When and how to change your pricing metric
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
What is a pricing metric
The most important pricing decision is the choice of a pricing metric.
The pricing metric is the unit of consumption of your offer for which the buyer pays. It is (or should be) closely connected to the value metric, the unit of consumption of your offer through which the buyer or user gets value.
In the B2B SaaS world there are many different pricing metrics. Some of the most common are
Per user
Active user
Named user
Total users
Per transaction
For consumption
For availability (whether the solution is used or not)
Per connection
For throughput
For performance
Speed
Accuracy
Uptime
For usage (or value path completion)
and on and on
This is an open list as new pricing metrics are invented everyday. Your pricing metric should help communicate your value.
When to change your pricing metric
Changing your pricing metric is like brain surgery. It is one of the most important decisions you can make for your business. The pricing metric is how you get paid. Before deciding to change your pricing metric make sure you have a compelling reason to act. How you approach a change to pricing will depend on the reason for acting.
Your pricing is a frozen accident
For many offers pricing was set in the past, no one is quite sure why the pricing metric was chosen, and it no longer reflects how the company thinks about its business and how it creates value for its customers.
When this is the case, a thorough review of pricing is needed and this may result in a change in the pricing metric.
Quite often the pricing metric is based on the commodity value that everyone in your industry has and does not track your differentiation value.
You are changing your business model
Business models are changing and many companies are considering a change in business model. Some manufactures are layering in software and data services (the Industrial Internet of Things) while software vendors are shifting to SaaS and subscription models.
Other companies are changing their growth model or combining two or more different models. Product led growth (PLG) is attracting a lot of attention recently, but the most common model is still sales led growth. The five growth models that Ibbaka supports are
Product Led Growth
Sales Led Growth
Service Led Growth (check out our new LinkedIn community on service led growth)
Community Led Growth
Relationship Led Growth
The type and combination of growth model can impact the choice of a pricing metric.
You have new ways to deliver value
Companies these days are expected to continuously innovate and find new ways of creating value. There are three main ways companies do this.
Improve performance on an existing value driver (add more value in the same ways you already add value)
Change how an existing value driver works (make incremental changes to how value is created and delivered)
Add a new value driver (provide value in a new way)
In the first case, incremental improvements; a change in pricing metric is almost never required.
In the second case, substantive improvement; a new pricing metric is sometimes needed, but should generally be avoided.
It is the third case, when you are creating value in new ways, that a new pricing metric should be considered.
You are entering a new market segment
When one enters a new market segment a change in pricing metric is often called for. The definition of a value-based market segment is
‘a set of potential customers that gets value in the same way and that buys in the same way.’
New segments require new pricing metrics as they get value in a new way. One often wants to differentiate an offer for a new segment from the existing offer. Using a different pricing metric is one very effective way to do this.
The market has shifted
It sometimes happens that the standard metric for your industry has changed and you need to change with it.
This often happens at the phase shifts in the technology adoption cycle. Geoffrey Moore’s model provides a good way to think about this.
Pricing metrics generally change from early adopters, to early majority to late majority, to laggards and end of life. Companies that miss these shifts are often at at serious disadvantage. Companies that are ahead of the game can use this as an opportunity to shape the market in their favour.
How to choose a new pricing metric
Choosing a new pricing metric requires market research into how customers get value. The pricing metric should track the value metric. There are several ways this can be done. In some cases there is a value metric that also works as a pricing metric and that can be tracked by the solution. This is the ideal state.
The ideal state is rather rare though. The next thing to do is to look at the variables in the value drivers and see if one or two, sometimes three, of these can be combined into a pricing metric.
Sometimes even this is not possible. This usually reflects market commoditization or a lack of differentiation. In this case, one can design a pricing metric that acts as a proxy for value. This is a poor third choice, but it does describe most value-based pricing today.
Learn more about How to choose a pricing metric
Pricing metrics can be hybrid (adding in usage-based pricing)
Pricing metric change does not have to be an all or nothing thing. One of the big trends in pricing over the past few years has been the adoption of usage-based pricing. Research has found that the best approach here (the one that delivers the most growth) is to combine usage-based pricing with a subscription. Generally, the usage pricing metric should contribute 15-30% of the revenue with the subscription covering the other 70-85%.
Choosing a usage metric that reinforces the value messages implicit in your subscription pricing metric is an important part of adding in a usage-based pricing metric. Of course, not all usage is associated with value. The best usage-based pricing metrics are based on value paths. A value path is a sequence of user actions that results in something of value to a user or buyer. See value path.
Introducing a new pricing model
A change in pricing metric means a change to your pricing model. Introducing a new pricing model requires careful planning. There are generally three different work streams.
Prepare internal systems
Your CRM, value management system, pricing software, and financial software will all need to be updated. Contracts and other legal documents like the End User License Agreement will also need to be revised. This is also a good opportunity to take a fresh look at security and data privacy.Communicate to new buyers
You will need new marketing materials, including value studies, a new pricing page, and the sales team will need to be trained and supported on the new pricing model and how to sell based on value.Existing customers should be migrated
This is often the most difficult part of introducing new pricing. In general you want to bring all of your customers onto the same pricing model. This supports fairness and transparency, which are important to many buyers today. But trying to slam everyone over into the new pricing model all at once is not likely to succeed.
The best approach to segmenting the market for pricing change is by Value to Customer (V2C) and Lifetime Value of a Customer (LTV). In most cases one wants to get the most valuable customers across first and build confidence and success stories (high V2C and high LTV). One then works on the High V2C and low LTV sector, trying to improve the LTV at the same time. Improving LTV could come from increasing average contract value or from decreasing churn, or both. Last is the low V2C and high LTV customers. Here one needs to understand why the V2C is low and how one could change it. If one cannot improve the V2C these customers may need to see lower prices. As for the low V2C and low LTV group, do you want these customers? A price change can be a good time to prune your customer base and make sure you have the customers you want.
Pricing metric and pricing model design is the most important set of pricing decisions.
See What to price? What to optimize? How to optimize? Three key pricing questions.
