One of the biggest challenges of the emerging cloud service and subscription economy is pricing. The new products that are emerging are disruptive to previous ways of doing business. They leverage cloud technologies that drastically lower operational costs, and are able to combine a number of technologies to do things never before possible. As a result, this new generation of services have a much lower cost structure than the services they replace.
This poses a huge challenge to service vendors: how much to charge customers for them?
It is tempting to leverage the lower cost structure to blast away competitors with disruptive pricing. But is this a good long-term strategy? Our view of the market is that in developing pricing strategies, vendors are focussing too much on their costs and not enough on the value they are delivering to customers. Here are three important things every subscription economy should do in developing pricing for their products.
1. Compare your offering to traditional alternatives. An emerging subscription economy lifestyle product offers a cloud-based monitoring system, and access to professional advisors. To procure this previously would cost hundreds of dollars per month, but they are offering their basic level of service for just $45 per month. While it’s not clear how they came up with this number, one thing is essential: in presenting the value proposition to a prospective customer, they should compare it to what it would normally cost. Apple’s pricing strategy for apps has severely destroyed value in the eyes of customers. With so many free applications around, customer expectations have been significantly lowered, and customers vacillate about spending $3.99 for an app that is probably worth $20-50.
2. Give yourself permission to change the price. Once a price is struck, it sets expectations of value in the eyes of customers. It’s very difficult to change this perception. What if you made a mistake in pricing? As a vendor, you need to retain ownership of all aspects of your product and brand, and that includes the price. The answer is to explicitly give yourself permission to change the price from time to time. In the subscription economy world, this can be achieved by using ‘introductory offers’, special pricing that is only valid until a certain date, or to flag pricing increases that may happen over the life of the product. Telecommunications service and pay TV vendors do this all the time: “$40 a month for the first six months of your contract” (then in small print, “rising to $65 per month”). These messages convey to the customer that they are getting a special deal, and the service is actually ‘worth’ more than they are paying.
3. Understand and monitor your cost structure. Modelling a business in terms of its fixed and variable costs is how to determine break even, and ensure it remains profitable. This is predicated on knowing the fixed costs, and the margin on variable cost items. But in the subscription economy world, this is often far more complex. Vendors usually offer some level of service at no cost, and the true cost to serve paying customers is a function of their utilisation profile. A similar thing has been happening in the telecommunications world for years. ‘Bucket plans’ offer customers either unlimited or capped usage of a particular call type for a fixed cost per month. As an example, consider a phone plan that offers 500 minutes per month for $20. If every customer used 500 minutes every month, the vendor would likely be losing money. But the fact is that they don’t, and the vendor pricing analysts model usage profiles to determine this. Further, they have sophisticated ‘revenue assurance’ functionality that track usage and alert them to customers whose usage profiles don’t fit the pattern. The lifestyle service referred to above offers unlimited access to advisors (via e-mail or SMS or chat) for a set fee per month. This is an identical costing model to the telecommunications bucket plan. Every interaction with an advisor has a cost and the vendor needs to estimate the average number of interactions per month. They will lose money on some customers, make money on others, and hopefully it will average out across the board. How can they ensure profitability? One option is to price it away, i.e. to charge customers for every interaction. This is a user-pays model. But from the customer perspective, it’s overly complex. Further, they don’t want to penalise customers for using more of their service. This is where a good billing system comes into play – using telecommunications-style revenue assurance techniques, and capturing every customer interaction as a ‘billable event’ (what we call the generic equivalent of a telecommunications ‘call data record’). By capturing every one of these events, the vendor can assign a cost to each one, and then model customer usage patterns and profitability. But as the adage goes, you can only manage what you measure.
By focussing on the value your customers get from your offering, and developing a deeper understanding of the ways they use your service, you can stay ahead in the subscription economy pricing game.