Launching a Software Pricing Revolution
Sellers must improve price-benefit alignment in order to grow software industry sales.
By Erik Keller, Wapiti
Dec. 12, 2005
In the enterprise software market there were so many truisms: Hire a large sales force of ex-Oracle or -SAP sales sharks. Get a top notch R&D staff in the Valley. Get a CEO with a long track record. Simply connect the dots and watch the cash roll in.
These software startup SOPs have been supplemented over the past few years by more frugal funding mechanisms as well as having a larger portion of R&D and support services located in low-cost, high-quality regions including India, China, Romania - and Indiana. For some, open-source has become an interesting option.
While these changes are helping companies survive these slow-growth times, they have done little to fundamentally address an important issue that will continue to plague the software industry: the relative cost-benefit imbalance of any given solution. A dramatic shift in software companies' approach to pricing is needed in order to drive industry growth to the next level.
Unlike most other commercial and consumer markets, there is only a slight relationship between the cost (and ultimately the price) of any enterprise-software product and its benefits. In fact, most companies in the enterprise software industry continue to practice one of Peter Drucker's key business sins: cost-led pricing rather than price-led costing.
Regardless of whether a company is building a content management, human resource, order entry or price management solution, the costs of doing business are fairly consistent (see table). But as history often shows us, in the fledgling technology industry, past is prologue.
A look at the hardware business model of the 1970s - 1980s was very similar to that of software today. Today a combination of Intel, Microsoft and open source has created a dynamic in hardware that forces every supplier - from makers of cheap PCs to high-end multiprocessor boxes - to adhere to a very draconian business model. These influences have begun to hit the software market.
For example, most enterprise software companies sell their software for hundreds of thousands of dollars give or take. All have elaborate ROI discussions around how their technology will deliver a high and fast return on investment. But the relative impact on shareholder equity and return on equity are rarely discussed. Because everything appears alike, buyers are hard pressed to differentiate between content and customer data management, for example. Without a large, driving initiative such as Y2K or Sarbanes-Oxley, software companies perform sporadically as do their respective markets.
Last year, in my capacity as a Research Fellow in residence at AMR Research (no longer the case), I authored a view of risk-reward for a broad array of enterprise applications. (see chart).
When you look at these initiatives, with few exceptions, there is little difference between the business model of software companies offering such solutions. All have R&D, marketing, sales, and other staffs costing the same per person. All operate in nearly the same fashion forcing them to look very similar from a supply perspective and easy prey for Drucker's cost-led-pricing sin. Yet all have very different risk-reward profiles and thus different value for buyers. And if you haven't noticed, software has a totally different profile than nearly any other market.
Unfortunately, most industry analysts (Wall Street and market research) are unable to identify this issue and offer help to buyers and sellers as to what connotes a good "price" for a given benefit. And there is little chance of this happening as most sector analysts (for example ERP, CRM, SCM, and so on) are as biased toward their market spaces as the vendors they cover. It would be the rare analyst who would write, "My space has become less important to corporate profitability so clients should decrease investments by 30 percent in the coming year." As a result, all analyst reports read remarkably similar in why corporations should invest in a given technology. They sound eerily like Wall Street analysts' reports in the late 1990s were recommending nearly any technology stock regardless of fundamentals.
These software startup SOPs have been supplemented over the past few years by more frugal funding mechanisms as well as having a larger portion of R&D and support services located in low-cost, high-quality regions including India, China, Romania - and Indiana. For some, open-source has become an interesting option.
While these changes are helping companies survive these slow-growth times, they have done little to fundamentally address an important issue that will continue to plague the software industry: the relative cost-benefit imbalance of any given solution. A dramatic shift in software companies' approach to pricing is needed in order to drive industry growth to the next level.
Unlike most other commercial and consumer markets, there is only a slight relationship between the cost (and ultimately the price) of any enterprise-software product and its benefits. In fact, most companies in the enterprise software industry continue to practice one of Peter Drucker's key business sins: cost-led pricing rather than price-led costing.
Regardless of whether a company is building a content management, human resource, order entry or price management solution, the costs of doing business are fairly consistent (see table). But as history often shows us, in the fledgling technology industry, past is prologue.
A look at the hardware business model of the 1970s - 1980s was very similar to that of software today. Today a combination of Intel, Microsoft and open source has created a dynamic in hardware that forces every supplier - from makers of cheap PCs to high-end multiprocessor boxes - to adhere to a very draconian business model. These influences have begun to hit the software market.
For example, most enterprise software companies sell their software for hundreds of thousands of dollars give or take. All have elaborate ROI discussions around how their technology will deliver a high and fast return on investment. But the relative impact on shareholder equity and return on equity are rarely discussed. Because everything appears alike, buyers are hard pressed to differentiate between content and customer data management, for example. Without a large, driving initiative such as Y2K or Sarbanes-Oxley, software companies perform sporadically as do their respective markets.
Last year, in my capacity as a Research Fellow in residence at AMR Research (no longer the case), I authored a view of risk-reward for a broad array of enterprise applications. (see chart).
When you look at these initiatives, with few exceptions, there is little difference between the business model of software companies offering such solutions. All have R&D, marketing, sales, and other staffs costing the same per person. All operate in nearly the same fashion forcing them to look very similar from a supply perspective and easy prey for Drucker's cost-led-pricing sin. Yet all have very different risk-reward profiles and thus different value for buyers. And if you haven't noticed, software has a totally different profile than nearly any other market.
Unfortunately, most industry analysts (Wall Street and market research) are unable to identify this issue and offer help to buyers and sellers as to what connotes a good "price" for a given benefit. And there is little chance of this happening as most sector analysts (for example ERP, CRM, SCM, and so on) are as biased toward their market spaces as the vendors they cover. It would be the rare analyst who would write, "My space has become less important to corporate profitability so clients should decrease investments by 30 percent in the coming year." As a result, all analyst reports read remarkably similar in why corporations should invest in a given technology. They sound eerily like Wall Street analysts' reports in the late 1990s were recommending nearly any technology stock regardless of fundamentals.
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