In a prior post, I identified the right pricing model as one of the key success factors for “industry in the cloud” (IC) providers. Pricing is critical for all businesses, but it is especially critical (and complicated) for IC providers.
Every company understands that an increased dollar in price realization flows right to the bottom line. We have all heard the old example that a company with a pre-tax margin of 10% which achieves a 1% increase in price realization increases pre-tax profits by 10%. This is just simple math. But companies used to assume that they could do little about getting more for their goods and services given a competitive market and the limitations of technology and analytics that were available . In other words, many companies saw themselves effectively as “price-takers”, rather than “price-makers”.
This has all changed. Starting with the use of “revenue management” techniques of the airline industry in the 90s, continuing with the advent of new technology and analytics, and extending into the knowledge gained from behavioral economics, companies have learned all sorts of techniques for improving price realization. Witness the growth of the pricing optimization industry–from pricing consultants to dozens of vendors of analytics and pricing optimization solutions.
Every company, including ICs, now thinks extensively about the right price level and structure. But ICs also have to think about who to charge, not just how much and how. ICs have multi-sided platforms and have to think about whether and how to charge buyers, suppliers, intermediaries–or all of the above. And they have to get this right, or they will not get the participation needed from all parties to build a thriving platform. In my work with clients and in reviewing the successes and failures of ICs over the past 10 years, I see flubbed pricing models as a key driver of many of the failures.
An IC has to think about the value of the platform to each of the parties engaged on the platform–buyers, suppliers, and intermediaries. Each party’s value can be different and can even be based on different metrics. In addition, it is often the case that one party’s participation may need to be subsidized to attract other participants. Subsidization can come in the form of reduced prices relative to the value delivered to that party, free, or even paid inducements to participate! (An example of the latter would be in the p-card industry where the card issuers typically pay a portion of their merchant fees to the buyer in the form of signing fees and rebates to get the buyer’s spend on their network, which compels merchant participation.)
Another example may be useful. To avoid using examples from clients or former employers, let’s use Ebay/PayPal as a simple and familiar one. Ebay has always been free for buyers. After all, without them who will buy the Pez dispensers or used cars! Ebay charges suppliers a small listing fee and a percentage of the proceeds from any sale–all of which averages about 9%–a lot less than a traditional auction house (20%), but a substantial fee. PayPal was originally an intermediary that handled payment, until Ebay realized just how integral payment was to their marketplace and bought them (after trying to kill PayPal with their own product). PayPal nets them about another 3% of sales for handling the payment piece. Ebay has tinkered with the pricing (and non-auction sales formats) multiple times in its history to try maintain seller participation, grow listings, and drive out rivals. And when they tinker, they hear from their community!
In the B2B space, I have seen companies vying to be the IC provider for the exact same industry with similar founding dates, total revenue, and throughput, but with very different pricing models. The company that had figured out its pricing model and had thought through where they were going and how pricing was going to evolve on each side of their platform was growing rapidly. The other company was struggling and stuck in neutral. They still had still not decided how much to charge each side to attract participation.
In summary, ICs have to address at least the following issues:
- Which side of the platform to charge? Buyers, sellers, intermediaries? All of the them?
- What metric to use for charging: application use, documents exchanged, dollar throughput, trading relationships established, advertising CPM, etc?
- Whether to use single or two-part pricing, that is a fee to participate and then an additional fee for more usage?
- How and whether to bundle various services?
- How to structure pricing to encourage even more use by participants?
Traditional pricing textbooks cover the notion of pricing for value rather than cost and are starting to incorporate learning from behavioral economics. The literature on two-sided markets and platforms is also starting to be quite useful. But there is a lot to be learned simply from studying the many public (and some private) ICs. I keep a database of about 40 (mostly public) ICs, marketplaces, managed service providers, and auctioneers that provide some insight into what is working and what is not. Every manager involved in an IC should do the same. There’s no room to be stupid about pricing.