Every software vendor faces a serious pricing conundrum.
Early on, in the hunt for initial logo customers, vendors tend to be very willing to drop their price to secure the deal. In their rush to gain market share, pricing and value analysis take a backseat, with the resultant effect that the price that they charge their customers is not commensurate with the value that they deliver. Research indicates that only 41% of seed stage companies take a value-based approach to pricing. Even worse, by undercharging their customers, the “framing effect” comes into play, and they find themselves unwilling, or unable, to increase their prices even as their product delivers a growing value proposition.
Big vendors have tremendous pricing power, and are able to raise the prices even if it causes resentment in the customer base. This conundrum affects startups, and most software vendors. As a result, a vast majority of them end up with “classes” of customers, each paying vastly different amounts for essentially the same levels of service.
This phenomenon is detrimental in the long run for the vendors and their customers. In an ideal world, the price paid is proportional to the value derived. As the product or service matures, it delivers an increasingly compelling value proposition. If the vendor is able to raise the price in proportion to this increase, they will be able to invest more into the product and further expand the value proposition, which in turn benefits the customer. While this is an oversimplification, the point is that there is plenty of scope for a mutually beneficial, and expanding relationship.
Pricing is a complex subject that is a function of many factors, but ultimately, the customers’ willingness to pay (WTP) is the most important variable that implicitly (or explicitly) determines the price. To keep revenues commensurate with the value proposition, vendors should invest in improving the customers’ WTP.
Two questions arise: how can vendors increase the customers’ WTP? And, more importantly, which department should get the job done?
The “ABCD” Value Chain
The figure below is a simplified view of the typical software value chain. Engineering and Product Management build the product, Marketing broadcasts the value proposition, and Sales closes the deal. Customer Success (CS) is responsible for delivering the value to the customer. Not every company, especially in the early days, has a formal CS function, but it is always part of the fabric of the company. The role may be played by Professional Services, Support, Engineering, Account Management and sometimes, even the executives take personal responsibility for CS.
CS professionals play a vital role in this value chain. They are not only the “eyes and ears” of the vendor, but also the department closest to the customer. To state the obvious, they need to be an integral part of the value chain, working closely with Engineering, Product Management, Marketing and Sales. In order for them to be effective, their observations and opinions need to be factored into the product development lifecycle.
As the function that is closest to the customer, CS needs to take a proactive approach to not just delivering value, but also increasing the customers’ WTP. They need to work with Product Management to deliver new capabilities that are most relevant and useful to customers. They need to collaborate with Marketing to develop messaging that will be compelling to customers. They need to team up with Sales to ensure that the right reference points and expectations are set with new prospects and existing customers.
The most effective CS professionals also communicate constantly with their customers. While value is always an implicit part of the conversation, pricing, and more importantly, future pricing changes need to be a part of the conversation. They need to carefully consider how they communicate value and pricing. Even though CS uses different channels under different circumstances, the message creation process itself is very similar to how Marketing does its job. In that sense, there is a lot that CS can learn from Marketing.
As we know, Marketing relies heavily on Prospect Theory to craft messages for various audiences on multiple channels. Let’s see how this could apply to CS and the pricing discussion with customers.
Prospect Theory and Pricing Strategy
The prospect theory was proposed by psychologists Daniel Kahneman and Amos Tversky in 1979, and they received the Nobel Prize in economics for it in 2002. To summarize prospect theory in a nutshell, when choosing among several alternatives, people avoid losses and optimize for sure wins because the pain of losing is greater than the satisfaction of an equivalent gain. Marketers have been using this theory to develop effective messaging for years now.
Let’s take a simple example – insurance. The picture below shows an actual ad from gopetplan.com.
As you can see, messaging from insurance companies is heavily focused on the cost of catastrophic events, such as expensive surgery and complicated health conditions, and the assurance that comes from having insurance. When framed against the cost of these events, the premiums tend to look very small. Consumers tend to overestimate the probability of these events, and their desire to avoid that improbable loss makes them more inclined to pay a high premium. From a purely rational perspective, this may or may not be the right thing to do, but human psychology is not always logical. This is the Prospect Theory in action.
There is a lot of very interesting material out there about the Prospect Theory and how it can be used by vendors. Let’s examine how vendors can use it to improve their customers’ WTP, and specifically, the role that CS plays in this vital activity.
Six Takeaways from the Prospect Theory
1. Avoid Surprises
People, especially in a professional context, don’t react very well to surprises. Reasons for this response can range from a fear of the unknown, to risk, to an actual disruption. While this is not necessarily rational behavior, instinctive fear of a loss will supersede a logical reaction.
Whether you want to roll out a fancy new feature, take your service down for regular maintenance at midnight on a Saturday, or increase the price when a contract comes up for renewal, you need to let your customer know well in advance. In this instance, it is better to over-communicate early on so you can ensure that there are no surprises.
2. Pay Attention to the Negative Moments
Prospect Theory tells us that people feel greater pain when they lose something than when they have an unexpected gain. You could have done many things to delight your customer, but unfortunately, the effects of an unsatisfactory experience will linger for longer, regardless of seriousness or frequency. Therefore, CS professionals need to watch out for those moments, and take proactive action to reduce the intensity of that pain.
3. Identify and Address Sources of Inhibition
The customer is subject to many pressures at work, and they can manifest in unexpected ways. For example, you may have been in a situation where your customer knows and acknowledges the value that your product delivers, but remains unwilling to think about expanding usage. This is an early warning sign that the customers’ WTP has not moved.
However, this stance may not be related to your product. Your stakeholder may not want to deal with the unknown risk in dealing with expanding usage to other departments. Or, she may be tied up with other priorities at work. In these situations, you need to bide your time and wait for the right moment to strike. Your Customer Success Managers (CSM) should be able to identify the reasons underlying their inhibition, and design their responses appropriately. The next steps contain some suggestions for how they could do so.
4. Talk Risks, not Benefits
We have been trained to highlight the benefits of our solutions. However, it’s important to keep in mind the context within which they are framed because it makes a lot of difference in how they are understood.
Let’s consider an example – Customer Relationship Management (CRM). CRM vendors tend to make pitches in terms of how they help better manage your sales force, and make contributions to the pipeline. Despite this argument, Gartner estimates that nearly 50% of CRM implementations are failures. Poor adoption is one of the biggest drivers of CRM failure.
Instead of emphasizing contribution to the pipeline, if CRM vendors talk about how Sales teams with a CRM platform can prevent opportunities from slipping through the cracks, they will secure the enduring attention of Sales management. This will lead to not only better adoption, but also greater investment in the overall success of the deployment within the customer.
Now consider these two scenarios – which one do you think will result in a higher WTP? The takeaway here is that when CSMs speak with their customers, they should be looking at framing the benefits of their solutions within the context of the risks that they help mitigate.
5. Quantify in $$$ Where Possible
Many vendors do ROI studies. Some of them discuss intangible returns such as an increase in productivity, while others talk about hard dollars saved. Which do you think has a larger impact – a “20% improvement in productivity”, or a “20% decrease in cost”?
The point here is that you always want to present the benefit in terms of tangible metrics that the customer can relate to in real life. Hard dollars saved is a very direct metric, but there are others too that can serve as a proxy (such as hours saved). When returns are described in tangible terms, they implicitly address the customers’ aversion to loss. Addressing this loss aversion has a beneficial impact on the customers’ WTP.
CSMs are in a unique position because their interactions with customers are more frequent and focused. By paying attention to this aspect, and describing tangible benefits, they will not only do a better job of communicating value, but also improve the customers’ WTP when the time comes to renew and expand.
6. Simplify the Choices
Customers tend to balk at making a decision when presented with complex and poorly understood scenarios. This is because they find such situations risky because of the unknown; their aversion to loss leads to procrastination at best, and rejection at worst.
The most effective approach to decision-making in these scenarios is to break them down into their component parts, and filter our what is not relevant. This is why Marketers present side-by-side product configuration pages that are simple to understand, while conveying the differences between product versions.
CSMs need to consider this strategy in their communications with their customers. The options need to be presented in the simplest possible terms. More importantly, the customer should be made to feel like they are making the choice, instead of the decision being forced on them.
Pricing is a complex subject, but it does not have to be contentious. By taking the optimal approach and applying the right strategies, vendors and customers can find a happy medium that is a win-win for all parties involved. The conversation always starts with the value delivered, but that by itself is insufficient. Beyond quantifying value, vendors need to consider how the value is framed, and delivered to customers. Most importantly, they need to think about the messenger. As the function that is closest to the customer, CS is the tip of the spear, and the companies that realize this fact, and act on it, are likely to have the most mutually beneficial relationships with their customers.