The hidden treasure of value-based pricing (1/3)
Are you getting paid according to the value your software provide to your clients?
One of the many remarkable quotes of
perfectly fits with the direct provocation of this post.Price is what you pay, value is what you get.
And after interviewing more than 1000+ private software founders, I couldn’t agree more. I have rarely observed a structured approach in methodology (strategy), infrastructure (data, systems, and processes), or sales reps’ incentives.
Pricing is one of the most unoptimized elements in B2B software.
In LatAm, pricing is taboo.
The outcomes are straightforward (but the devil lies in the details).
I will try to keep things simple and in this post, I will tackle briefly how changes in price policy can create value in a purely theoretical way.
The different value-based pricing techniques, infrastructure, and economical nuances will be held in the second and third posts.
Cheap Ltd and Pricey Ltd are two exact software twins in a zero-inflation country. Pricey Ltd woke up feeling confident and decided to raise 10% of its prices yearly.
The parameters at the kick-off of this experiment are:
There are three optimistic scenarios for this bold move.
A perfect arbitrage
A positive trade-off of price and churn
A positive trade-off of price, volume, and churn
In the perfect arbitrage, it will be quite straightforward. Pricey Ltd. decided to adopt a yearly raise of 10% without any additional churn. Hence, it will be valued 2x more than Cheap Ltd in 5yrs.
Now for a positive trade-off in the price vs. churn scenario, we are dealing with the 10% yearly uplift but with some competitive consequences.
Some of the existing clients decide to leave the platform as they are more price-sensitive. However, new sales haven’t been affected.
[PARAMETER CHANGE] Higher 5% churn!
Anyhow, Pricey Ltd. was still able to secure a 1.6x valuation from a superior boost of higher ACV per client that will increase operating margins and thus the value of the company.
Now, for our last scenario positive trade-off between price, volume and churn existing client price sensitivity boosts additional churn and new growth is affected.
[PARAMETER CHANGE] Higher 10% churn and Less 5% Gross New ARR!
Not only do existing clients churn but also the company loses new sales from price-sensitive buyers.
What happens?
Still, Pricey Ltd. is valued 30% above Cheap Ltd. for the same ACV effects over its P&L, boosting operating margins.
Conclusion:
The scenarios above are intentionally subject to reductionism and oversimplify the complexity behind price policy changes and the true nature of price elasticity that will vary upon:
Software’s mission-criticality
SMB or Enterprise clientele (share of IT spend)
Market size and industry concentration
Competitive Dynamics
However, it serves as a foundation to start asking questions and work on potential initiatives that can create value when effectively implemented.
Coming up next…
Different SaaS pricing models (pros and cons).
Investing in value-based pricing incentives and infrastructure
Economics applied in Horizontal vs. Vertical Software Pricing.