Two pricing-packaging responses to platform commodification
Steven Forth is a Managing Partner at Ibbaka (currently on leave). See his Skill Profile on Ibbaka Talio.
Every successful platform eventually sees its core functionality get commoditized. That is the nature of business, what is unusual and differentiated becomes business as usual. Highly differentiated functionality that supports a price premium becomes what everyone does with the price set by the market. Commoditization is not a sign of failure. It is a sign of success. Only the most important and general functions become commodities.
Today relational databases are a commodity. You can get them through your preferred cloud infrastructure provider at a price close to cost. There are open source alternatives. Hundreds of thousands, if not millions, of people know how to write SQL queries, it is taught in many high schools (I with they would teach regular expressions too).
Other enterprise systems, from Customer Relationship Management (CRM), to Learning Management Systems (LMS) and basic Human Resources Information Systems (HRIS) are also approaching commodification. There is not a lot of money to made in the core systems, the innovation and real money is now being made around the edges.
What should companies do when their core platform is being commoditized? There have been two main pricing responses.
The Bundling Strategy: Add differentiated functionality to the platform to try to maintain differentiation and pricing power
The Separation Strategy: Carve off advanced functionality from the platform and offer it separately, possibly independently
There is a third strategy, for companies operating in multi-sided markets, that we will sketch below.
The Bundling Strategy
Most companies faced with commodification begin with a bundling strategy. They start adding product extensions to the platform and use this to try to defend their pricing.
Database vendors added fancy load balancing, workflow management and security features.
CRM vendors have snapped up all sorts of extension functionality, from social media sentiment tracking to Configure Price Quote (CPQ) modules.
LMS vendors have absorbed each new advancement in learning, such as Learning Content Management Systems (LCMS) and Learning Experience Platforms (LXP) through acquisitions or by developing just enough functionality to be able to ‘check the box.’
This approach works for a while. Buyers get excited about the new functionality and are willing to open their wallets to pay for it. But this only lasts so long. Eventually buyers get exhausted by the innovation, and the innovations drift further and further from the core purpose of the platform. Instead of the innovation supporting a premium value, the value of the innovation gets captured into the platform, and is discounted heavily. Buyers start saying things like
“I just want the basics, all this other functionality is a nice to have, don’t make me pay for it.”
“I can get the functionality I need a lot of places, make it easy for me to compare solutions or I won’t buy from you.”
I’ll take all the bells and whistles please, but just include then with the basic pricing metric, don’t try to nickel and dime me.”
When this happens, and it almost always does, one needs a different strategy.
The Separation Strategy
At some point most platform providers reach a point where then need to disconnect the platform from the advanced, differentiates, functionality and offer them separately. This is true even when the platform is required for the extended functionality to be used.
The advanced functionality should be priced using a value based pricing approach. The commoditized platform must be priced to market, often to a slight discount to market.
In value based pricing, one begins by building a value model that estimates the economic value of the solution. Ibbaka Valio is a software platform used to develop and manage such value models and use them to design the price.
A value model is a system of equations that helps to quantify the economic impact of things like increased revenues (pipeline metrics), lower operating costs (there are many different equations than can be used here), lower risk, and so on. These equations have variables that are used to tune them to the value provided to any specific customer or market segment. In value based pricing, one or more of these variables is also used as a pricing metric.
By separating the value added and differentiated functionality from the commoditized platform one can optimize the price for the more valuable part of the offer while remaining competitive for the platform. Of course you will need to strip out all the additional functionality you have added over the years as you tried to prevent, or at least delay, commoditization. A platform offered as a commodity at a price set by the market should not be burdened with extra functionality. It should be offered at market parity and no more.
We provide more context on these design choices in Pricing and Packaging Design - Two Packaging Patterns.
How to choose between the bundled and separated packaging and pricing strategy
How do you choose between the two strategies? Here is a simple checklist.
The most common experience is to begin with a bundled strategy and then keep on trying to execute past the point of diminishing returns. At some point, all successful platforms, the ones that find truly broad adoption, get commoditized and a new competitive strategy is needed. One can often get an edge on the market by moving early, accepting commoditization, and offering a stripped down version of your platform at or even a little below the market price.
Why would one offer a platform below the market price?
Bringing buyers onto your platform is often the first step in getting them to adopt your more differentiated, more valuable, and more expensive differentiated functionality.
Leveraging a multi-sided market
There is a more extreme strategy that some companies adopt. If it is possible to create a two sided market, where your platform connects two different types of demand, then it can make sense to offer the platform for free to one side of the market while monetizing the other side.
The obvious example of this is Google Search and Google Adwords. Google could have charged per search. Instead, it gives away search, a service for people who are looking for something, and monetizes people who have something they want to be found.
Other examples are the many learning content platforms that provide a simple LMS, generally at no charge, to content providers while monetizing people taking the content, or benefits providers that provide a benefit management system at no charge while monetizing the benefits.
As business becomes more connected, and multi-sided markets more common, we expect to see more people try this strategy. If you have a platform that is being commoditized, take some time and see if you can convert your platform into a multi-sided market. It may be just the move you need to transform an old technology into a new business model.