Whether your service revenue is around 10% of the total business or 70%, an adequate revenue and pricing model for your various advanced service offerings is vital to successfully monetising your (new) advanced services.
The reasons are:
- It is much easier to sustain and defend business activities if they contribute to the margin, generating income to cover expenses and investments.
- As value propositions and business models evolve, we must secure revenue from these new, growing activities and value propositions to sustain and grow the business.
The challenge – finding the right revenue and pricing model
A vital challenge for monetising your advanced services is establishing an adequate revenue and pricing model that optimises the revenue we capture from our new services.
There are three aspects to this:
- Not leaving money on the table.
- Support the value proposition and value perception.
- Avoid unnecessary friction in the sales process.
Let's elaborate a bit:
How to capture the revenue potential in the market without leaving too much money on the table?
- What are customers willing to pay?
- How are competitors pricing similar offerings?
- What alternatives do your customers have?
How to support the value proposition and your customers' value perception?
- Price communicates the value. For example:
- Low prices disguise the high value.
No or low prices mean cheap quality.
High-value services may be reassuringly expensive.
- A profit-sharing model can communicate a lot of confidence and credibility.
- Your revenue and pricing model can be part of the value proposition. For example:
- An annual or quarterly fixed invoice can add to the convenience for your customer, compared to raising a new purchase order with procurement each time.
- A dynamic outcome-based pricing model can help your customers mitigate risk:
Only pay a lot when the results are outstanding.
And maybe even pay nothing if the results were below expectations?
How to avoid unnecessary friction in the sales process?
Complex pricing with a wide range of possible fees to pay leads to longer sales cycles. It increases uncertainty for your customer about what they will end up paying. Purchasing and legal teams need much time to review the related contracts and may push back.
Is it worth the effort for your customer?
Is it worth the effort for your sales team?
What is a revenue model
A revenue model is a framework for generating financial income.
It is a crucial component of a company's business model.
For each revenue stream (income from a specific offering and a specific customer segment), it defines aspects like:
- What is paid for?
- How is paid?
- How much is paid?
The Revenue Model Framework from the TIAS Business School gives an excellent overview of these key elements and some examples in the bubbles.
A good revenue model is aligned with:
- Customers' needs.
- The Value Proposition.
- Characteristics of the product or service.
- Competitive landscape.
- Business needs (e.g. predictable income, risk, reducing transparency).
So, how could we apply this for advanced services?
- What is paid?
- In the end, you do want enough cash.
- But you also need more data from your customers, not only captured by the equipment but also about their processes, maintenance activities and use.
- In an early stage of a new service, you also need to find good demo customers and case studies to demonstrate the customer value of your solution.
- What is paid for?
- In most service contracts, this is a combination of availability, response time, and time & material.
- Some contracts add a performance element: a bonus if the uptime exceeds the service level agreement and a penalty when the uptime is below.
- A few contracts are based on the use of equipment that is being serviced, like a power-by-the-hour or pay-per-click contract.
- Another option could be outcome based: paying for the cost-savings achieved with your services and solutions, like reduction of energy usage, reduction of consumption of raw materials, or what have you.
- How is paid?
- A one-time payment may be the most suitable if you deliver the value via a one-off assessment and consulting.
- A subscription with recurring payments makes more sense if you perform an ongoing activity.
- How much is paid?
You have similar choices for both one-off transactional payments or recurring payments from a subscription. For example:
- Fixed pricing.
This can also apply to value-based pricing. The fixed price is agreed upon during the sales process after adequately assessing the expected.
- Dynamic pricing
This is based on the actual use or outcome in a specific period.
- Or a combination of both, with a fixed retainer fee and a variable fee.
What is a pricing model
A pricing model is the way you determine the price level of your products, services, and solutions.
For sure, there is a long list of different pricing models.
They all boil down to one of the following fundamental pricing models:
Various cost-based pricing
After calculating the total cost of delivering the service, you add a markup to cover overhead and generate profit.
This model is suitable when it is hard to articulate the value for value-based pricing or when the differentiation of your services is not strong enough to ask for relatively high value-based pricing.
The aim is to secure sufficient margins for a sustainable business in a more commoditised industry.
You determine the price based on some estimation of customer value and the value your customers perceive. This could be based on market research, a value assessment during the sales process or a KPI of the achieved value.
This strategy doesn't consider the cost of delivery, so this model works best for services for which the prices significantly exceed the costs of delivery and for which customers are willing to pay a premium regardless of your cost for delivery.
The aim is to maximise profitability in times of strong differentiation.
You base your prices on the prices of similar services or solutions of competition, which heavily depends on market data.
This model works best when there is little differentiation between services and solutions and intense competition.
The aim is to defend your market position, grow your market share, or enter a new market with strong competitors.
With all pricing models, you may want to assess the price sensitivity (how will a change of price impact the demand from customers).
Also, read the 9 driving factors for price sensitivity.
How will you evolve your revenue and pricing model this year?
I know: all good theory, but:
- How to bring this into practice and make it work?
- What revenue and pricing models do other service businesses test and implement?
- What works, and what does not work?
Exchange experiences and insights with your like-minded peers
The upcoming Service Transformation Summit on How to Monetise Advanced Services is ideal for discussing this with your peers.
You will get:
- 4 high-quality presentations from your peers.
- Extensive and in-depth discussions.
- Post-summit report from the presentations and discussion.