Chris Mele: Investors, Pricing Science, and Optionality

Back in 2006, Chris raised $13M from angels for his startup CompanionCabinet. He quickly realized he’d made a critical error–he would have been able to avoid fundraising entirely by better understanding how his customers derived value from using the software and their willingness to pay for it.

This sparked his interest in pricing strategy and the science of monetization which, after a successful exit from his software company after twelve years, he pursued with Software Pricing Partners.

Chris shares practical approaches to pricing and monetization that you can use–from startup to public company–that will allow you to optimize your revenue, profit and long-term growth.

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Transcript

Chris Mele 

Welcome everyone. I was just talking to somebody this morning and saying that yesterday, I giggled all the way in because I drove here. And in 2014, I actually had to fly up to Boston to see the Business of Software for the first time. And it’s just a pleasure to be here and I’m really happy that this event is in North Carolina. I have told Mark for years that it needed to be here. And my big irritation was I had to read, I had to leave the Research Triangle Park area to fly to Boston. I mean, I like Boston, but it’s not as great as it is here. I popped a little, let’s make sure we got a..

So we were talking about PLG, and I hate acronyms, so I threw this in. I want to make a couple comments about PLG. For the longest time, we have had everything from self service, go buy it without a rep. We’ve had direct sales, go buy it with a rep. We’ve had partners, resellers, value added resellers, OEMs, where we embed our software into somebody else’s software, we become their cost driver. And the reality is that some mix of that is probably right for your business.

Bill Aulet did a talk in 2014 that I loved here at BoS, and he said, The problem in the software industry is we keep creating new acronyms and definitions for some some things that are pretty popular. One of his examples was, it’s not a pivot, it’s a change in business strategy. So you’ll see we’ll talk about some of that here today, but let me tell you a little bit about what we do.

So I wasn’t always a pricing expert, in fact, I was terrible at it. And so in 08 after 10 years at the helm of my software company, I hired software pricing partners as we move to the cloud. And we used AWS at the time, it took us a year to do the security layer. I think you can do that in like four hours tonight, if you want. But back then, it was not what it is today. So we make pricing easy. And when I was in a conversation earlier, also, I think it was maybe, let’s say, within Martin or someone, that we were talking about looking at the.. No, it was at breakfast, sorry. It was looking at the perspective of how the customer buys. And if you ask me, the number one mistake that everybody makes, we want to sell software on how we want to sell it, but not on how the customer buys. And that’s really a critical piece.

And so what we want to do is we’re gonna talk a little bit about the software in the background there. That’s our level setter platform. That’s how we come up with scenario planning and develop pricing models. We’ll talk a little bit about that here in just a moment, and we’re going to dig into I think what you’ll find is some surprising data about what we do wrong in pricing.

Software pricing partners is the category creator, 1982. Clearly, I’m not that old, maybe just a little bit older. But does anybody remember? So this is going to blow you away if you’re under the age of 35 Does anybody remember the on prem days? I don’t. So, I’m glad that you do. But in the on prem days, we had an actual physical box, if you can get a load of this. I’m talking to you in the front and you were tethered. Your parents were tethered to a wall, and a jack, an Ethernet cable, they called it, and a computer that weighed, like, 470 pounds, so you could not, like, you know, do the thing and move around the office with it. And most canon engineering companies, which was basically the ecosystem of software companies back then, would charge you. It was a single processor, by the way, no such thing as dual processor, yet. Would charge you based on a license, just a flat fee, 50 grand. And you know, your dad could get up and he could move, and Charlie could come in and sit down. But it wasn’t like he could both get, like, dual use out of fighting over a CAD design. So it was self regulating.

And then some smart outlet came out with the network, then some other smart outlet came out with a network license server. Actually, it was Apollo computing. First it tanked, if you remember, Globetrotter became dominant. The dongles disappeared, and we started passing out licenses on the network. The first 28 companies went through their pricing projects in the late 80s. This stuff is decades old, and out of that came the concurrent user licensing strategy, charging for the number of users that would access the system at any one time. All right.

Fair use policies

I think somebody saw the news. We were talking about this earlier. I think it was at Slack, you can have an active user. Well, sorry, you can have a user on the platform. If it wasn’t active, you didn’t build for it made news, made headlines. Wow, amazing. People been doing that since 1989 fair usage policies have always been a topic of great discussion, because you want to keep a customer for a really long time. You wanted them back then to pay the annual maintenance stream of 18 to 22% now we want them to stay on the subscription stream.

Does anybody remember Black Monday? Raise your hand if you remember Black Monday in the Reagan administration. Again, I don’t know what you’re talking about. Not that old, but my dad, I remember him talking about it because he said it was Trump’s fault. My dad hates him. And so what basically happens in Black Monday is, if you’re selling a million dollar software on prem upfront, you’re not selling that during a recession.

So what they did is they came out with this. What software pricing partners did is came out with a thing called financial overlays, subscription based billing for on prem software. We actually still use that technique today for some of the late bloomers coming over to the cloud. And what that does is it moves the risk, financial risk. It mitigates the financial risk. It says, I’m, you know, if you’re going to spend a million dollars on software and you don’t put it in, you’re going to get fired. But if I stretch out the subscription stream, well maybe that, if I stretch it out too far and don’t charge enough, maybe, like, your time to value, instead of being a couple months, becomes six months, because it’s not that urgent. So part of the art of coming up with a subscription billing structure is to make sure you, as the software company, don’t absorb too much financial risk. It’s a better balance between both.

Usage based pricing been around since ’92 isn’t that crazy? Decades. People were charging based on the use of their software. People would charge you based on the number of security vulnerabilities that you found in your software. All of these terms, usage based, consumption based they’re just descriptors of patterns that have been around for a long time, and we’re going to explore some of those. And then we talked about the level setter platform that we debuted in 2018 so this is around. If I’m going to swap a metric and become usage based, what kind of revenue might I drive and what kind of scenarios might I play out so that I can make the right kind of decision and not get bogged down doing all this stuff in excel.

There has been a lot of companies that have gone through the process of their pricing over the years, and everything that we talk about today is B2B software. This is not B2C. B2B software is a group phenomenon. Often the buyer is not the user. We have procurement teams and other things that get involved. There’s a lot of other stuff that happens in B to B, but we are talking about monetizing intellectual property today. We are not talking about monetizing plane strains and automobiles.

If you can master monetization. This is my big journey. I had a software company for a lot of years. I don’t like to think about the millions that I lost and some of the mistakes I made, but it was millions because I didn’t understand pricing. And if you can get control of this, what I would tell you is my big lesson learned, my big journey, is software pricing is the science behind how you’re going to make money on the product that you’re investing millions on. And mastering that science is actually putting you in control of the valuation, putting in control on the destiny of the actual software entity, and if you ask me where it fits, it is a discipline on par with product management. We eventually took, took us five years. Would model out what we were about to build, what its monetization upside might be, and we use that to prioritize the roadmap and drive what we were doing in new product development. So that means I’m designing the product around, its pricing, its packaging, its licensing, and that’s before the pizza goes under the door and the coat comes back.

So to tell this story, though, I think we have to just rewind a little bit to the birds of paradise in Papua, New Guinea. I’m sure you’ve seen some of this before. It’s a very complicated dance. It’s actually one of the most complicated mating rituals on the planet. Males go to great length on the left here in the black to differentiate. The whole dance is around differentiated. This has evolved over millions of years. It was not designed depending on your religious beliefs. Wasn’t designed by a human depending on your religious beliefs. Okay, I’ll just stop there. I personally think, if you ask me, the male’s a little too aggressive. It has evolved to differentiate, but it has evolved naturally over time. There are other examples of this, sage grouse, very complicated mating ritual, mud skipper and the weedy sea dragon, which my son really loves the colors of. Of course, it’s not unique to just animals. It also works for the software salesperson. Thank you, April for the setup of the century. I’m so thankful I went right after her talk.

I think this is great. You know, in the dance of the enterprise sales rep, you know, we’re doing the the buyer just wants to know, is this like a million dollars? Is it $100,000 is it 5000 but what are we taught? We’re taught, no, no, we got. We gotta do the value thing, like, look over here, right? And so we spend a lot of time and energy in what I would argue is a bit of a ritual, sort of like a mating ritual. You’re going to get married to a soft to the software vendor and the partner, you’re going to be together for a long time, hopefully with running the software for many years to come. This is the example of running through the demo. Here’s a list box. Here’s another, this field you can put put the data in the field. It’s amazing.

So if you want to know what the buyer thinks about this it’s true what procurement teams think of it’s also true in the animal kingdom. I thought this one really captured what everybody thinks of this process.

Listen to the phone call, and I just know when the video goes off, the prospect is doing that.

So is the system design optimal? That’s really what we’re here to talk about. What is missing from the system design? Now you probably know from the title of the talk it might have something to do with pricing. So here’s the system design today. You build a great product, you gain some traction, you go get investment capital, and then you grow your business. That was certainly my story. It was late 1999, I worked at Ernst and Young, computer science, and started my career coding in COBOL and assembler, just to put a little date stamp on my forehead here. And then eventually got into starting a software company. I had three years, no pay. Back then, does anybody remember the 0% APR game? You could trade out a credit card and they didn’t charge you the transfer fee. What an amazing way to build a business. And then eventually, kind of hit a cap for me, that was $270,000 of credit card debt. And that gets really scary, really scary.

Now I’m going to skip over what happens in between then, and eventually, in 2004. Just trust me that my hair was longer than Mark’s beard because I couldn’t afford a haircut. It wasn’t really as long as Mark’s beard. Nobody’s here is as long as Mark’s beard, but it was a rough it was a rough time, right? I couldn’t figure out how to get paid. We were selling $3,500 software. Eventually, we were selling three, four or $500,000 software, just one of those things that we did not know the value of what we had created.

It’s supposed to be Kumbaya, and it was Kumbaya. I remember being flown over to a chateau in New Zealand. I was everybody’s hero. We had an 18 month backlog on the software. What an amazing story. You would call me up and with my newfound sales skills that I had a co a sales coach for five years, recorded every phone call I ever made all the way down to the second mark. You would tell me, 17 minutes, 22 seconds. Why did you say that you completely unwound the deal and everything went sideways. And I would be ugh like, there goes another one, right? I have to rinse and repeat and learn and learn and learn.

So we get up to 2006 and I remember, and I told somebody this yesterday, oh, I was so cocky. I remember, I’m so glad they didn’t have the iPhone back then filming me. But I remember saying, building a business pretty easy. I don’t know why everybody gets all spun up on this. And you know what’s coming in two years, right? The 08/09, market crash. So it’s supposed to be Kumbaya. But what is actually, is it’s kind of a mess. You know the story, right? This just came out in Bloomberg. You’re going to sell your company. You’re going to get loaded up with debt. Those that did that took on enormous amounts of debt, restructured, recapitalized, etc. Everybody was shooting for the moon. Sometimes things change. We can’t control them. Now we have a $500 billion corporate debt storm from companies that are underwater, or at least paying interest rates that are seemingly high right now.

So if you want to know what I think the system design is all about, here’s what I think we’re creating. You have no idea what I’m talking about. All right, anybody that knows what this is, raise your hand. Those that do not have their hands raised up, you can ask them the question of all right, fine. It’s set in the future. This gentleman is a researcher. They’re making Soylent red and other food products. Soylent Green is based on plankton. The climate gets all screwed up. Surprise, plankton stuffs getting produced, and so they start grinding up people and eating them like they eat the people at the bump. You know what I mean? Yeah, so that’s for yeah. Okay, we’ll talk later.

Is anybody familiar with William Halstead? Nobody’s familiar with. Does anybody have any friends that are in the medical community? Okay. William Halstead is an absolute pioneer in this time frame with everything from anesthesia, new surgical techniques, infection control. He actually is on record for Purdue for doing the first surgery with a patient under the influence of cocaine. Since then, everybody does it, but back then that was new, was totally new. So he’s a real pioneer. And he invented a system called See One, Do One, Teach One – apprenticeship in the medical space, five years at a min, eight years at the max, you get indoctrinated, not just into the surgical techniques and the things that people are learning, but you get indoctrinated into the cultural norms of what it’s like to be into this particular field. Should be a great system. 150 years later, oops, US surgeons are killing themselves at an alarming rate, depression, anxiety. It turns out. And I was at at a party two weeks ago, and I have a friend who is one of the top for real brain surgeons in the world. And this gentleman comes up and begins to talk to him about how we really need people like him, right? Because these people can disassociate. They can handle death and extreme quantity.

This gentleman, dear friend of mine, deals with high morbidity cases. 90 plus percent. You’re pretty much dead, unless you go to this guy, stroke victims and things like that, and he gets them back on their feet. Well, it turns out, surprise, those people are human right? They have all kinds of issues and other things that they need to deal with, and they have to deal with immense amounts of loss. But this has been going on forever. Let’s open up a whole new dialog with my friends, just to help them be depressed.

See One, Do One, Teach One. Let’s apply this to tech. It’s a little bit different. In tech, we have different kinds of role models that are super well balanced and schweaty, as my grandmother would say. These are people that have really amazing relationships with their kids. I love that shot. It’s really not fair. I googled and try to find some freak ones, and that one just really creeps me out. I have a daughter that’s six, never use social media.

So let’s take a look inside of what this system is producing. All right, so we’ve been indoctrinated, just like everybody else, but I’m going to dig into the patterns of pricing and what it means for your business here. It’s a pretty mind blowing screen. This is from our level setter platform. We’re going to talk at concept, and then we’re going to drill in and look in detail. You’re going to see a smattering. It looks like a blood splatter, actually. So you see a bunch of different dots here. You see orange dots, you see green dots. What this is, is invoice, transaction data for a company at scale. When you reach scale, this is patterned after 40 years of transaction data. Our software produces sample data sets, etc, based on what software companies produce in their invoice transaction data. We have a green dot. A green dot is a landed price. A landed price says I have $100 list, and I worked you a deal and charged you $2 but maybe on my schedule, because of the quantity that you bought, my scheduled price in Orange was supposed to be $5. So we have this interplay of how dollars flow through the organization, anchored at list and the game, of course, is your net price extraction rate. How fast can I in aggregate, extract net price from a particular market segment. That’s what we’re going for. That’s what the job of pricing is, a sales enablement function. That’s what we’re trying to grease the skids for. Want to keep things simple and off we go.

We’re going to take a look at the x axis here. That’s list goes all the way up to a couple million. We’re going to take a look up here at the top. List price and this data set renewal, 481 million. This is a big company. Think SMB, mid market, high velocity kind of stuff, 83.5 million in net and discounts of 397 million in order to get to that now, that discount figure is a combination of just the difference between list and net. So what do you notice right away? Holy moly, what an inefficient nightmare. And you’re going to tell me that this isn’t unique, and I’m going to tell you, every client that comes to us has this picture. I haven’t seen one picture that doesn’t look like this. I mean, there might be less dots, less murders, but still the same story every single time we go through this.

Let’s take another look. Remember, we’ve got orange dots and green dots. This is a stove pipe. I don’t know why we came up with that name. It just because it’s vertical. It doesn’t carry with it any I should have created an acronym, SP, I don’t know. So what we’re looking at is green dots and an array of deals that have landed at an array of landed prices anywhere from a 35% discount at the bottom all the way up to an 80 plus percent discount at the top. And you can see from the heat map that every one of those deals, every one of those green deals has a corresponding orange deal somewhere else on this map of where it should have been sold. But right away, we call this a margin swing. What is the margin swing of this configuration? So think I have a certain amount of API calls, a certain amount of storage, certain amount of users, or some configuration of product that are being sold, and we’re just inspecting and looking at the velocity of what’s flowing through the system. And of course, in aggregate, this is how our software computes the optimal of where we should be pricing right? And if we arm sales reps with the optimal, we don’t have to fight all day long on what that number should be. And the game comes down to, can I give the rep team a scheduled net price for everything that I sell, and for everything I sell, I mean every configuration at every volume, because if I can do that, I can anchor their comp and anchor their rewards and recognition around how close they get to schedule net, and I can begin marching that up over time.

But this is chaos, so the first thing we have to get to is uniformity. Now in this environment, this is a mess. What happens in this particular scenario? Companies will have renewal discussions where the renewal team will lose the deal, because the customer has learned, if I come in on new business, I get a better deal. So these are big organizations, lots of sales people.

We have scenarios where I call certain reps and different things happen. And before we start nailing on the rep for just a second, remember the rep’s job, or the partner’s job, or the reseller’s job, is just to land a deal, right? So there’s a lot of stuff that could be happening in here. They could be addressing, for example, a partial use argument. The job of packaging, which we’ll get into in just a second, is to neutralize partial use arguments. If I show up to the party and say, I only want 20% of your software, can I have an 80% discount, and it’s a $200,000 deal off of a million. You’d be amazed how many times that deal will get approved, either informally or formally on a deal desk. Why? Because we feel empathy for people who are not lying. They’re just saying, I love it. I just don’t need all this other stuff that you put into this particular package or this particular offer. And so I might as a sales rep say, Well, you have a partial use argument, so I’m gonna give you a higher discount. So I might be addressing inefficiencies in my packaging by doing this, or I could just be horse trading, which is fine.

Now if we step back and you didn’t even see that graph that I showed you. Even if you didn’t understand it, we could just look into the public filing and probably predict what would be happening here. So this is Fastly’s 10k. If you just Google on either consumption based or usage based, you get these little carve outs.

Here’s what it says. We have limited experience with respect to determining the optimal prices for our products. We do not know whether our current or potential customers will even accept these new packages or the impact that they’ll have on our pricing model. Put another way. There is no other place in that 10k that you would get away with this. Could you imagine telling somebody we’re going to embark on a rebranding initiative, and we decided to go it alone? We don’t really know what rebranding means, but Charlie, his six year old daughter, is one hell of an artist with a crayon. She’s going to work on our logo. You just would never get away with this. But we tolerate it, actually. We buy stock on it too. And people copy it, isn’t that hysterical? There’s like six people in the back and they’re going to run out because they copied Fastly’s pricing model? And that’s the other big lesson learned, don’t copy this stuff. People are making it up all over the place, and they don’t know what they’re doing.

It’s funny when you look out, here’s Cloudera. It’s almost identical. I don’t know who the rep is that’s selling the Word templates for annual filings, but he’s getting in all the 10Ks. This guy’s like, killing it. He’s probably the same dude that did the RFP template.

Okay, so here’s where you’re destined to become. Pretend I’m in a time machine like I often wish that I would come back and tell my younger self, all the stupid mistakes I made. Your list prices are going to vaporize in the form of discounts at scale. That’s the path you’re headed on. That’s the indoctrination that we’ve all gotten to because pricing has been treated with the science your net prices are going to erode over time. Why? Because pricing is typically an event. It, and when pricing it as an event, you’re always adding more product or more capabilities, and that product is always changing and adding new value, but you’re not changing your price to account for that.

Now, who remembers the on prem days when we would not just bill you upfront and 20% annual maintenance, but we did this other thing at the end of the year. What did we do at the end of the year for the on prem days? We would make another version, and we would charge you for it, right? We would charge you for it. And then, of course, you wouldn’t upgrade. And this is the beauty of the cloud. And then you had, like, dual old code base, New COVID, totally annoying. I get it, but we got money. We got money, but when we moved to SaaS, where did all that money go? It just goes into the maintenance stream. It’s yours forever. Just buy a product. He’s getting better and better and better. There’s no other place on the planet that you can go accept software and pay a static fee and get an in perpetuity feed of brand new features. But we give all this stuff away, which is why yesterday at the table, I was saying most software companies are undervalued, most net prices erode over time. Buyers are going to game the system. Of course, you’re going to copy from your competitors, and your answer to fix this problem is going to go back to your roots. Because what my roots were, what are you going to do to drive more revenue? I’m going to create more product, baby, I’m going to create more product, and I’m going to put more blood splatters on that screen than you can even see or witness. It’s going to be an incredible story, right? Anyway, we just keep churning the wagon. Churn. This is not value based pricing, but it is a rodeo.

Value based pricing occurs when I understand the value, from earlier discussion, the differentiated value that is a big chunk of what we’re trying to monetize. But when I understand my value, then at scale, I should be able to extract the maximum net I should be able to do five or 10 deals in the time that a competitor does one deal. Value based pricing is not I’m going to get the most out of you, because let’s say we have software that is going to instrument a chemical spill. We’re going to do a safe and efficient operation of the plant. We have software that’s going to instrument that plant. There’s a classic problem. It’s an IoT pattern that occurs a lot, you don’t want to instrument the whole plant because it’s expensive. And so you instrument partial plant until you have a chemical spill, then you instrument the whole plant, right? And then it’s like, how fast can I do that? Well, if you instrument the plant after a chemical spill, you’re going to pay such a premium. If you instrument it beforehand, you’re probably going to get a better deal, because in value based pricing, we always put the optics on, well, how do I get the most out of your situation or your situation? And when I do that, I put those data points that you saw out there in the field, and I pepper the market with 80% discount, 70% discount, 82% discount. Buyers aren’t stupid. We know how to go get that data. There’s entire firms that it will now give you that data. And so when I go in to buy that software, and I know that somebody down the street paid 82% I can guarantee you, I’m going to get 83%. Before I was even into pricing, I could get 83% any of you guys could do that and gals.

So what do buyers want? This comes out from Gartner, who I recently learned has an agenda, which they do and just fine, but it still drives home the point. Procurement often will say these words, buying software is worse, worse worse than buying a used car. They show up to the party and they don’t trust a word you say. It has nothing to do with your sales pitch or anything like that. It has to do with their arming of the of the data points. They don’t want to be taken advantage of. What people want in the system, they want the system to produce a trustworthy output in the form of a consistent net price that they can trust that they’re being treated uniformly and fairly.

The other top reason, oops, price is not in line with expectations, because nobody sets them with any science anyhow. So here’s what we want to do to kind of twist this around. Now, this is just a general framework. All the graphics here were generated with AI, not the content.

Mid journey is my favorite AI engine of choice.

We’re going to start with this idea of what are the three problems that we’re trying to solve? There’s actually three distinct problems that we have to solve in order to bring a monetization strategy forward so that we can achieve something that we’re going to inject into this madness that’s going to put consistency, uniformity and trust back into the system. If we put trust back into the system, we can extract maximum net price. We have a pricing model. Those are price points paid. We’ll walk through that in a second, offering model, and, of course, the licensing model.

If you’re in a position right now and you do not know how you’re going to charge for your software, you can just take pricing, take the offering model, put it on the sideline. I wish I had done this. I had a offsite, I went to the cloud, I took everybody to the Grove Park Inn, if you know where that is, we had a three day management off site. Took the exec team up, and here’s how the meeting started. First, our VP of Sales stood up, and surprise, we should have a really low price point, because there’s a gazillion remodelers and home building supply companies. And if we just have a low price point, we’re going to penetrate into all these 1000s of customers. We were in North America and Europe. And think of this as miniature ERP software for interior and exterior products, for configurable goods. That was what our engine did, which is that, if you’ve been involved in that space, incredibly complicated on a configuration challenge.

So then he sat down, and then had a marketing stand, stands up, and she begins to present how we had just become customer of HubSpot, and we need an all in one solution, right? So she’s talking about something completely different. We didn’t know that at the time. And she starts talking about how we need just one size fits all. Dealers need everything that we need, or everything that we’ve developed to get them to value as quickly as possible. These are each like, 45 minute sessions.

Sits down and then our controller, I’m sorry, our COO, who was a former controller. His name was Steve. He stands up and he says, I think, I think that we should take a percent of the purchase order. And he showed an Excel spreadsheet that went out to, like, column ZZ. It was like two and a half point font. Nobody could read anything. But he had modeled out that, you know, we were going to rule the galaxy if we did that. And we vomited all of that on the table on the first session. And then on top of that, it got really weird, really quick, because I was thinking of a larger customer in Europe. Lisa was thinking of maybe a smaller customer over here down in Florida, and Nick, who was over on the sales side, was thinking of a full service remodeler in a completely different category. And so we were just we were not communicating. We had no framework by which to digest this. I wish that somebody had said, Steve, sit down. We’re not talking about, I’m sorry, Lisa, sit down. We’re not talking about all in one solutions, and we’re not going to talk about price point, but the right discussion to have had is, should we have taken a percent of the purchase order, or should we have done it with a user model? And that’s the licensing model.

The licensing model, put simply, is not, is it consumption, or is it usage based? The licensing model in my world is just, what’s the range of quantities that you want to see on the sales floor? That’s all it is. Consumption, usage, those are all just blurry things. We sit on top with gradients. They could be super high quantities or super low quantities. Some of the worst licensing models, the absolute worst one, would be the fastly consumption model, or the fastly consumption unit, the FCU, because in the sales dialog, somebody go, what the hell is that? And now the, now the sales person, you know, we start unwinding the deal. Well, you know, we charge a little storage, a little bit of compute, and we do a little bit of this, a little bit of that. The best metric of them, all that everybody wants is percent of revenue, incredibly hard to get.

But all these answers exist in between, and what goes in the quantity field turns out to be directly impacting your valuation. Let’s take dental. Dental often charges you based on location. A dental practice, maybe they have two or three locations, they tend to drive within 3060, miles. The owner doesn’t really want to go a whole other state over on the other side. To build the fourth location is a big lift. So if you are charging based on location, your job of getting expansion sales, you’re going to shut that down. Because for me to buy another location, I have to come to grips with the fact I’m going to drive 60 or maybe two hours here to Raleigh, open up another dental practice, then I have a physical build of that practice, right? So your years out before you’re going to see another quantity in.

Play that the other way I run charge you every time my AI model runs on a facial detection algorithm, and all of a sudden, you’re a company that has 70,000 cameras, and you’re asking me, or I’m asking you, How many times is your facial detection algorithm going to run? That’s an absolutely unknowable number. And so what’s the buyer going to do? Well, he’s going to change your go to market motion. He’s going to say, let’s do a pilot first. And that’s what they do. They do a pilot. They think they allocate 150,000 for the budget the software company is cheering. And then they get the bill for 650,000 they terminate the pilot, which happens for real, and then if they want to negotiate and continue on, they’re just going to oscillate that deal to a flat fee. Happens all the time. Most of the consumption strategies that you see that people are talking about when we do our competitive intelligence gathering oscillate to flat fees.

Licensing

Okay, so licensing is really important. We also talked about the architecture of the revenue stream. Are we going to bill in advance? Are we going to bill quarterly in advance? And if you pay me a year up front, I give you a discount? or do I bill you yearly in advance and if I if you pay me quarterly, I charge you a premium. The net price can be exactly the same, by the way, just how do we want to nudge customers to make the right choice.

The offering model is basically a combination of product, features and services. This is a horrible mistake I made. I forgot about services. Services can really close the gap. Services are a wonderful test bed for new products. Some of our customers are actually just services. They just, that’s all they do. Service consultancies. That’s a wonderful bed of intellectual property, and you can monetize that, and you can wrap services around each one of your offers to better differentiate them product services.

And third category that sits in the offering model is insights. There’s a great example of analyzing a bunch of recruiting databases and how hiring and HR, attracting talent is done, and in analyzing those customer environments, they actually learned that if you want to hire an enterprise architect in Charlotte, I know them, all four by name, good luck. They’re all coupled up with great jobs. Then if you were to advertise to somebody out of state who wasn’t even looking for a job, who also had kids, they are four times more likely to move back to their college hometown than anybody else, and you can market to them with a new opportunity, because they maybe want to come back to Raleigh.

Now, if you know that, and you extract that feature and put it in an enterprise edition as some sort of insights engine, you can get paid for another form of intellectual property. So this is the game of pricing, all the things that we can’t touch.

And then finally, if we know what is in the Quantity field, if we know what it is that we’re offering, well, then and only then can we attach a price point, right? And that was my big fail. We were changing around what we were offering, and so any discussion we had on price point was completely irrelevant. So you process the tree from the bottom up. Make sense?

Pricing and Philosophy

Now, I think one of the most powerful things that you can put at the base of your pricing strategy is its philosophy. Now if you’re in engineering, like I was in computer science, the closest thing I got to philosophy was an art history course that I had to fail, almost fail. I got a D in it in like the fourth week they played music, and there goes this from the Baroque era. I was like, I’m out. I have no idea what you’re talking about. And so I didn’t get any philosophy, and I wish I had, if you haven’t read anything by Joseph Campbell or Alan Watts, I highly recommend. But philosophy actually is one of the wonderful things that you can put and explain to customers of how you price.

And I have a proposed definition here for you. So it’s only until you achieve pricing consistency and uniformity that you’re ever going to be paid fairly for your value. If I can ever show up to your party, your sales process armed with a discount that you’ve given somebody, you’re not going to get paid fairly for your value.

There’s a wonderful test here. Raise your hand if you bought an iPhone directly from the app store? I’ll raise my hand because I did. Okay. Now keep your hand up if you successfully negotiated a discount on that it doesn’t exist anywhere. And if it did exist, the entire conference would go over to the person raising their hand, and we all go shop at that store, and bingo, we would have erosion of net prices, right? If you only get paid if there’s one thing that you could take away from my talk, you only get paid for your value if you achieve consistency and uniformity in your pricing. I love this picture because it exists in like every company slide. The customers at the center, it’s all about the customer. But if you buy my software, I charge you a million too. I surcharge you 200 grand above list you you were the unlucky but you bought 400,000 the exact same thing is that putting the customer at the center? I don’t think so. I don’t think so. Do you want to know who’s at the center? Here’s who’s at the center.

Oh, my God, I’m sorry. Oh, oh, my six year old daughter said she was going to do something for Halloween. My adrenaline.

Here’s who’s at the center. It’s not the customer, it’s this guy, but it’s not this guy who’s taking advantage. It’s this guy or gal who hasn’t been given the system or the playbook all the way through for going to extract in that price in the market. So if you want to put the customer at the center of your universe, what you want to tell them is, we treat all customers uniformly and fairly. Discounts are earned. They are never given. They are earned through the size of commit. And if you pressure me on price, I understand that you may want a discount. We look at less scope, less services. If you want more scope and more services for the same price, I say I understand, however, it wouldn’t be fair to our other customers. How about as a final check off, I show you the last half dozen contracts of a similar scope, so that you see that you’re being treated uniformly and fairly. That’s what procurement wants, They want to be treated uniformly and fairly. Nobody wants to look like an idiot and find out later that they paid the surcharge.

Market fairness, pricing, most powerful philosophy that you can put under the hood. Maybe remember BBNA before they were bought by Flexera? Walker white, added 5 million to the bottom line in the first 12 months. His margin swing was probably 85 points. He brought it down into a half point on the sale to Flexera, huge premium. Why? Because he could show exactly what that forecast, forecast was going to bring in, and it was a competitive buy, and that forecast, you got full value, extra multiples on a competitive acquisition, and was able to achieve uniformity and consistency. Now, just to give you an idea of where they came from, where they came from was people before we got a hold of them. As people were buying at the end of the quarter, people were buying at the end of the year, and Rebecca, their CFO, had the worst job at the planet. I think this is why I think the average tenure for a CFO. I don’t have any data on this, but it seems to me like one to two years, and the CFO is like, I’m out.

So what happens is Rebecca on New Year’s Eve, the sales reps get in on the game because they know at New Year’s Eve, if they can just be in the chunk of deals that hits Rebecca’s desk at 3am or later, her forehead has already hit the desk, and they’ll get the deal approved, and some ridiculous percentage of the deal, 70 or so percent, would come in the night before the new year. That’s total dysfunction, total dysfunction, pain and suffering.

Who’s familiar with Bamboo HR? What an extraordinary rocket ship that they came up with. Stalled out at 22 million. Market fairness under the hood, within 18 months, they equipped 150 million. They were accreting, increasing their sales forecast 15% month over month, and still trying and just just absolutely killing it. Today, they’re going to approach close to 300 million, probably by the end of the year. I don’t know the exact number, but I know it’s over 250 million. Sellers and buyers trust each other highly. Think of their ecosystem that they’re selling against ADP. This is like the most commoditized, boring thing you could think of – HR software. Yet they created the highest trust, in my opinion, in that market segment people, they cheer over this company. They put all this trust back in the system. They put all of this good feeling back in the system, and then they crank that revenue engine frictionless.

So here’s some lessons learned, and then I’m going to open it up for questions, because I think what will make it the most fun is if you pepper me with really hard questions, things to kind of think about.

Pricing is a process. It’s not an event, it’s not a study.

It’s not something you do every three years in some cathartic effort, if you are in a certain cadence and you have a certain number of sprints or release cycles, then you should be discussing pricing all the time, thinking about, really, where does the intersection between what is maintenance and support versus what is true, differentiated or additional value that I didn’t promise. And then how do we monetize that in a way that isn’t mind boggling, that we don’t have 20 different optional add on components, and we start creating complexity. So monetization is about simplifying things again, for the sales process, never misrepresent to get market intelligence any time that you there’s tons of people that operate in the fringe. You know who they are. They’re trying to monetize you all the time, right?

The day that you buy into this idea called mystery shopping. Has anybody ever heard of this before? All right, so mystery shopping in a retail setting is fine. It’s your it’s your stores. You can mystery shop your stores if you want. But what happened in our industry is it got co opted into I’m going to call the competitor as a services organization. I’m going to pretend to be a buyer, spin up a fake website, I’m going to get your price list, and then I’m going to use that to influence my strategy, which is, of course, the craziest idea on the planet based on what I just showed but that’s what happens, right? And there’s this really interesting thing that happens in competitive intelligence gathering, and that gathering, and that is just like if I handed you a gun with bullets, if you pull the trigger, you’re on the hook. Liability passes up the chain. So if I do mystery shopping on your behalf, and you hire me to act like a fake buyer, you’re on the hook.

Apt in and peg assistance. Has anybody heard about this in Virginia? $2 billion plus state level award, not just mystery shopping, but a whole bunch of other things that are questionable on the integrity front, it falls under unfair and deceptive trade practices, triple damages, return of legal fees. It’s a violation of the US Espionage Act. It’s a violation of trade secret law, state and federal, and the list goes on and on. If you are in an if you are an incumbent, and you have a disruptor that is messing with your revenue model, and that disruptor mystery shops you. that’s a million bucks for a lawsuit. You’ll lock them down and distract the management team. That’s what I would do. I would just do it out of principle, because I think if you mystery shop me, you’re one of those people, so don’t do it.

Never misrepresent. Also misrepresenting sets a really dangerous precedence and a cultural norm inside of your company, and then that becomes the new norm. And then do something the next time is a little bit easier and a little bit easier and a little bit easier, until eventually, I think, in their filing, which you can go Google and read about. They called him the spy. They referred to him as the spy. Your approach should be to compute a scheduled net price for everything you sell. There should never be an unknown net price for a deal with a salesperson that has to you and say, I have this configuration. It’s a little bit unique, and now we have to go into the back room and figure out how we’re going to price and package it. That should never happen. And so think, instead of hypotheses that need to be validated, you bring your hypothesis out into the marketplace the price point that package, you test it, you rinse and repeat, and you iterate, iterate, iterate. If you iterate faster than the incumbent, most incumbents that are larger, you’re lucky to do a price change once a year in their sales kick off. So if you’re iterating multiple times throughout the year, you’re going to settle into a strategy that beats them.

Hold everyone accountable to landed deals that are close to scheduled net and try to get that as close as possible, and always be raising net prices. Best practice, set your list prices at the beginning of the year. You use ethical Competitive Intelligence and other techniques to and inputs to kind of set that so it’s within a sea of or a realm of possibilities. It doesn’t look crazy. You don’t want your list price to look ridiculous. But then throughout the year, think quarterly I’m gonna adjust my net prices. Think quarterly cohorts, I’m gonna raise my net prices.

That’s all I got for you, so we can open it up for Q&A.

Q&A

Mark Littlewood 

Okay? Mic runners, your time has come. We’ll get a mic up to Mark anyone else with a question so I can make sure they’re lined up. We’ve got one here. We’ve got a mic there. Oh, are we going here? It’s great. Start.

Audience Member 

What’s your view and approach on introductory pricing, and like, when to use it.

Chris Mele 

So I prefer to use a well, let’s rewind by saying, traditionally, what you would do is you would have a beta, and that beta would then be offered to an organization, and as soon as the organization hears that it’s free, or, I’m sorry, hears that it’s beta, they’re going to say, thank you, I’ll take it for free, and my value add. What is your name, Jason, is that I’m going to use the software, except what happens is, I don’t use the software. I don’t have an executive sponsor. You don’t get the usage that you thought. But actually a worse thing happens in that scenario, and that is that that company kind of comes all in and kind of proverbially craps on your roadmap. So you think a deal is about to happen. This actually happened to me with Lowe’s, which was a big strategic we were strategic advisors to them, and it took us a lot of years to get in, and we were always so close to a deal. And so what ended up happening was we started creating roadmap features under the guise of free for a new cloud edition, and we never got a chance to actually really close that.

So I shift that whole discussion over into once you have product, well, I don’t even know what product market fit is these days, but once you have a product that somebody’s going to potentially spend money for, you flop that whole thing over into an early access program, even if you think it’s a beta an early access program. This is where services come in. Early Access program says, I have a product that I that I’m going to, you know, half a dozen folks are going to come in their value at which, by the way, you pay for you pay a premium, because the value add is we’re going to listen really closely, and our roadmap is going to conform, because you’re paying is going to conform in a lot of ways to make you happy. So at the end of the Early Access Program, you’re going to leave with a competitive advantage, because the software that we’re creating is going to more closely aligned to your operations and your workflows. And early access allows me to add services in and. And what I would do is, if I understood the sea of price points, so you can go out there and look and see is this 100,000 50,000 just, just a general ballpark, I would get something on the high end.

So, so I’m not a I’m not a big fan of free. I don’t know if you could tell that. I don’t think it has a role. I just think it’s hard. It’s a lot harder than people thinking conversion to pay is really, really hard. And so I like to get money moving pretty quickly, especially if angel investors are on the hook, and we start extracting 100, 200, $300,000 deals. That’s like, everybody’s gonna fly you to New Zealand, right? And so I like to put structures in place where people can transact with me and I can have a very open dialog. So for example, in that early access I would term limit. Term limit is always your friend. If you’re not sure how to price, term limit, and then you just be open. You tell them like transparency is key. You tell them, Look, I’m not sure on what basis we’re going to charge for the software. Let’s say you flat fee, and this is your testing process, right? You’re gonna flat fee at 25,000, flat fee at 50,000 let’s say you do a 75 150 and a 200,000 and you have open dialogs with your customers around how do you want to buy it? What would be the easiest for your procurement team to approve? What would be the most preferential from your perspective as you grow? And you just are very curious, and like Bob was saying earlier, you don’t need to do that with 1000s of people. You need to do that with half a dozen. With half a dozen. And the pattern is going to become very, very readily viewable, very quickly.

And so in those price points, what I’m trying to understand is how to gear my labor model long term. Am I going to need a bunch of reps or a little bit of reps? Maybe I am going to do some form of a self service motion up front. Maybe I’m not going to do that, and I’m trying to get a sense of how hard is it to extract that net price. If I leave that test and I have $150,000 deal, but it took, like, eight months to land it, and it was pain and suffering all the way around, and lots of price sensitivity and lots of discussion. Maybe I want to back off of that a little bit. And then there’s another trick that you do, which is you do not, ever, ever license an edition of your software. We call this funding the roadmap. Do not sell them the Enterprise Edition, because you’re selling them the Enterprise Edition at the lowest value point, right? So what you’re going to do in that legal terms and conditions is enumerate the capabilities. So I have 10 capabilities, and then I sell over here, and I now have 11 capabilities, and I do a deal here with 11 and then I have 15 capabilities. What does that enable me to do? When I have the 11th capability that I numerate in this contract, I list out, I go back to you on the 10 capabilities and say, Hey, I’ve got this 11th capability. Would you like to we call that funding the roadmap, okay.

Mark Littlewood 

Okay, Ricardo.

Audience Member 

What do you think about says rep commissions. Commissions. Because you told there that when they have it, they and if they have to make their cut, they will, will try to push the price down with discounts, because they have the commissions. What do you think about they having or not having the commissions?

Chris Mele 

Well, I think that in bamboo case, they went commission less, right and so, but that didn’t happen overnight, because first they had to get rid of the chaos and get to uniformity. Once you get to uniformity, then I think you have a fertile ground to explore what commission list might look like. It worked incredibly well for them. They did a lot of role playing, a lot of practice, a lot of sales dialog. I don’t have a problem with I mean, sales people love rewards and recognition in any form, and so I think if you’re going to have a commission program, what I would highly suggest is not maybe metering them so much on number of deals or cumulative revenue, but instead, and of course, this means that you’ve got some of your pricing figured out. Reward them on how close to the scheduled net price that they’re getting. That’s a really key way to give them rewards and recognition, because if they land on the scheduled net price. I mean, if you just took those graphs, you got 10s and 10s and 10s of millions of dollars of recapture just by getting rid of the discretionary stuff. And so I would probably start with that first and then explore commission less carefully.

Mark Littlewood 

We’ve got one more. Let’s mark I think you had your hand up first for questions. Put your hands up quickly. Don’t just sit around. I don’t mess about here last one.

Audience Member 

So we’re a software company. We sell generally standard software packages, and we’ve always had standard prices on our website. And when we look at the traffic, generally, people come into our website because they’ve obviously got a problem. The first thing you do is go to the pricing page to see where page to see whether it’s in the ballpark for them. Then they go to the demo and download the demo if it fits their their their pricing model, or their cost. We find increasing a lot of our competitors, if you go to their website, the question, how much does it cost? Is not actually one that you can get a very easy answer to. USA. You have to fill out a long form, or you have to phone somebody who will presumably tell ask you how much you’ve got and tell you this is the price, is exactly what you can afford. So I’m curious what your take is on having standard prices on a website which are clearly this is what it costs, versus talk to us, and we will, we will come up with a special value based pricing scheme for you.

Chris Mele 

Well, how you decide to how you I think it’s a game of extremes. And maybe on one extreme, you know, we don’t show anything and call and on the other extreme, we show everything all the way down to the calculations of our net prices when you buy. And of course, that’s a competitive disadvantage, but somewhere in the middle is probably something, right? So first, I do think you need to do your homework and have an offer. Remember, this is a list price, not not a net price, and have a list price that is in a range that isn’t going to be scary and polarize people out. But like we also talked yesterday, I think you were actually at the table. Every product has a minimum, and so it’s okay if your minimum purchase is $25,000 I mean, I would probably put that out there. I don’t really want to talk to somebody under the product’s minimum, and so that’s a great gate check to do if you’ve done your homework on the minimum and have calculated that correctly. And so when you go to produce your price points, I think you also just have to pay attention to the sales force, because the more you put out there is, the more you’re going to arm the buying population with. And that could be a great thing, or that may not be a great thing. So sales enablement and how you’re actually executing in the marketplace, you want that pricing page and that data that’s on there to support that.

So I think if you’re kind of quasi not sure about it, go with the product minimum. Go with an open list price, and maybe not debut everything, and have sort of a couple different options or as low as, you know, starting as low as this price, and then, you know, I can call and engage. I don’t think that you have to answer it all on the website. I don’t know if it’s a point solution or or if it’s a more complicated solution, but I think you can give them enough to be dangerous, but I think if you give them nothing, it’s kind of hard to make a decision if you’re even going to be in the competitive set.

Mark Littlewood 

Thank you. I know there’s a lot of questions now, unfortunately, you’ve lost your chance to ask Chris, because like all of our speakers, he flew in off jet plane this morning, arrived five minutes before his talk start. Now he’s off to the airport again, so you’ll never see him. Oh no, this is BoS, so he’s around all the time. So go and find him at lunch time.

Chris Mele

Managing Partner, Software Pricing Partners

Chris and the Software Pricing Partners team help B2B software companies monetize software and services, launch new products, and implement continuous monetization processes.

A CompSci grad at Miami University, Chris’ career began at EY where his projects included working with Netscape to launch the nation’s first online banking system on the Netscape browser. Bitten by the dotcom bug, he became a director at Rare Medium focused on online strategy for early dotcom growth companies. In 2002, he co-founded CompanionCabinet, serving 12 years as CEO before joining Software Pricing Partners in 2014 where he enjoys working with some of the fastest-growing software companies in the world. Ask Chris about pricing, eFoiling and why he likes breakfast for dinner.

More from Chris.

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