Dude, Where’s My Predictable, Growing Revenue? XaaS Key #2
Right Product And Service Design
Part 1: Good, Better, Best
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.
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:
“Just bundle everything together in one package, one price – so simple, it sells itself!”
“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:
“Why are our recurring revenues still so small?”
“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.
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:
Note how well Salesforce.com designed this cascade of offers:
1. 4 separate packages;
2. A clear indication of increasing features and functionalities by package;
3. “Good” (Essentials) clearly positioned as a basic, entry-level package;
4. 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.
Next, let's continue with discussing XaaS pricing: common mistakes, how to avoid them, and how to do it right.
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 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:
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.
2. 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.
Part 3: Mixing It Up – Blended Product/Services Offers
A lot of product companies want to build anything-as-a-service plays. In my introduction to this series, “From Transaction To Relationship: 6 Keys To Winning In XaaS”, I mentioned these examples:
Hewlett Packard: in 2019, signaled it will make its entire portfolio available in XaaS offers by 2022.
Cisco Systems: in 2020, longtime CEO John Chambers said "If I had to do Cisco over, I'd do it all as a subscription based model”.
Of Course You Do It. Everybody Does It. Right?
Yet not every product company moves to XaaS. And not every product company moves to XaaS elegantly:
XaaS? Whatever: Too often, product companies will price a new connected/”smart” product at a premium, and then will treat the XaaS component of the offer as an afterthought, capturing no value from XaaS.
Example: a B2B durables company charging $800 for a $50 piece of IoT-enabled commodity networking hardware. Then pricing IoT services at $2.99 per month. Then wondering why their XaaS revenues are so small.
Surprise!: Others will intend to capture value from XaaS – but will forget to make the recurring monthly services clear to customers, leaving them confused about why they have to pay so much every month after having already paid for a product.
Example: my bicycle trainer cost me $300 – but to actually use it, I have to pay another $60 per month for the app that controls it. I didn’t know the app was required when I bought the trainer – and I can assure you, I won’t buy from them again.
Outta here: Still more will simply abandon XaaS altogether, moving back to a purely product-only offer. Or they won’t even try in the first place.
Example: too many to mention!
Unsurprisingly, the most common concern I hear from product companies wanting the benefits of XaaS but too hesitant to try is how to price their combined product and service offerings. For example:
Do I make the product free, and only monetize the services?
What’s the appropriate pricing blend between the product I sell up-front, and my XaaS packages? 70:30? 60:40?What’s making this so difficult?
Cash Is King
In my introduction to this series, “From Transaction To Relationship: 6 Keys To Winning In XaaS”, I also mentioned that XaaS is similar to a leasing model. Fundamental to leasing is the concept that the buyer can have access to a product or service, without having the full amount in cash required to immediately purchase that product or service. Therefore, the seller also does not receive the full cash amount of the product or service value up-front, but over time.
However, the typical product sales model involves buying raw materials or components (cost of goods sold), adding value to them (gross margin), then selling them (revenue), then receiving cash, one-time, for the full value of the product.
So for product companies, cash is king:
I want value: A lot of product companies are “value stocks”, meaning that investors reward management for delivering consistent cash, not for plowing cash into innovation – including new business models.
I want it now: Product companies aren’t accustomed to capturing “deferred” cash flows. Instead, they’re accustomed to selling their product and then receiving the full cash amount within 30-45 days.
Junk in the trunk: Product companies have something most software and services companies don’t: significant cash tied up in components, raw materials, and finished product: inventory. Lots of money in inventory means lots of cash tied up. Lots of cash tied up makes value stock investors unhappy. And lots of unhappy value stock investors can make management at value stock companies…unemployed.
Rocket science: Some product companies in mature, commoditized businesses may still be practicing cost-plus pricing, delivering the cash their value investors demand, but requiring very little pricing innovation. Any pricing models involving deferred value capture, penetrating product to drive services revenues, recurring relationships…require skills typically not in the typical product company toolkit.
So What Do I Do?
Above, we covered how to price XaaS offers. I mentioned that pricing XaaS for product + services offers is tricky. But I also mentioned that there is a way to do it.
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 profits and cash your investors expect, and you are able to convert some revenue to XaaS without risk. The product (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 product price.
In Plain Language, Please!
"Speak to me as you might a young child, or a golden retriever. It wasn’t brains that got me here, I assure you that."
John Tuld, “Margin Call”, J. C. Chandor, Lionsgate and Roadside Attractions, 2011
Let’s say your company, Widgetech, makes widgets. It costs you $5 to make a Widget Classic. You sell it for $10. Your gross profit is therefore $5 per widget, or 50% gross margin. In fact, since you are in a stable business, your gross margin has been 50% since the 1960’s, and your boss, the CEO and his or her bosses, the board of directors, reward you handsomely for keeping the margin right at 50% (this happens more often than you may think). Being extremely simplistic, you make $5 in cash for every widget. (Figure 1)
You hire some smart whipper-snapper strategy geek to shake things up in your company, because you’ve heard of this XaaS stuff and how wonderful it is. We’ll call this person SG, for simplicity. SG recommends making your product connected, with some memory and some firmware added, and creating a suite of related applications and services. This newfangled widget, let’s call it Wonderwidget, costs $6 to make.
While SG leaves to get a cup of coffee, your management team proposes pricing the Wonderwidget at $12. That way, you would earn your typical gross margin of 50% on a gross profit of $6 ($12 - $6 = $6; $6 / $12 = 50%). Heck, you even earn $6 in cash (again, very simplistically). (Figure 2)
Everybody’s happy, right?
We’re Gonna Get Our Bonus! Right?
No, everyone is not happy.
SG comes back into the room with a fresh keg of steaming hot latte, and says no to the pricing scheme. SG has done their homework and figured out that customers are willing to pay $15 for Wonderwidget, based on:
Customer surveys and focus groups;
Genuine benefits the Wonderwidget creates for customers, in terms of productivity value, time saved, etc.
$15 for the Wonderwidget? GREAT! Now your gross profit is $9 ($15 - $6 = $9), and your gross margin is 60% ($9 / $15 = 60%). Again, being extremely simplistic, you make $9 in cash per wonderwidget. Margins are up, cash is up, everyone is happy. You want to give SG a raise, maybe you’ll even let SG fly business class for once. (Figure 3)
Everybody’s happy, right?
Hold It Right There
No, everyone is still not happy.
You’re still not getting the benefits of XaaS, notes SG.
SG proposes setting the up-front sales price of the product at $11, holding the gross profit per Wonderwidget at $5 and the (simplistic) cash at $5. Then, SG proposes different services packages to offer on a subscription basis.
Your controller, product managers, and the sales manager (you invited him/her to the meeting as a guest on a junket) explode. Our margins will erode! We won’t get out bonuses! You’ll destroy the business!
Why The Heck Would Someone Do This?
Easy. You’re (very simplistically, again) earning the same cash you did as before - $5 per widget. But now you have a full $4 ($15 - $11 = $4) of value to capture in XaaS offers (Figure 4).
And, you realize all the benefits of XaaS: (Figure 5)
1. Predictable, smoothed revenues.
2. Predictable, lower costs.
3. Larger addressable markets.
4. Sticky, direct customer relationships.
You’ve got room to experiment with the service package pricing – it’s essentially risk-free money, since your product price is below what your customer perceives as the value of the solution, it includes your typical profit, and you therefore are delivering roughly similar cash flows.
What’s Going On Here?
This approach relies on the concept of perceived value, which I had the privilege to learn from Professor Mohanbir Sawhney at the Kellogg School of Management (I barely deserved the “B” I got in his course, I assure you that!).
Professor Sawhney defined perceived value as “the perceived worth of the set of benefits received by a customer in exchange for the total cost of the offering, taking into consideration available competitive offerings and pricings.” (Mohanbir Sawney & Deval Parikh, “Where Value Lives in a Networked World”, Harvard Business Review, Jan. 2001).
There are two key implications:
Price is not based on the vendor’s cost, or on traditional margin expectations.
Customers will pay an incremental price for something, if the incremental benefits outweigh the incremental cost.
In this example, SG figured out that customers saw the incremental benefits of Wonderwidget as being worth $5 more than Widget Classic. Therefore, the vendor can set the price of Wonderwidget up to $5 higher than Widget Classic.
But Wonderwidget only costs $1 more to make. And for a company working to deliver cash to investors, Widgetech is tempted to capture that $4 in incremental profits immediately. But this won’t deliver XaaS benefits to Widgetech.
Say It Again, SG
So here is a summary of how to make blended product/services offers: (Figure 6).
1. Calculate the total perceived value of the new solution.
Take the existing price of the old solution.
Calculate the incremental perceived value to your customer. You do this through customer surveys, focus groups, comparisons to comparables, and a deep understanding of the benefits you can actually deliver to your customers.
Add the incremental perceived value to the existing price. This becomes the new value you are entitled to capture from the new, XaaS-enabled solution.
2. Calculate the new product price.
Take the existing cost for your existing, non-XaaS-enabled product.
Next, calculate your incremental costs for the new solution that can support services, through connectivity, applications, etc. This is your incremental bill of materials for connectivity, and new operating costs for development, IT operations, etc. (We left out the operating costs in the above example, for sheer simplicity.)
Add the incremental costs to your existing costs for the old solution. This is your new cost for the new solution.
Take your typical gross profit, and,
Calculate your new product price by adding your typical gross profit to the new cost, ensuring you can deliver cash to your shareholders.
3. Calculate your incremental XaaS value.
This is the total value, less product price. Design services packages to capture the incremental XaaS value. As mentioned, you’ve got room to experiment with the service package pricing – it’s essentially risk-free money, in this simplistic model.
What’s The Catch?
What if the incremental perceived value is less than the incremental costs? Then you have a problem – either your customer doesn’t see much value in the new solution, or it costs too much to deliver that value. But don’t throw the baby out with the bath water – iterate.
This financial model is simplistic; it assumes gross profit is cash. Obviously, it isn’t, and obviously, there are going to be several incremental costs to offer services on top of a product platform, including new IT, sales, and marketing capabilities. I wanted to highlight the basic concepts – which can be expanded to include these costs. In a future article, I’ll talk more about the new skills and capabilities required to offer XaaS – and how there’s a vibrant ecosystem of enabling solutions that relieve you of the burden of doing it all yourself, from scratch.
Hopefully that simplifies things around combined product/service offers. But there are some other tough choices to make, which I will highlight in the next section.
Part 4: Three Tough Decisions
We’ve discussed product/service design and pricing, offering some rules for how to successfully create the right offers for customers. In offering XaaS, however, you’ll confront some difficult decisions that can’t easily be solved with rules. So here I’d like to lay out the “open issues,” tradeoffs, and challenges that are not easily solvable – but at least you can be aware of them.
Most of these relate to achieving the ultimate success for XaaS plays: becoming a platform.
Platforms: Make the World Your Stage
I’ve heard, and even heard myself saying, things like this:
“We want to be the operating system for lighting.”
“We want to be the IoT platform for Smart Cities.”
“We want to be the SaaS platform for human resources.”
We all know that ‘anything-as-a-service’ pales as a buzzword compared to platforms. Platforms are the holy grail of business: occupying a place in the ecosystem that everyone else must go through to make money.
Good platforms are value-added toll booths, giving you access to customers along with a treasure trove of support and analytics. Bad platforms are just … well, toll booths that annoy customers and other ecosystem players alike.
Many companies contemplating XaaS offerings are aiming to become a platform, and charge others for the privilege of doing business with the rest of the ecosystem. But very, very few get this right: after all, there was only one Steve Jobs, and Apple expended considerable effort creating the Apple University to try to replicate his genius after his passing.
So, central to many of the challenges of designing XaaS offers is the platform question.
There are three tough strategic decisions to make in product and service design and pricing – mostly related to seeking a platform role:
1. Penetration/adoption pricing versus premium pricing
2. Closed versus open systems
3. Future-proofing versus replacement cycles
Let’s dig deeper into all three.
1. Penetration Versus Premium: Pay Me Now, Or Pay Me Later
In my last article in this series, “Mixing It Up – Blended Product/Services Offers,” I noted that hardware companies skew towards capturing all value in a single, one-time sale. For hardware companies looking to capitalize on IoT, a common means to offering services, the preference will be to use tried-and-true pricing strategies. So new product lines are priced at a sizeable premium compared to existing products, and then prices decrease, often around 30% per year, as competition, commoditization, and familiarity take hold. This strategy isn’t necessarily bad – after all, it has served companies well for ages.
Startups also often follow the premium pricing approach since they often lack the luxury of being able to wait to capture value. I know of XaaS startups whose strategies include making implementation a profitable, paid service, in order to maximize revenue now.
However, if you are trying to establish a platform, your strategy might be different. If you want your platform to offer your own or third-party future services, or are trying to create an industry-wide standard, you might to price lower in order to drive penetration – before someone else does. And you won’t want to charge customers to implement your product or service as it just creates another barrier to penetration. No doubt a lower price will depress your revenues and profits now but it has the potential to capture sufficient market share to make yours the platform of choice.
In either case – make your call on penetration versus premium pricing. And stick with it.
Example: Pricing for Penetration. In my second article in this series on pricing design, I noted that Adobe priced Creative Cloud well below what many thought was a reasonable price. Creative Cloud replaced a “perpetual” (buy it once, own it forever, but with no upgrades) product priced around $2,500 with a subscription policy. Using the simple math I laid out in the previous article, Creative Cloud could have been priced at $100/month.
It wasn’t. Instead it launched at $50/month, with promotional offers as low as $30/month. The lower $50/month pricing fulfilled several key strategic objectives:
Proof of concept: rapid conversion of the Adobe customer base to Creative Cloud built strong early subscriber numbers, helping to demonstrate the validity of the SaaS approach.
Standard: it cemented Adobe’s role as a creative industry software standard.
Platform: it also created a platform for offering new applications, including third-party applications.
Example: Pricing For…What? A durable-goods manufacturer I worked with struggled with how to package and price XaaS offers as it introduced new IoT-enabled products. Some camps in the company argued for low, penetration-based pricing to build a sizeable user base and data sets that could be monetized in the future. Another camp insisted all new products should be priced at a (huge) premium, then over time lowered in price, following the usual product pricing strategy. This camp also argued that, since future revenue flows from not-yet-developed emerging services and data monetization could not be accurately forecast, the penetration pricing strategy could not be followed, or even trusted. Regardless of which camp was right, the point is that pricing arguments delayed the launch, costing the company critical time in establishing a platform play.
2. Closed Versus Open: One Big, Or Many Small
We’re all familiar with closed versus open platforms: iOS versus Android, Amazon Kindle versus Barnes & Noble Nook…the list goes on. Even bicycle components can be open or closed platforms. Until recently, Shimano and SRAM components were relatively interchangeable, whereas Campagnolo components only worked with other Campagnolo components. (Much to my relief, I can now use a Shimano Ultegra cassette on my Campagnolo Potenza groupset, saving me the cost of a new hub for my custom wheel … but I digress.)
Product companies face a multifold predicament when offering services on top of their products: Will their services work only on their own products? Will they allow services from other vendors to work on their products? And will their products work together with other vendors’ products, in a total solution, or only their own products? (Figure 1)
It’s a tough decision, with multiple tradeoffs. Many textbooks have been written on this subject, so I’ll focus purely on the issues for companies new to XaaS, particularly hardware companies.
If you use a walled-garden approach in your transition to services, you could realize significant benefits:
All mine: You will capture 100% market share of products and services in your solution – since you lock out your competition from your product and service solution.
I’ll take more: You potentially also capture higher market share than usual, since every product and service in a given solution must come from you.
Better together: Also, you may speed up adoption, since you design and develop all of your products to work seamlessly together, and don’t have to conduct costly and laborious interoperability testing with others.
But this comes with significant risks:
You’re not alone: You may not gain very much market share in the overall market – unless you are clearly first, and clearly better. It’s unlikely your traditional competitors aren’t already developing their own services-enabled products and suites of services.
I’ll get back to you: You may stunt the growth of the overall market, since customers need to make permanent decisions on which vendor’s solution to select. They may not have enough information for this.
Variety is the spice of life: Market growth could be slow since customers may be accustomed to mixing products from several vendors, and don’t want to be told to purchase a full solution from one vendor. For example, in the lighting industry, very few full large-scale lighting projects such as large office buildings or outdoor city lighting come from a single vendor.
I thought this would be easy: Finally, if you have limited experience with developing new apps – a reality that most incumbent product companies considering IoT have had to face – you face the prospect of slow growth of your services revenue. Since you won’t be enabling other companies with more applications experience to access your platform, customers can only use the applications you develop, as you learn to develop them. They will not have access to a selection of competing applications from experienced application developers, and may not see the value in your product + services offering at all.
The core consideration for product companies is this: fragmentation. Commodity, mature markets can be very fragmented. And often B2B sales are based on projects, with customer preference to have multiple vendors involved in each project. In this environment, being closed may work at first, but ultimately will be challenging to maintain.
Example: Half-Open, Half-Closed, Fully-Confused. A durable goods company I worked with struggled for years to determine whether to offer a completely closed solution of IoT-enabled products and proprietary applications, or to open up their IoT platform to third party applications. “Opening up” was a completely novel and terrifying concept for a company, accustomed to fighting over individual unit sales and market share, and now dealing with a fragmented market characterized by sourcing products for individual projects from multiple vendors. But this company had very limited information technology skills.
Different groups within the company argued over closed and open approaches – and even launched the two approaches alongside each other. The result was stalled development efforts, confused go-to-market, repeated market launch delays, very slow market adoption after launch, and missed opportunities.
3. Future Proof Versus Refresh: (Don’t?) Play It Again, Sam
We’ve all faced that time-honored question as consumers: do I fix it, or do I replace it? But increasingly, we’re faced with a different dilemma: do I need to upgrade it, or not?
Future-proof products can add functionality without the customer having to buy a new generation – at least anytime soon. Refresh cycle products require the customer to buy a new product to get the new functionality. Sometimes they’re called “forklift” products when the customer actually needs to remove and completely replace the older-generation product.
If your goal is to be a platform play, it’s not obvious whether you should make your products future-proof or refresh-oriented. Each approach has both advantages and drawbacks for vendors: (Figure 2)
Let’s focus on one of these factors, as an example: uncertainty. A former client of mine, a new-entrant telecommunications company, asked us to create a product and services strategy. My manager on the strategy project suggested a platform strategy, including the required network and services components to enable “not-yet-invented emerging services.” A client team member then asked, “Can you give me an example of a ‘not-yet-invented emerging service.’” My manager innocently replied, “Well, no, because they haven’t been invented yet.” All humor aside, the point is important: it’s hard to predict where customer needs will be in 5 months, let alone 5 years, but future-proofing does require making tough decisions on functionality and product specs. This is especially true of white goods with a long lifespan.
Of course, the most important perspective on these two approaches is the customer’s: (Figure 3)
Again, let’s focus on one of these, for example, “forklifting.” For cyclists, “What do you ride?” doesn’t refer to frame brand or material. It refers to components, or groupsets. Shimano and SRAM groupsets aren’t rebuildable: if a part breaks in your Shimano gear shifter, you’re buying a new one. They behave more like refresh products. Campagnolo components, on the other hand, are rebuildable, and highly backwards-compatible as long as the number of gears does not change, making them somewhat future-proof. They behave more like future-proof products.
However, all groupset manufacturers break the future-proof mold when they add more gears to the cassette (rear gears). The vast majority of cyclists don’t care whether there are 10 or 11 gears in the rear cassette – except when you break a part in a gear shifter, find out the part is specific to the 10-gear version and has been discontinued, and you have to buy an entirely new groupset. Because of one broken part, and a generation-change in product by the vendor, all of your other components are now obsolete and must be removed just to replace one faulty part. (Yes, this happened to me. And yes, it annoyed me to the point that I exercised my right to change vendors.) In this case, vendors are forcing you into a refresh situation, when you thought you were owning a future-proof product.
We All Get Trophies!
I’m not saying there is a right or wrong approach on any of these three critical decisions:
1. Penetration/adoption pricing, versus premium pricing
2. Closed versus open systems
3. Future-proofing versus replacement cycles
I am saying, however, that you can thoughtfully analyze your situation – your market, your customers, your competition, your capabilities – to come to the right decision.
What’s Your Take?
I’m interested in your take – especially if you work in a product business that has considered XaaS offerings, and/or considered platform plays. What challenges have you faced? What are the tough decisions you have confronted? Comment here, or feel free to contact me. I’d love to hear from you!