If you are like most businesses, you struggle with the age-old problem of trying to define the perfect price for your service. You also struggle with what can and is offered as a service. While this is true for all industries, in cloud service it is a particularly acute problem. It is important to remember that the cloud market has plenty of opportunity for providers to differentiate offerings or for completely new providers to enter the market and compete. However, unseating the market leaders will not come from selling commodity services.
While providers like the old recurring, predictable contracted revenue model, customers are becoming more educated, have more visibility and are demanding that their bill be better aligned with their actual consumption. In addition, service differentiation does not mean simply bundling multiple features to justify a single flat price regardless of a customer’s interest. Customers are reacting to the “tyranny of packages” as they realize they are being forced into a commodity model. There is no question that the value-add bar needs to move higher and service providers need to build tailored, high-margin, sticky relationships with customers. Using financial commitments, you can achieve predictable revenue while providing customers with elasticity to utilize reserved instances, on-demand instances, bandwidth etc.
Defining Your Price
The key to defining the perfect price is highly dependent on the perception of value on the part of both the customer and the supplier. I want to stress both because the concept of a two-way commitment has somehow gotten lost in billing for cloud and many other services. What is often misunderstood and not planned for is that simple solutions often have consequences that are hard to recover from—one of the most obvious is service commoditization when you cannot differentiate beyond the box you are in. It’s time to take a fresh look at the myth surrounding how companies price their offerings. For example, if you were to believe the hype, every company should be selling every service as a subscription. I have highlighted what is going on with subscriptions and over-simplification in previous blogs.
We all intuitively know that it is sometimes easier, particularly when you are starting out, to be tempted to keep things simple and go with a single subscription price for a service. It may also be tempting to choose a pricing strategy that does not take into account the fundamental concept of a two-way commitment. This was at the heart of the definition of a subscription service well before the Internet became so pervasive in our daily lives. You remember those days, a subscription in which the customer and service provider both benefit—the service provider can cover costs, maintain margins and grow the business while the customer receives value and is treated fairly. So what happened? Well, along came vendors looking to bring a simple and easy to understand concept to the masses that also coincidentally supported what their limited products could do. The concept of a two–way commitment was missing and more unfortunately, for the service provider, service differentiation and stickiness was also gone.
Drawbacks of the Single Subscription Pricing Model
If you are only able to price based on a single subscription price, you have split the market into those customers that are happy to get the service and those customers for whom it is not a good value. How does this impact the business? As a service provider you have some population of “Gobblers” who are over utilizing your service. Will you always have enough low-cost users to offset them? Will low feature users develop a sense of unfairness in the pricing? After all, they are paying the same amount as the Gobblers, this may adjust their perception of the value over time and result in increased churn. They are also susceptible to simple and niche services. In SaaS, for example, one of the big promises is constantly increasing features and functions for the same price. But does that make sense? How big are the potential audiences for these features? How can you get more?
Customer’s behavior and the service usage has some degree of variability. If you add more price points and limitations on features available at those price points then you are bounding customer behavior to smaller and tighter boxes. Bumping into cliffs and walls are not comfortable and inviting customers to re-evaluate their purchase of your service on a frequent basis is also not a good idea. Spending more money might invite a new purchasing process and evaluation hindering business agility for both vendor and customer.
You can try to add more features to entice new customers, but often bundles are perceived as negatives: PC Bloatware, having to get a Sunroof and Mag wheels with your Bluetooth radio on a car package, the list goes on…
The Consumption Model
Some may propose as an alternative to give up on subscription billing models and focus on consumption models instead. This can be a good strategy if you focus on value. But vendors must be careful in defining what the value metric is. A good current example of where this is going wrong is IaaS. IaaS is one of the most popular consumption based pricing models around these days. However, how does a customer perceive the value of one compute-hour versus another, how does one differentiate a gigabyte of usage? So it is easy in a pure consumption model to align your pricing so that it is in proportion to customer utilization and costs to provide, but when the customer perception of value is just on a commoditized unit of measure, then your pricing will face huge competitive pressures. Rightscale publishes surveys of cloud computing pricing models and you can see the fierce competition in an undifferentiated business is pushing prices down very rapidly.
Service providers across industries need to track more forms of utilization and establish new measures of value. They also need to allow customers to use more if they want to but be aware of consequences. The key is transparency as well as the flexibility to adapt, change or tailor service offerings to drive service differentiation and stickiness. We’ll continue exploring this topic in subsequent blogs.
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