Tag Archives: revenue

How to price new enterprise software products

The enterprise software market is almost always a paid one. So how do you price a brand new enterprise innovation?

sw_px-200pxSoftware is one of those “magical” goods in microeconomic terms: it has virtually no Marginal Cost. So how do you get a customer to pay you thousands—or even millions—of dollars to buy something you can reproduce for free?

If you’re looking for a “magic formula” to calculate the price of your software, you can hit the ‘back’ button. You won’t find that here. Instead, if you are looking for a strategy to establish a tangible, defensible price for an intangible innovation, read on…

STEP 1: Price by the value you create

There are many, many software pricing models. However, at the end of the day, you’re going to have to defend your quoted price. This is easiest to do, if you price based on what your customers value. Figure out what units your customers use to measure value, and then pick a price model based on those units. Now you have Value-based Unit Pricing.

STEP 2: Use ROI to establish your “list price”

Enterprise software purchases are investments in “promised value.” However, it will take a lot of work for your customer to “unlock” that value: they have to get budget approval, initiate a program, execute it without over-runs, integrate it into their business operations, etc. To make it worthwhile, your software will have to provide a large return on this upfront cost—at least 40-50%. If your software cannot do this, it will never clear the triple wicket of business sponsor, IT manager and procurement manager.

Look at the market—and more importantly—what it costs your customers to do the very thing you are trying to automate or improve. Calculate the cost per year and subtract enough for a 40% ROI. Now you have your List Price. (Note: if there is already software you want to displace, price your product to make replacement of it something that yields a 40% ROI. Why should anyone take the risk to buy your product if it is not good enough to do this?)

STEP 3: Use co-development to establish your “maximum discount”

When you go to a new customer with a new product and quote a price, they will immediately ask for a discount (especially if you are new to the market). How do you insulate yourself against this? Establish a fixed lower bound for your software that you can legitimately never price below (at least until 1-2 generations pass and everything changes).

The best way to do this is by using co-development partnerships. Co-development partners not only buy and use your product; they provide added time, people, teamwork and insight to make it better. (This is not only good for them, it is also a path you can use to establish market leadership). Co-development should be rewarded with your Maximum Discount.

Once you have done this, whenever a follow-on customer pushes for a larger discount, you can point out that your co-development partner only received your maximum discount because of the work and time they contributed.

STEP 4: Build your price rate cards

You now have all the tools you need: value-based unit pricing, list price and maximum discount for co-development. You are now ready to give your sales and contracts team all those wonderful spreadsheets to calculate the price of your new enterprise software—at least until the next generation of innovation arrives…

A Few Closing Remarks: Two things to NEVER do when pricing your software

Give it away for free to get the deal*. You will inevitably get enticed to give your software away for free to get a major customer. Don’t fall into this trap. Once you have done this you have established your software truly has zero Marginal Value (not just zero Marginal Cost). It is really hard to negotiate UP from zero. Give away add-ons, charge implementation at cost—do anything—but don’t give away enterprise software for free (*unless you are using a Freemium model, of course).

Demand premium pricing. You may be so proud of your latest and greatest software that you will want charge more than “legacy providers” for your innovation. Unfortunately, unless you can demonstrate—at a visceral level—that your software provides value that no one else can, you have destroyed the ROI value proposition of your product.

Article first published as How to price new enterprise software at Oulixeus

The Social Networks that Are (and Would Be) King

man_who_would_be_king_w_masonic_280pxYesterday, I argued that the reason that Groupon is worth 100x the value of MySpace is inherently due to the Total Net Value of the connections between their members. To create a social network with value, you need focus on using it to create valuable connections between members—from two different points of view:

  1. Your members must easily see more value from maintaining connection on your network than the time and effort required
  2. Your company must be able to realize higher revenue from these connections than it costs to operationally support them

If you achieve the first point, your network will organically grow quickly through word-of-mouth. If you achieve the second, you will realize value from this growth. When you combine both together you tap Metcalf’s Law to generate valuations that grow geometrically, becoming a Social Networking King.

Applying this to today’s four Social Networking Kings

Looking at today’s leading social networks through the lens of Net Connection Value explains why they are so large and valuable:

Twitter

Many have questioned the value of Twitter: some love it; others simple do not “get” it. Regardless of how you feel about it, Twitter is the King of Low Cost Networking. It currently has an estimated value of almost $7 billon.

From the member’s perspective, connecting with others (and maintaining these connections) requires the minimum amount of effort possible (i.e., one click). As such, the value I obtain from perusing a Twitter stream, even if it is minimal, comes at no cost to me. This has fuelled explosive growth.

From Twitter’s perspective, the cost to maintain each member’s simple profile and the sharing of 140-character messages is also about as low as one can get (just compare it to the cost of hosting and sharing videos on YouTube). The trick is focusing on extracting revenue from this low cost—something Twitter is doing more of these days.

Facebook

Everyone focuses on Facebook’s sheer size. However, Facebook is the King of Personal Connections. It is the most valuable social network in the world, valued at up to $70 billion on the secondary market.

When you ask people why they are on Facebook, they talk about how much it does for them: it makes it easy to keep in touch with friends, share pictures, etc. Thanks to the Social Graph, it is just easy to use Facebook to share things of interest you find on the Internet with your friends. To most, the value of Facebook greatly exceeds the effort required (and associated privacy risks). This is why it is so big.

This size is critical to Facebook’s success. The cost of maintaining so many images, posts, etc. is not cheap. However, Facebook is now so large that it is sitting on one of the most valuable—and exploitable—demographic data sets in the world. This provides enormous selling power for advertising and eCommerce. As Facebook continues to grow, its profits will grow geometrically (a simple expression of Metcalf’s Law). However, if it shrinks one day…

LinkedIN

LinkedIN is the King of Professional Connections. Three years ago it became my primary Rolodex. It has filed for an upcoming $170-million IPO, which would give it a $2 billion valuation.

People join LinkedIN because it gives them immediate value at virtually no risk. With minimal effort they get low-level advertising of their professional background (and can maintain low cost connections with colleagues they meet). Increasing their activity brings higher rewards, from outreach by headhunters to demonstration of “thought leadership” on professional groups.

LinkedIN’s has taken great proactive steps to extract as much value for cost from its members and their connections. Its data is highly structured, enabling very targeted searches. This is good for advertisers, recruiters, sales professionals and anyone seeking a job. This has given LinkedIN pricing power to charge for higher-fidelity searches, targeted advertising and job postings.

Groupon

Groupon is the King of Social Commerce. More specifically, it uses social networking to make real-life shopping networks easier and more efficient for all. It has been valued as high as $15 billion.

Consumers join Groupon to save money. They recruit their friends to save more money (and have fun shopping together to save). Businesses join Groupon to sell more of their existing inventory (if they have excess inventory, they have a clear reason to join; if not, they have no need). The value of Groupon to members is as clear as it gets: it’s all about money.

The cost mechanics of Groupon’s technology infrastructure more closely matches that of a commerce platform than a social network (i.e., the revenue it obtains from each transactions is far, far greater than its cost). It simply needs to get large enough (something it has already done) for this revenue to pay for its underlying capital investments. This is a very clear financial model for investors.

What is interesting about Groupon is its human network: it relies on thousands of employees to find sellers and close deals. On the negative side, this is labor-driven cost; on the positive it is a huge barrier to competitors (and a proven financial model). Again, Groupon’s size wins out (due to Metcalf’s law). Of course, the way to beat this is to add social networking to an existing sales network with existing connections…that is another post.

And the Social Networks Who Would Be King

gorgeSimilarly the Net Connection Value concept explains why other social networks have failed to create similar value:

MySpace. MySpace is Facebook “gone wrong.” It targeted the wrong demographic, leading most to question the value of joining it. This led to smaller size and lower ability to extract value from connections between its members. It is now selling for 15 cents on the dollar.

YouTube. YouTube is an interesting idea. However current technology infrastructure costs are enormous. So far, it is still struggling to achieve profitability. However, I would bet that Google is the company who can eventually make costs low enough to extract search value from its content.

Flickr. I use Flickr so I can share pictures beyond my circle of Facebook friends. However, to most people Flickr is a specialist provider of a service Facebook already provides—without the need to sign up for an administer yet another login. Many are asking if Yahoo! will eventually disband Flickr.

Delicious. I was an early Delicious user. However, I have not added a bookmark in over a year. It too, is a specialist service that Facebook already provides—with one-click—through the Social Graph. Yes, Delicious provides better organization. However, to the average user the effort is not worth the benefit. The future of Delicious is also in play.

White Label Social Networks. Since 2005, many companies have strived to create their “own Facebooks, YouTubes and Twitters” for their employees, partners or customers. Their small size and focus makes them victims of Metcalf’s Law—when it was free, the average Ning network had less than 10 people. To combat this, they need to focus their perceived value as high as possible—and to relentless focus on business returns that outweigh their costs. Some have done this; others have not.