Amongst the most common questions I get as a mentor are “What should my business model be?” and “How do I price my product?”
B2B business models have been changing over the decades I’ve been in the technology business. In the very early days I remember the many struggles over how to deal with enterprises: volume discounts? Site licenses? Perpetual or time-limited licenses? Then came LANs (Local area networks) and more questions: license by the seat? by the number of users? By the number of simultaneous users? Microsoft and others solved these problems, only to have the arrival of the Internet and the Cloud disrupt business models and pricing yet again.
Today many SaaS companies rely on a subscription model which has many advantages, the biggest being predictable, recurring revenue. And the pricing model is often $XXXX per month but only ~85% of 12 months if purchased in advance. This is a win-win situation in which the customer gets a substantial discount and the startup gets terrific cash flow. While you can’t recognize revenue on your income statement until the service is delivered that really isn’t important, it’s payment in advance that helps growing companies with insatiable appetites for cash.
But today B2B business models have changed yet again as the article on ZDNet points out: Enterprise software vendors mix and match monetization models: What happens when subscription, usage and licensing converge? N.B. the sub-title: Enterprise software vendors are subscription happy, but they’re delving into usage plans for customers too. Toss in some perpetual licenses and your negotiations with strategic vendors are about to get more complicated.
According to a report by Flexera, enterprise software vendors are employing a variety of monetization models:
Flexera found that enterprise software vendors are using subscription models for 74% of their products compared to 64% using perpetual licenses and 59% following usage-based models. Forty-seven percent of vendors are using outcome and value-based models. Flexera surveyed 321 software suppliers.
The eternal challenge for software vendors is aligning price with value. This is particularly difficult for startups who have yet to establish the market value of their offering. The best approach for startups is to use the real estate model: look for comps. Comps are comparable offerings. But by all means avoid trying to undercut established vendors on price, as you risk getting into price war with cash-rich incumbents like Microsoft and Salesforce, who can drop their prices and put you out of business.
While the article’s many charts on various deployments of different business models and projections on how they will change over the next three years are valuable it skips quite lightly over a concomitant and perennial problem for software vendors: how to enable prospective customers to try before they buy? Options range from time-limited copies to the freemium model.
My advice to founders is to offer a very simple evaluation model and freemium fits the bill. It provides a zero friction option for prospects to evaluate the basic value of your offering while at the same time offering a strong incentive for customers to upgrade to the full product once they are comfortable adopting it widely. One well-known and successful freemium model is Slack. Slack enables users to try out Slack for an unlimited amount of time and then offers three pricing options, Standard, Plus, and Enterprise Grid with the latter being “For extra large businesses or those in regulated industries.” The action item for the latter being “Contact Sales”!
While once software vendors hid their pricing models behind “Contact Sales” today a startup can learn a great deal simply by searching the web for pricing models of comparable enterprise vendors. However, be aware that the freemium model can get very complicated with Slack having over two dozen features that vary by its four pricing tiers. You will spend a lot of time arguing about what features should go into the freemium version and what type of upgrade paths you offer.
For startups I have three words of advice: Keep it simple. Economic decision makers can’t be bothered wading through pages of options for a brand new product. Make clear that whatever your model, it applies to version 1.0 only and keep any license agreements to one year. That way as you learn your market and better understand how customers value your product you have the flexibility to make changes with version 2.0.
I would strongly encourage founders to avail themselves of the experience of a freelance CFO with extensive experience in B2B software firms. They can help you craft a business model and pricing scheme that will be attractive to customers and will benefit your cash flow. And talk with your peers about their models as well. As usual, market research involves primary research, talking to customers, competitors, analysts and consultants, and secondary market research, scanning the web for research from firms like Flexera and comps from companies like Slack.
Here are the principles I advise you stand by:
- Keep your business model and pricing simple! Leave complex hybrid pricing models to the established vendors.
- Do not compete on price.
- Don’t box yourself in with long term deals.
- Get help from advisors and consultants.
- Invest your time in learning the market.
- Sell based on your customer value proposition, not your business model or price.
- Focus your innovation on your product, not how you sell or price it.