Why tying B2B software pricing too closely to usage and performance is risky

Fast Company

4 days ago

During tough economic times, buyers' usage and performance often take hits, leading to financial losses for B2B software companies.
[Courtesy of Chris Mele]
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Picture this: You decide to focus on your fitness and order a monthly protein bar subscription. The protein bar company tells you that it will only charge you for the products if you build a certain percentage of muscle in the first year.
That pricing strategy is absurd—certainly a great deal for you, the customer, but a bad one for the protein bar company. You could eat every single protein bar in your subscription, but still not build a certain percentage of muscle in the first year because you have a habit of skipping the gym.
The problem with pricing strategies like this is that they tie pricing not only to customer usage but also to customer performance. I've yet to see a protein bar company that uses such a pricing approach, but unfortunately, I've seen many B2B software companies link their pricing to the usage and performance of their customers. Essentially, some leaders of software companies go beyond arguing that their products provide value; they are so convinced that their products are foolproof that they argue that, actions aside, customers will get results. Software companies that tie their pricing too closely to customer usage and customer performance often end up suffering, especially during uncertain times.
On the surface, heavily tying pricing to customer usage and customer performance in the software world doesn't look as extreme as the two examples above.
Some software companies might opt for one or the other—and/or have a softer interpretation. For instance, in terms of usage-based pricing, a corporate messaging solution provider might charge buyers by the number of active users or storage consumption. Moreover, not every example of usage-based pricing has the same level of risk. As for pricing centered on customer performance, a CRM solution provider might charge by the number of qualified leads a buyer produces with its software or by taking a percentage of revenue a buyer generates through its software.
When the economy is doing well, sure, pricing tied to customer usage or customer performance can keep software companies afloat and even result in record profits. In a booming economic environment, buyers with usage-based pricing are likely to be willing to write larger checks for more users or storage. Buyers with performance-based pricing will be more likely to generate leads and revenue in a prosperous economy, leaving the software vendor with a larger share of the profits.
But when the economy starts to decline, that's when software companies that have made their pricing too reliant on customer usage or customer performance—or worse, on both customer usage and customer performance—can find themselves in trouble.
Tying pricing too heavily to customer usage and customer performance can harm software companies during times of economic uncertainty. Under a strained economy, buyers' usage and performance often take hits.
For example, in terms of usage-based pricing, a software company that charges for the number of quotes generated through its platform might see a drop in numbers during tough economic times, as its customers have less of a need and lower budgets.
As for performance-based pricing, consider the same software company instead charging for the number of quotes won through its platform. If those buyers start making less during an economic downturn, the software company could be left with even less.
It is imperative that software company leaders revisit their pricing models as soon as possible to strike a balance between predictability for their companies and flexibility for their customers.
Software company leaders should proceed carefully and thoughtfully, with detailed rollout plans that include iteration and testing schedules, when making more substantial changes to their packaging and pricing. An example of a larger change would be a software company's executives changing the basis by which they charge for the software, such as moving from the number of users to the number of surveys, especially during uncertain times.
As far as the trifecta of licensing, packaging, and pricing, it's generally riskiest for a software company to change its licensing model. Pricing and packaging iterations tend to be less risky.
Regardless of which part of the trifecta software company leaders want to change, they should take strategic de-risking measures. The specific de-risking measures they should pursue depend on their unique circumstances. However, there are several approaches they can consider.
For one, they could revisit their offering models. When revising their offering model, executives of a software company could look for a lower entry point on an offer with less functionality, explore various sales promotions, or revisit their minimum purchase threshold, to name a few options.
Software company leaders should also consider examining their cost structures to identify potential optimizations. By doing so, they can reduce their spending without impacting their margins or increasing prices for their customers.
Software company leaders could also increase implementation support to help customers get onboarded more quickly, which, in turn, enables them to see the value of the software faster. For instance, instead of taking six months for implementation, software teams could set a goal to reduce the timeframe to three months.
Additionally, software company leaders might consider offering managed services. For instance, if an email marketing solution provider notices that its customers are laying off large numbers of marketing employees, it could offer a managed service to help those customers with email marketing in the interim.
Finally, software company leaders could offer temporary sales promotions that protect their companies while giving customers some breathing room. However, they should make it clear that these price cuts are temporary sales promotions and not permanent. Permanently cutting a list price can backfire in a big way—cut a $1,000 list price down to $500, and good luck bringing it back up to $1,000 even once the economy gets better.
During turbulent economic times, software companies should clean up and de-risk their products and pricing. If they're struggling or taking a hard hit, they should consider making larger changes to prevent further damage. However, at the core, the software companies that avoid tying their pricing too closely to customer usage and customer performance stand the highest chances of survival when uncertain times hit.
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