform
Usage fee - a monthly consumption fee for the volume of API calls
This three-factor pricing model was needed to make sure that the central relationship of value-based pricing was maintained across deals of very different sizes.
Value > Price > Cost
Ideally, value increases faster than price increases faster than cost as the solution scales.
Managing discounting for hybrid SaaS pricing models
That is the ideal world, but most B2B clients will want to negotiate, and the larger the opportunity the more they have been trained to expect some level of discounting. Buyers, especially from procurement, have been trained to lock in future discounts at the beginning of a deal and will often ask for discounts based on target levels of usage that they are not willing to commit to.
There are several approaches to managing this discounting pressure. The first rule is to know your target value capture ratio and make sure that you achieve it. The value capture ratio is the percent of the value created that you capture back through price. In B2B SaaS this ranges from 5% (a 20X return for the buyer) to 20% (a 5X return for the buyer). See Pricing and Planning: 3 Approaches to Discounting. One thing to realize is that the value capture ratio tends to decline with scale, larger companies and larger deals are often able to get more value than smaller deals (is this fair, not really, but it is part of the power relationship of modern business that favors large companies).
One option, the simplest, is to apply the discount to the total subscription and not to the individual components. This is often the best approach as it reduces the number of things to negotiate. Every time one introduces a new pricing factor one offers the buyer one more thing to negotiate, which can delay deals and complicate the sales process.
Sometimes a top-level discount is sub-optimal. Another approach is to discount each factor separately or to only provide discounts on one factor. The question is then which of the pricing metrics to discount on. How you answer this question will depend on your pricing goals and how you expect usage/consumption to change over time. If we knew the future deciding the best discounting approach would be easy, but of course we do not have a perfect crystal ball.
One approach is to discount the fixed part of the subscription, in this case, the platform fee.
Another approach is to discount the variable portion, in this case, the number of devices connected or the number of API calls.
We recently coached a customer on this question. There were two very strongly held positions in the executive team.
The finance (and the pricing) teams wanted to avoid any discounting on the platform subscription and only offer a discount on consumption. They felt that the platform fee represented core value and also set a floor for the deal that they needed to make sure they made the profit margins they had promised investors.
The growth team wanted to discount the platform subscription and not the consumption subscription as they felt the growth targets would be achieved or exceeded.
What was missing was any discussion about value and whether the company would meet, exceed or fall short on actual value delivery.
Putting together pricing and discounting, one gets two critical uncertainties.
How much will the solution be used?
How much value will the solution deliver?
Combining two critical uncertainties is the foundation of scenario planning, a framework for helping us to think more effectively about an uncertain future. One way to conduct scenario planning is to combine the two critical uncertainties and use them to generate four different scenarios. Pricing and discounting can then be combined with usage assumption to generate four scenarios. One can go further and calculate the probability of each scenario and then ask what can be done to ensure that one ends up in the top-right scenario.
Value and Use Below Assumptions
This is the worst-case scenario. These customers are likely to churn. Discounts alone are likely not enough to help.
Is the lack of value to customers a result of the lack of use, in which case driving use up is the top priority, or is there something else getting in the way of value?
Value Exceeds Use Below Expectations
This is not a bad situation as value is being delivered and that needs to be communicated to the customer.
This scenario often occurs when pricing uses the wrong usage metric, one that does not track value. Pricing redesign is often needed.
Value Below Use Exceeds Expectations
This is where a discount on usage pricing makes the most sense as it can help bring alignment.
This will only work if the platform pricing component is large enough to achieve the value capture ratio.
Value and Use Exceed Expectations
This is where you want to be. The buyer is happy and is getting a lot of value.
Make sure the buyer understands how and why they are getting the value.
Make sure that the value to customer (V2C) and price are tracked together.
Recommendation
Discount the platform first if
You are confident in the usage projections.
The platform price is a barrier to closing the sale but the usage price is not
Usage is the primary driver of value
Discount usage first if
You lack confidence in the usage projections
The usage price is a barrier to closing the sale but the platform price is not
Usage is not the primary driver of value
Answering point 3 above will require a value model and then scaling tests on how value to the customer (V2C) changes at different usage levels.
Contact Ibbaka today to discuss how Ibbaka
can help you to transform your pricing
