Product Pricing – there is no magic formula

So your product is ready and you are pitching to your potential early customers. What should be your licensing model and the fee?

Licensing Model

The traditional approach for enterprise products has been a permanent (perm) license consisting of a one-time payment upfront and an Annual Maintenance Contract (AMC) fee from year 2. A benefit of the perm license is that you get most of your revenue from the client upfront.

SaaS products introduced the subscription model. This license is for a fixed time interval and must be renewed periodically (monthly, annually). Investors prefer this approach since it results in a more predictable year-on-year revenue stream provided customer attrition remains within control. 

At Sapience Analytics, the previous company that I co-founded, we initially opted for the perm license to generate cash quickly from our early clients. Once investors came on board, we transitioned to annual subscription.   

With both perm and subscription, the license fee can be on per user basis or a combination of a fixed base fee and per user.

There are other approaches and permutations, a few of which are noted below:

• Pay-per-use which involves a one-time payment for each completed transaction. This is popular with online gaming sites. Another example is AWS server provisioning.
• Outcome based pricing - for example, a job portal may charge a monthly fee (subscription) or when a person has been hired (outcome based), or a combination of the two.
• Freemium license in which the base functionality is free, but users pay for added features, services, capacity, or convenience. Freemium is more of a marketing strategy since it incentivizes people to sign up for the free service, make it a part of their routine, and then consider paying for added services.

License Fee

There is no magic formula to decide how much you should be charging your clients. An entrepreneur struggles with multiple and conflicting objectives: generate revenue, be profitable, build market share, sign large deals and marquee clients, win against the competition etc.

I have listed different ways to determine the license fee, and you can compare more than one approach to converge on the most appropriate initial pricing.

Cost-plus

• What are your operating costs (development, support, sales and overheads) and near-term investment requirements? How many clients and users you expect to sign over the next year? Based on estimates for the above, you can compute the license fee that will help cover costs and generate profit to drive further investment and growth.
• Indian IT Services companies priced their hourly billing rate based on costs which turned out to be 20-35% of equivalent hourly cost per employee in the US. That differential and availability of the right skills has helped them build a $180 billion industry over the past 30 years.
• If you can do this successfully for your product, you won’t need VC funding. A great example is Zoho, founded in 1996, which has scaled to an estimated $350 million in 2018. 

 Value based

• Quantify the value that your product can deliver to the client or user (increase in revenue, reduction in cost, improved customer retention etc). The license fee can be set to be a reasonable percentage of the value being delivered. 
• As an example, luxury brands price their goods at very high rates compared to their cost and customers are willing to pay for the prestige of owning the brand.
• This is easier said than done for a startup. In the early days of Sapience, we tried this approach with couple of large clients. In support teams for example, the productivity gains with Sapience can drive a 20-30% increase in revenue by enabling their existing team to service more clients. We asked to be paid a fraction of this gain but weren’t successful. Clients were reluctant to share how much financial benefit they derived.
• Even if your licensing fee is not directly value based, it is important that you have an ROI calculator. Enterprise products may require a setup and adoption phase before value is realized. There will be internal investments that your client must make to deploy the product. Make sure you factor in these costs when computing the ROI.  
• The calculator can lead to interesting insights. For example, products that improve productivity or provide cost savings will typically deliver 4-10X more dollar savings per user in the US and EU compared to India. This makes the same solution more attractive in Western markets. Most global product companies handle this by offering steep discounts in India especially for large deals. My recommendation for startups with a ‘Made in India, Built for the World’ solution is to find a way to pivot to the US after you have perfected your solution and established a strong referenceable customer base in India. 

 Competition driven

• If there are already existing players in your space, then you can calibrate your list price based on whether your product is positioned to deliver more value to the client at a comparable fee or offer similar capabilities at lower cost.
• At Sapience, we built an enterprise people analytics solution that has no equivalent even today. But in early years, clients would confuse it with the myriad time tracking tools that exist. With proper marketing to highlight our superior and highly differentiated product, we were able to win clients at reasonable license fees.

 Zero fee

• What better example than Whatsapp? Founded in 2009, this app from a 50-person company had 900 million users when it was acquired by Facebook for 19 billion dollars in 2014.  
• An extension of the zero-user fee model is an ad-based revenue mode. The end users don’t pay anything and instead the app vendor gets revenue from advertisers on their website. Apps that display ads based on context and actual user click get paid on Cost Per Click (CPC) basis. There are other apps that simply display ads and charge for CPM (Cost Per Thousand or Mille) impressions (users accessing that web page). CPM rates are much lower than CPC. Some apps charge the users a fee for an ad-free experience.

While all this may sound complicated, in practice as an entrepreneur you will already have a vision and plan that will guide you to a preliminary pricing strategy. I’ll close with a few suggestions:

• Make sure that you have a list price. Offer discounts based on volume, tenure or simply how badly you need the deal.
• Do a candid assessment of why you are losing deals. It is easy to blame it on pricing, but it could well be the product or how you are positioning it.
• If you are winning most deals, it is time to increase your list price and/or reduce discounts.
• Be ready to walk from a few deals if the client asks for an unreasonable price – maybe you will discover that more often not the client then agrees to your quote!

Look forward to your views and experiences on this topic.

[This is the third article in a series called I2B (Ideas To Business) intended to invite discussion about the “how to” of tech startups. I have also covered these topics in much more detail in my book ‘From Entrepreneurs to Leaders – Building a Billion Dollar Product Company from India’ published by McGraw Hill back in 2010. It is no longer available online, but I have a few copies left. If you would like a complimentary copy, message me your postal address on LinkedIn and I’ll mail it to you.]