Aligning Pricing Strategy with the Technology Adoption Life Cycle
Whenever a new category emerges, as AI is doing today, as SaaS and mobile and cloud computing have each done earlier in this century, markets develop through four distinct stages of adoption, each of which calls for a different pricing strategy. Getting this right means first agreeing on what stage of adoption the category is in and second committing to the pricing strategy appropriate to that stage. Here’s how it plays out.
The Early Market: Pricing and the Project Playbook
The early market is the time for first movers, so by definition, there are no established reference points for pricing the product. There are, however, established norms for pricing professional services projects, so the reference price from the buyer’s point of view is based on an estimate of what it would take a highly skilled project team to develop the offering from scratch.
Given how early it is, this is also a good reference point for the vendor as well because it must do an enormous amount of special engineering to get these first implementations up and running to the customer’s satisfaction. That includes not only a project team for implementation, but also a forward-deployed engineering team to co-innovate with the customer to ensure they get the results they value most, as well as to create a direct line to the product engineering team, who will modify the product roadmap as necessary to prioritize whatever is needed to complete the project.
The goal of early market development is to create a flagship reference account that shows the world what good could look like. This will likely be a money-losing effort in the short term but a huge boost to market development going forward. The customer must be prepared to write a big check to underwrite the effort, something visionary customers are willing to do, provided they get a bespoke outcome as a result. The vendor also wants to see a big check, not just to help cover the cost of all the non-recurring engineering that will be required, but also to serve as testimony to how valuable their new offering is.
The pricing mistake vendors make at this stage is to write a contract that assigns the bulk of the price to the product and tacks on the services on a highly discounted basis. That is intended to introduce a premium price point for subsequent market development. Unfortunately, this approach runs counter to the customer’s expectation they have bought a project, not a product. If you discount the services, they have no incentive to stop consuming them, and the project can drag on forever. If, by contrast, you price the services at no discount and discount the product to make up the difference, now you are both aligned to parting ways sooner rather than later. You can still use the total price of the deal as a reference point for marketing purposes because its internals are opaque to the outside world.
Crossing the Chasm: Pricing and the Solution Playbook
To penetrate a mainstream market with a disruptive innovation at a time when you have few customer references, no established ecosystem, and the technology is still under evaluation, your target customer has to have a truly compelling reason to buy. Typically, this consists of an urgent need to address an industry-specific business process that is not only underperforming but deteriorating as well—IVR phone trees in customer service, taxis in competition with Uber or Lyft, retail banks losing their next-generation of customers to all-digital fintechs, or e-commerce websites that either nobody comes to or they leave shortly thereafter without buying anything.
In such circumstances, process owners will have tried all the available fixes to their problem and will still find themselves losing traction. In short, they are desperate for a solution, and that is what makes them willing to listen to a new entrant. A solution is precisely what you must deliver to win their business. In marketing parlance, we call this the whole product, the precise set of products and services needed to fulfill the target customer’s compelling reason to buy. That is what the customer wants to buy and pay for—no less, no more.
This lends itself to solution bundles that are priced relative to the use case they address. Pricing is value-based, the value being calibrated by the costs entailed by the current system’s underperformance, combined with the costs of whatever vendor solutions are currently in place, and further calibrated by the risk entailed in not addressing additional performance deterioration. From the vendor’s standpoint, these offerings are high margin because the cost to deliver decreases as the solution becomes standardized, the cost of marketing decreases as more customers come into the fold based on peer references, and the bill of materials decreases as more and more of the whole product becomes baked into the core product.
Different vertical target markets will have different problem use cases, so you can price each solution bundle separately as long as it has been sufficiently customized to be specific to that industry. This represents a terrific pathway to get to $100 million or more in ARR. At some point, however, if the technology is broadly applicable, it will transition from niche market vertical adoption to widespread horizontal adoption, leading the next stage and its playbook.
Inside the Tornado: Pricing and the Product Playbook.
You know a tornado is forming in your emergent technology category when, for the first time, your sales team calls on the customer, they already have allocated budget for your offer, or they have already sent out a Request for Proposal. This is what happened, for example, with smartphones and mobile apps in the first decade of this century and cloud computing in the second. It initiates an intense battle for market share, typically resulting in one company gaining gorilla status and by so doing garnering the largest share of the profit pool along with a global ecosystem organized around serving its customer base, one that will keep its power for many years to come. This outcome is not lost on investors, such that the company’s market cap escalates to an entirely new price point, which it will hold for a very long time.
Pricing inside the tornado should make the product easy to sell. This applies both to the price points per se, but also to the time and effort it takes to close the contract. Tornadoes only last for a few years, so the focus has to be on gaining as much market share as fast as possible. The caveat is that these customers must be retained in order to succeed, such that the cost to acquire can be amortized over future consumption as well as upselling and cross-selling additional products.
The competition will be fierce as every vendor in the category has gorilla game aspirations, but only one can actually win. If you find yourself falling behind in this race, the best strategy is to pull back into niche markets where the whole products are sufficiently demanding and the market segments are small enough to escape the interests of the top players.
The goal of the tornado phase is to build as big an installed base as you can before the market transitions to the fourth and final stage, the one where virtually all the profits from the new category will be realized.
On Main Street: Pricing and the Consumption Playbook
For the first time in the life cycle, we are now pricing for the long haul, with most of the revenue coming from our installed base, supplemented by as many new logos as we can acquire. Here, the goal of pricing is to be easy to buy.
This seems like an easy ask, but in fact, one of the most common complaints established enterprises get from their customer base is that they are hard to do business with. This is the result of an accumulation of pricing models building up through new product introductions, company acquisitions, special promotions, and the like. Each model entails its own review process, extending the time to transact and imposing annoying demands on both buyers and sellers. Absent an intervention, the total set of processes to navigate will escalate indefinitely, bringing even the most agile go-to-market teams to their knees.
The mistake most vendors make at this point is to revamp their pricing to squeeze more margin out of the existing processes rather than reengineer them for faster and better throughput. That’s because the primary metric on Main Street is cost reduction, which is fine in itself, but one that needs to be accompanied by a focus on latency reduction as well. Transaction latency entails both costs and risks that, if not acknowledged, will, like cholesterol in your arteries, accumulate to fatal concentrations. To stay healthy, you have to proactively address this concern on an annual basis. Product-led growth is a great example of a strategy based on so doing.
Wrapping Up
Pricing as a discipline has largely been in service to maximizing returns from Main Street markets. The earlier stages of the Technology Adoption Life Cycle play havoc with its core principles, and vendors must be willing to adjust their pricing tactics or suffer the consequences. Zone management can help here, as each zone is well-suited to take the lead at a different point in the life cycle, and pricing can be managed by zone instead of by global fiat. We know intuitively that one price does not fit all—we just need to operationalize it.
That’s what I think. What do you think?
