Have you ever wondered why pricing software feels so complicated? Chris Mele, a pricing expert from Software Pricing Partners (SPP), shared some insightful perspectives on this topic at Business of Software USA, drawing from his own experiences and decades of industry data.
It turns out, many businesses make a fundamental mistake: they try to sell software based on how they want to sell it, rather than focusing on how the customer actually buys.
Chris learned this the hard way with his own startup. Despite raising significant funds, he realized he could have potentially avoided fundraising altogether if he had better understood how customers valued his software and what they were truly willing to pay. This experience sparked his deep dive into the science of monetization.
For years, software pricing was relatively simpler. In the days of physical “on-prem” software (where you bought a box or installed software on your own servers), companies often charged a large upfront license fee plus an annual maintenance fee. Licensing approaches in the early days were focused on individual use tied to specific machines (single-user or desktop licensing). With the rise of networks, the need for sharing software among multiple users arose leading to licensing approaches that charged by or concurrent users (the number of users accessing the system at any one time).
Then came SaaS and the cloud. The annual maintenance stream essentially became the subscription stream. But while the delivery method changed, many companies struggled to adapt their pricing models effectively.
The Chaos of Current Software Pricing
The reality of B2B software pricing for many companies looks like a chaotic “blood splatter” of deals landing at wildly different net prices. Even large, successful companies exhibit this pattern.
This happens because there’s often a huge gap between the list price and the actual “net price” the customer pays after discounts. Discounts can range dramatically, sometimes exceeding 80%. This “margin swing” makes the system (i.e. the marketplace where buyers and sellers come to terms) incredibly inefficient.
Why the big discounts? Sales is rarely given a complete pricing approach, forced to fill in the gaps with their own approaches to the problem. Sales reps need to land deals, and they might offer discounts to address non-profits, regional pricing, customer’s “partial use arguments”, (where the customer only needs part of a software package), payment term or contract length incentives, custom ramp schedules and more–or simply through negotiation.
This chaotic pricing environment has major consequences:
- Eroding Net Prices: Over time, the actual profit companies make per deal goes down.
- Buyers Game the System: Customers learn about past discounts and use that information to negotiate even lower prices, seeking an “83% discount” when they know someone else received 82%.
- Lack of Trust: Buyers, especially procurement teams, feel that buying software is worse than buying a used car because they don’t trust that they are being treated fairly or uniformly.
Often, companies try to fix revenue problems by simply building “more product,” adding complexity without addressing the core pricing issues. Copying competitor pricing is also a mistake, as competitors pricing strategies are often poorly designed and inefficient.
Putting Trust Back into the System
What do buyers actually want? They want a trustworthy system that produces a consistent net price, where they are treated uniformly and fairly. They don’t want to feel like they paid a “surcharge” compared to someone else.
Achieving this consistency and uniformity is key to being paid fairly for your value. Think about buying an iPhone from the app store – you can’t negotiate the price. That consistency helps ensure value is captured.
The Three Pillars of a Monetization Strategy (and a Philosophy)
To build a robust monetization strategy, Chris suggests processing three key components from the bottom up, anchored by a philosophy:
The Licensing Model
This is the foundation. It’s about defining the basis by which you charge: this is called the licensing metric or the value metric. Is it users, locations, usage units, or something else? The choice here significantly impacts your ability to grow revenue and affects your company’s valuation. Picking a metric that is hard for the buyer to predict can lead to failed pilots and deals oscillating to flat fees.
The Offering Model
This defines what you are actually selling. It’s a combination of your core product, features, and crucially, services and insights. Services can fill gaps, act as a testbed for new products, and differentiate your offers. Insights extracted from data can also be a monetizable form of intellectual property.
The Pricing Model
Only after defining the licensing model (what goes in the quantity field of your contract for each product) and the offering model (what’s included) can you attach price points effectively. Trying to set prices without understanding the underlying quantity and offering leads to irrelevant discussions.
Anchoring these pillars is your Pricing Philosophy. Chris proposes Market Fairness as a powerful philosophy. This means treating all customers uniformly and fairly. Discounts, if given, should be earned through the size of the commitment, not just negotiation pressure. Being willing to show potential customers contracts from similar deals can build trust and demonstrate fairness.
Key Lessons for Better Pricing
Chris shared several crucial lessons:
- Pricing is a Process, Not an Event: Don’t treat pricing as a one-off study you do every few years. Discuss it regularly, especially as your product evolves and new value is added. Make it part of your product development lifecycle.
- Never Misrepresent: Avoid deceptive practices like “mystery shopping” competitors by pretending to be a buyer. This has ethical and legal risks and sets a bad internal precedent. It also violates federal and state laws and can lead to hefty fines and even prison sentences.
- Compute a Scheduled Net Price: For every possible configuration of your product, know the target net price you want to achieve. Salespeople shouldn’t have to go back to a “back room” to figure out pricing for unique deals.
- Hold Everyone Accountable: Reward your sales team based on how close their landed deals are to the company’s scheduled net price.
- Always Be Raising Net Prices: While list prices might be set annually, look to adjust and increase your target net prices quarterly based on market learning.
- Rethink “Free” or “Beta”: Instead of free betas with uncertain conversion, use paid “Early Access Programs” where customers pay a premium for early access and influence on the roadmap. Using term limits can also help when you’re unsure about pricing.
- Be Strategic with Editions: When selling early, enumerate specific capabilities in the contract rather than selling a full “Enterprise Edition” at a low price. This allows you to monetize additional capabilities later by going back to customers.
- Consider Website Pricing Transparency: While you don’t need to reveal everything, providing some information, like a product minimum or a starting price, can help potential buyers gauge if your solution is within their ballpark. Showing nothing can make it hard for customers to decide if you’re even a viable option.
Mastering the science of software pricing is not just about setting numbers; it’s about understanding customer value, building trust, and creating a predictable, repeatable process that drives revenue and controls your company’s destiny.
This article draws on excerpts from Chris Mele‘s talk, “Investors, Pricing Science, and Optionality”, at Business of Software Conference.