Report: SaaS Driving Innovative Pricing Methodologies

The software-as-a-service (SaaS) model is driving a profound shift in the way that software vendors and channel partners approach pricing, according to a recent report by PricewaterhouseCoopers (PwC).

The report says that while the earlier licensing model laid much of the risk with the customer, and the new shift toward the cloud, managed services and SaaS, now places much of the risk with the supplier.

"The industry has to evolve," said Mark McCaffrey, a global software leader at PwC, in an interview with CRN. "Historically, you could set software prices almost where you wanted because the impact was directly to the bottom line, and cost and overhead was not a big concern as long as you manage your channels and sales forces properly. But, the new model forces a level of price discipline that can be a very difficult transformation for many companies. In addition, the hosted element introduces a whole cost infrastructure to support the delivery."

[Related: Channel Valuation Expert: SaaS Is Where The Money Is ]

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McCaffrey points to the cost of infrastructure and platforms used to deliver the service over a period of time, as well as a change in how sales and channels are compensated. "These are things that you need to get right in order to succeed," McCaffrey said.

Throughout his report, McCaffrey emphasizes a shift toward pricing based on the value that the service is providing to the customer, combined with consideration of the long-term value of each respective customer, which can be as much of an art as it is a science. In addition, providers are urged to target their communications based on the specific role of the intended receiver.

"You need to have a better understanding of how you're packaging your offer, and how your customers are perceiving value," he explained. "If, for example, you charge $9.99 for 30 GB, that will make sense to some people within the organization, but for others, it might be better to tell them that they will be able to store 10,000 images."

In short, companies need to be more aware of which people within the organizations are using their products, given the fact that dissatisfaction on their part can bring about an end to the contract much more swiftly than under the old paradigm.

"About 11 percent of the software market come from SaaS," said McCaffrey. "But if the trends we're seeing continue, and the buying method is toward cloud and hosted services, then figuring all this out is going to become imperative."

NEXT: Pros And Cons Of "Freemiums"

PwC advises that pricing strategy development begin with a hard look at your specific circumstances. Are you entering a new market? Are you trying to carve into a competitor's market share? Are you paving new ground in which you can set your own prices, based on whatever levels will be tolerated by the customer? This information, backed by solid data, can help determine breakeven points that can then be extended to determine acceptable profit margins.

McCaffrey believes that two years is an effective payback benchmark, given the cost of acquisition will remain high at the same time that revenues become annuitized.

One tactic in popular use involves the "freemium" strategy, in which a scaled-down version of a product is offered free of charge, but popular add-ons are provided for a fee aimed at restoring the provider to profitability in the particular transaction.

"The freemium model is going to become more prevalent," McCaffrey said. "The base service offered for free is used to enter a market, or open up a new customer. You can add new features for a fee, or perhaps you might limit the initial offer to just a few seats while the customer is getting acquainted with the product. But this needs to be done with great caution. If you give away too little, the scaled down version might undermine the sale. If you give away too much, the free version might be adequate to the customers' need, in which case the sale is also undermined."

The report states that bundling is also an important aspect of software-as-a-service. Customers are often resistant to paying higher fees for the same service at renewal time, so providers are challenged to be creative in bundling new features into the mix, which can be used to further open the purse strings. This adds to the pressure of establishing accurate prices from the outset, given that mistakes can either lose the deal or lock the provider into disadvantageous pricing levels.

"You also have to take the contract term into consideration," McCaffrey added. "When you bring in a contract for three years or five years, you're also looking at a very long time before you can adjust price. In addition, the initial price also sets expectations moving forward."

Conversely, setting the term of the contract for a short horizon can be equally problematic. "Ultimately, you are gauging the value of the contract based on the value of the relationship," he said. "So elongating that relationship is imperative."