What to price? Products, Use Cases, Value Paths
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talio.
Most SaaS companies price products. Seems like the obvious thing to do. We sell products. We talk a lot about product led growth, product adoption, product management, product roadmaps. We have product managers and product marketing managers. What else would we price?
But is product pricing always the right approach?
Remember the old adage
“People don’t want to buy a quarter-inch drill. They want a quarter-inch hole!”
Ted Levitt
One of the most compelling approaches to product development is the Jobs-to-be-Done framework. In this approach, developed by Clayton Christiansen of disruptive innovation fame, one asks what job a product or service is doing that would lead a buyer to buy or a user to use. The introductory article was published in the Harvard Business Review in 2016, followed by a book Competing Against Luck.
One of the classic examples asks what job does a customer hire a milkshake do.
Market researchers discovered that nearly half of milkshakes are bought in the early morning. Why is this? People faced a long, boring commute and needed something to keep that extra hand busy and to make the commute more interesting. They weren't yet hungry, but knew that they'd be hungry by 10 a.m.; they wanted to consume something now that would stave off hunger until noon. And they faced constraints: They were in a hurry, they were wearing work clothes, and they had (at most) one free hand.
The milkshake was hired in lieu of a bagel or doughnut because it was relatively tidy and appetite-quenching, and because trying to suck a thick liquid through a thin straw gave customers something to do with their boring commute.
Understanding the job to be done, the company could then respond by creating a morning milkshake that was even thicker (to last through a long commute) and more interesting (with chunks of fruit) than its predecessor.
In the afternoon, parents hired milkshakes to do a different job. They were an after school treat, or pick me up for their children. In this case a thinner milkshake that could be consumed more quickly had more value.
People in software will recognize these two scenarios as use cases. Can one price based on a use case?
Use case based pricing as an alternative to product pricing
Rather than organizing pricing around products, what would happen if we priced use cases, and then organized packages to support specific use cases?
Ibbaka has found this to be effective when
There is more than one use case in play
A package can be created specific to the use case or a solution configured specific to the use case
It does not work when
The technology has only one use case or when there are many use cases
The offer is identical for different use cases
In B2B, to price using use cases one begins by defining the buyer’s need (the job to be done) and then quantifying the value of solving the use case. This is done with a value model, a system of equations quantifying the impact of the solution on the customer’s business. One then decides how much of the value created by each value driver should be captured and use that to set price. The price metrics are based on variables in the value drivers.
Build a value model for the use case
Say what is needed to deliver the value
Set a target value capture ratio for each value driver or for the overall use case
Use variables from the value drivers as pricing metrics
Test the value and price across different scales of customer, make sure that the value capture ratio stays within a target range
Going beyond use cases, pricing value paths
Sometimes one needs to get more granular than use cases. This is where value paths come in.
A value path is a sequence of actions a user takes that result in something of value. The sequence of actions should begin on your system and ideally end on your system. The sequence ends when the value is achieved. Value paths can be connected together into longer value journeys.
The power of this approach comes from two things.
Value paths can be connected to other ways or organizing business, like business processes, value streams, or in healthcare care paths.
Value paths allow for finer grained analysis of how value is created at each step, how much of the value can be attributed to the solution, and how value should be shared with partners who are also contributing to the solution.
Use value paths when
More than one party is contributing to the solution
Value needs to be aligned to a well established set of business processes
The process for value path pricing is as follows.
Map the value path
Determine how much value is created at each step (this is often done probabilistically, by estimating how likely a user is to go from one step to another)'
Allocate the value contribution at each step (there are advanced causal analysis ways to do this but in most cases a simple, if defensible, estimate can be used)
Set a target value capture ratio - this is generally done for the full value path, it only needs to be done at the step level if one needs to share value with a partner
Value Path or Value Stream?
Value paths are sometimes confused with value streams.
A simple example of value path pricing
Lead generation is a simple example of a value path. There are many applications claiming to help with all or part of the sales process and lead conversion. How would one approach pricing?
In one sense the lead is only has value after it converts to a sale, but that is too simple. As there are multiple leads some of which will convert other of which will not it makes more sense to deal with probabilities, sales being a numbers game.
A few points to note.
It is the gross margin that creates the value and not the revenue. A system that attracted higher margin contracts would be worth more than one that attracted lower margin contracts. This is not modeled below but can easily be added, in fact, changes to a distribution are one of the more common ways that value is created.
Value can be allocated to each stage and then aggregates across the stages.
Attribution can be difficult and contentious, but it is important in pricing. Success has many parents, failure in. an orphan. Here three scenarios have been included, with the value attributed to the solution assumed to be 5%, 20% and 50%. In the real world attribution between 10% and 20% is most likely to be accepted by the buyer.
There are more sophisticated ways to estimate attribution, using causal analysis. This is a nascent topic for pricing, though it is well developed in other areas such as health economics and outcomes research. People wanting to go deeper into this, as it will become an important topic over the next few years, will find Causal Inference and Discovery in Python by Aleksander Molak an interesting read. Or if you are looking for a more general introduciton The Book of Why by Turing Award winner Judea Pearl is a good introduction.
How much much of the attributed value can be claimed in price? Another way of asking this is
‘What is the target value capture ratio?”
Let’s explore a range of value capture ratios from 5% to 30% across the three different attribution assumptions.
Wow, that is quite a range, $125 to $7,500 per year! This is why pricing can be difficult and why it is so powerful.
The first thing to do here is to investigate value attribution.
At 5% the possible price range is $125 to $750. To make matters worse,
the lower the confidence in value attribution the lower the pricing power, so a more realistic range is $125 to $375.
But at 50% value attribution the range is $1,250 to $7,500 and
with higher attribution comes higher pricing power to the range moves to $3,750 to $7,500.
Being able to demonstrate value attribution is a hidden key to value based pricing and it is much easier to do this with value path pricing.
In most SaaS businesses the actual value capture ratio we see in the market for well established solutions is 10 - 20%.
So, depending on value attribution, the realistic price range is $125 to $5,000.
Assuming a value attribution of 20% and target value capture of 20% (to leave some room for discounting) the list price will be $2,000 per year. So long as one can provide evidence of the economic value and the attribution this price is realistic.
Over the next five years we expect companies that support 3-5 well defined use cases to move to value path pricing. The companies that succeed with this will be the ones able to show cause for their value attribution claim.
