XaaS Key #2: RIGHT PRODUCT AND SERVICE DESIGN
TODD BRYAN, 7 JANUARY 2021
Dude, where’s my predictable, growing revenue?
Part 1: Product and Service Design
A durable goods manufacturer I worked with saw the benefits of the XaaS model and made bold commitments, setting a 5-year goal of 30% of revenues from recurring sources. After 5 years of hard work, designing new products with IoT technology, learning customer needs, creating value propositions, designing offers, training and rethinking the channel…less than 1% of revenues were recurring.
A software company I worked with successfully transitioned its user base over to an XaaS model, with great results. But in the strategic planning process, the XaaS team forecast stalled revenue growth in 2-3 years, setting off a minor internal panic.
What happened?
I Thought You Said XaaS Was Wonderful!
I didn’t say it was easy! Yes, customers, investors, and you will love it – if you do it right.
All too often, I hear the following:
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“Just bundle everything together in one package, one price – so simple, it sells itself!”
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“Just take the perpetual (license/ownership) price, and divide by lifetime of product/service – boom, there’s your monthly subscription price! How simple!”
This is usually followed a while later by this:
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“Why are our recurring revenues still so small?”
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“Why have our recurring revenues stopped growing?”
It’s easy to fall into the trap of slapdash product, service and pricing design. I will walk you through the traps in each of these, identifying the common mistakes to avoid, and the right approaches to adopt.
One Size Does NOT Fit All!
Bundling – collecting several products or services into a single package, at a single price – is a great concept. It simplifies sales – because you’re only selling one thing. It simplifies marketing – because you don’t have to target different segments.
But bundling can be taken too far. One size does not fit all; there are always going to be segments with different needs, and different spending appetites. Pursuing a “one size fits all” approach leaves money on the table, and surprisingly, is more costly than having multiple package offers.
The solution: “Good-Better-Best” packages.
Keep in mind these key design rules for your product and service packages:
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Have at least 3 – but usually no more than 5 – separate packages.
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Add features and functionality across packages, and clearly indicate which features are in which package.
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Make your “good” offer your minimum viable proposition (MVP). Make it clear that this is the bare essentials.
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Make sure the features and functionalities your customers really need appear only in the “better and above” packages. (And you do know what features and functionalities your customers really need and value, right?)
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Make sure your “best” package is several multiples – sometimes as much as 10X – as your “good” or entry-level package.
Why is Good-Better-Best product and service design so effective?
1. Segmentation: We’re not all alike.
For example, for accounting SaaS, a gas station owner in the countryside is not going to have the same needs as a pawn shop which won’t have the same needs as a law firm. They need different functionalities – and have vastly different appetites to pay.
Customers with basic needs won’t buy a high-priced package that offers them more than they will use; customers will more complex needs and greater appetite to pay may think an affordably-priced package isn’t offering them what they need. Different packages at different price points maximize your revenue.
2. Psychology: I’m not just good – I’m GREAT!
When was the last time you thought to yourself, “you know, I’m not the best, I’m not even better, I’m just plain old good”?Generally, only 10% of your customers to take a “basic” package, mainly out of affordability reasons. Around half will go for the “better” package – because who isn’t at least “better”, right?Around a third or more will think, “I’m the best and I deserve the best, whatever the price” – and will very quickly take your highest-level package.
High-end retailers like Nieman Marcus played psychology like this to perfection for years. I’m not suggesting that you (or Nieman Marcus, or anyone for that matter) exploit your customers. Instead, I’m suggesting that you maximize their satisfaction and perceived benefits in their overall experience with you. They will reward you for that.
3. Cost: For just a few pennies more…
For SaaS, there’s no incremental development cost and very little incremental operating cost between basic/good packages, and high-end packages. Features and functionality are simply “turned off” or “turned on”; there’s just one product, with on and off switches. As a result, the margins on higher-level packages can be incredible. This may differ in the hardware world – I’ll discuss that shortly.
4. Upsell: But wait, there’s more!
Once customers enjoy your basic or middle-level offers, it becomes much easier to convince them to upgrade to your highest-tier offers. Also, as you learn more about them, it becomes easier to sell them other products and services. This provides a growth path even if you have high market share, or have converted an existing customer base from perpetual to XaaS models.
Success Case Study: Salesforce.Com
Salesforce.com, one of the pioneers of SaaS and an incredible disruption success story, uses this “cascade” of packages extremely well. Consider below the offer cascade for their flagship CRM product:
Source: Salesforce.com
Note how well they have designed this:
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4 separate packages;
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A clear indication of increasing features and functionalities by package;
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“Good” (Essentials) clearly positioned as a basic, entry-level package;
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Salesforce.com clearly steers customers to the “Enterprise” package, helpfully telling us it’s their “most popular” (which means: this is the one you need, the others are good and deliver value, but you really need this one);
5. Unlimited” is priced 10X “Essentials”! Salesforce.com has determined not only what their different customer segments
need, they also have a good sense of how valuable the increased features and functionality are to them.
In the next part, I continue with discussing XaaS pricing: common mistakes, how to avoid them, and how to do it right.
Part 2: Pricing Design
Is The Price Always Right?
Pricing is one of the most challenging parts of product and service design regardless of revenue model. It’s even more so for companies transitioning from a perpetual model to XaaS.
The temptation is to merely think of XaaS pricing in terms of payback periods or total cost of ownership. That is, many companies set their XaaS monthly subscription price so that the customer feels they come out “even” within a certain time period, usually 18 to 24 months.
Under this model, Adobe could have priced Creative Cloud at well over $100 per month at launch. But it did not – instead, Creative Cloud was launched at $50 per month. Has it worked? Adobe’s growing revenues, margins and share price indicate that it has worked very well indeed.
It’s Harder With Hardware
Pricing design becomes more difficult when blending purchase plus subscription. The durable goods manufacturer mentioned earlier considered its XaaS efforts a failure after recurring revenues reached less than 1% of total revenues. However, the flaw was not in customer appetite, but in the company’s own offer design: hardware in the solution was priced 100 times higher than the annual services subscription price!
This actually betrayed the company’s own appetite for offering XaaS. By trying to capture most of the value in the initial hardware sale, the company was reverting to its traditional business model of cost-plus pricing, and immediately realizing full margins and cash after acquiring a customer. The temptation to do this is immense – as I will discuss in a later article, XaaS requires a lot of guts, patience, and financial fortitude.
The Answer: Price = Perception
At the end of the day, for any good or any service in any (deregulated) market, prices are set by how much someone is willing to sell something for, and how much someone is willing to pay. This is as true for XaaS as it is for stocks, used cars, or dishwasher detergent.
Many factors determine the price someone is willing to sell at, and the price someone is willing to buy at. For example, when Adobe set the price for Creative Cloud, it clearly thought about customer’s ability to afford the price: “costs the same as a latte per day”.
Pricing experts build sophisticated models incorporating data on comparables, substitutes, elasticity, utility, payback periods, marginal costs – real PhD. stuff. Here, I want to focus on one critical component of pricing most easily overlooked in XaaS pricing: perceived value.
XaaS pricing should be set by deeply understanding the perceived value your product/service offer creates for your customer. More specifically, for XaaS, do not ignore these two key sources of value:
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XaaS benefits: not just doing favors. In my introduction to this series of articles, “XaaS: 6 Keys To Success”, I mentioned that customers gain several benefits in an XaaS model: easier procurement, affordability and access, and automatic upgrades. There’s value for your customer in those benefits – and it’s your right to capture the value from that, within their affordability levels. It can be calculated – based on whatever new opportunities or cost savings you create for your customers.
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New features/functionality: making everything better. Companies considering combined product plus service offers can find pricing particularly challenging. For example, many IoT solutions include hardware, sold under the perpetual model, and services, sold in a subscription. Now there are two things to price – even more complexity!
Fret not – there is a solution.
This approach involves converting any incremental profit from your new offer into an XaaS package.This way, you are able to continue to deliver the margins and cash flow your investors expect, and you are able to convert some revenue to XaaS without risk.The hardware (perpetual) part of the offer is priced at bill of materials + your typical gross margin; the XaaS subscription is priced to capture the incremental value beyond the hardware price.
The next part dives into how to price a blended product/service offer.
Part 2: Pricing Design
Pricing is one of the most challenging parts of product and service design regardless of revenue model. It’s even more so for companies transitioning from a perpetual model to XaaS.
The temptation is to merely think of XaaS pricing in terms of payback periods or total cost of ownership. That is, many companies set their XaaS monthly subscription price so that the customer feels they come out “even” within a certain time period, usually 18 to 24 months.
If the perpetual offer price is $200, this could mean a monthly price of around $8.
Under this model, Adobe could have priced Creative Cloud at well over $100 per month at launch. But it did not – instead, Creative Cloud was launched at $50 per month. Has it worked? Adobe’s growing revenues, margins and share price indicate that it has worked very well indeed.
It’s Harder With Hardware
Pricing design becomes more difficult when blending purchase plus subscription. The durable goods manufacturer mentioned earlier considered its XaaS efforts a failure after recurring revenues reached less than 1% of total revenues. However, the flaw was not in customer appetite, but in the company’s own offer design: hardware in the solution was priced 100 times higher than the annual services subscription price!
This actually betrayed the company’s own appetite for offering XaaS. By trying to capture most of the value in the initial hardware sale, the company was reverting to its traditional business model of cost-plus pricing, and immediately realizing full margins and cash after acquiring a customer. The temptation to do this is immense – as I will discuss in a later article, XaaS requires a lot of guts, patience, and financial fortitude.
The Answer: Price = Perception
At the end of the day, for any good or any service in any (deregulated) market, prices are set by how much someone is willing to sell something for, and how much someone is willing to pay. This is as true for XaaS as it is for stocks, used cars, or dishwasher detergent.
Many factors determine the price someone is willing to sell at, and the price someone is willing to buy at. For example, when Adobe set the price for Creative Cloud, it clearly thought about customer’s ability to afford the price: “costs the same as a latte per day”.
Pricing experts build sophisticated models incorporating data on comparables, substitutes, elasticity, utility, payback periods, marginal costs – real Ph.D. stuff. Here, I want to focus on one critical component of pricing most easily overlooked in XaaS pricing: perceived value.
XaaS pricing should be set by deeply understanding the perceived value your product/service offer creates for your customer. More specifically, for XaaS, do not ignore these two key sources of value:
1. XaaS benefits: not just doing favors. In my introduction to this series of articles, “XaaS: 6 Keys To Success”, I mentioned that customers gain several benefits in an XaaS model: easier procurement, affordability and access, and automatic upgrades. There’s value for your customer in those benefits – and it’s your right to capture the value from that, within their affordability levels. It can be calculated – based on whatever new opportunities or cost savings you create for your customers.
1. New features/functionality: making everything best. Companies considering combined product plus service offers can find pricing particularly challenging. For example, many IoT solutions include hardware, sold under the perpetual model, and services, sold in a subscription. Now there are two things to price – even more complexity!
Fret not – there is a solution.
This approach involves converting any incremental profit from your new offer into an XaaS package. This way, you are able to continue to deliver the margins and cash flow your investors expect, and you are able to convert some revenue to XaaS without risk. The hardware (perpetual) part of the offer is priced at bill of materials + your typical gross margin; the XaaS subscription is priced to capture the incremental value beyond the hardware price.
This is a little tricky to explain, so I will publish a separate article focused on this.
I’ve worked on successful business model transformations in three of the world’s leading technology companies, covering all geographies. Are you looking for a strategic “secret weapon” to advise you on your business model transformation, without excessive hype or exorbitant information technology bills? I’d be delighted to discuss how I can put my experience to use on your business model transformation. Contact me. I am here to help.