Value-Based Pricing in the Tech Industry

Tech companies today face ever-intensifying price pressure. In a recent BCG survey of the industry, 82% of respondents reported facing challenges from low-priced competition. Major factors accounting for this price pressure include the increasing sophistication of CIOs and other tech buyers, startups with aggressive pricing strategies, and the wide availability of open source software and free offers.

Such price pressure, combined with internal and external imperatives to deliver volume, results in rapidly declining prices, threatening the long-term profitability of tech players. The figure below illustrates a typical pattern among tech companies in the wake of the financial crisis of 2008–09, with firms responding to price pressure by engaging in heavy discounting that was difficult to reverse even when the economy improved.

BCG has broad and deep experience working with tech companies that face price erosion in their markets. We help them not only to cope with pricing pressure but also to improve margins and profitability. We have found that when the right pricing mechanisms are combined with the right change management and incentives, companies can increase their EBITDA by 200–800 basis points. This makes pricing a powerful tool for short- and mid-term organic revenue growth.

Four Levers for Improving Pricing to Value

In our work with tech companies on pricing to value, BCG uses four major levers:

1.  Improving pricing discipline through discount guidelines. The quickest short-term impact typically comes from improving a company’s pricing discipline to avoid excessive discounting. BCG develops segmented price guidance to help businesses ensure that any discounting is targeted and realistic, based on history and the company’s strategy. This helps the sales force optimize the price-volume tradeoff, retaining share while protecting price integrity.

2.  Improving new product pricing to better capture value and competitive differentiation. Many product companies anchor the pricing of a new generation of products in how the prior generation was priced. To achieve better value, we recommend using three pricing lenses—customer value, economics, and competitive pricing differentiation—to get to the right price.

3.  Actively managing pricing to better capture value over the product and customer lifecycle. Whether a tech company should raise or lower prices over time varies a great deal by sector. In semiconductors and components, for example, products are usually launched at a high price, with the goal of managing a year-over-year price erosion curve to protect margins as unit costs decline. In software and high-margin hardware, companies often launch products at a low price to drive volume, but should look for opportunities to increase prices annually, particularly for subscription offers that deliver innovation regularly. In tech  generally, companies often underprice older technology when a new product is introduced to replace it, when a better course—particularly if an old product has high switching costs—can be to raise the price of the older product to motivate customers to migrate to the next generation (while also increasing margins).

4.  Packaging and tiering of new and existing offers. For companies that offer multiple products or product lines, the right packaging and pricing structure can help capture a greater share of the demand curve. Instead of simply trading off price and volume, such companies need to think about multiple products at multiple price tiers aimed at different segments. This allows them to charge more to customers who are willing to pay for higher-end versions of products—and less to those who are looking for something simpler. The key here is to develop fences to prevent lower-price products from cannibalizing higher-price ones. Effective packaging and price tiering of products in the innovation pipeline is one of the most powerful pricing levers in tech, with returns that are often more than 10%—and even over 25% in the long term—for the relevant products.

Partnering with BCG for Pricing to Value

BCG has deep expertise and experience across all tech sectors—semiconductors and materials; end-user devices; equipment and IaaS; software and SaaS; consumer apps and services; IT services—and the ability to tie this expertise specifically to market strategies.

We also know how to partner with our clients to generate fundamental improvements in shareholder returns. Tech companies can increase their EBITDA by 200–800 basis points in a single year by using the four levers described above.

Systems and processes can often be a barrier to making better pricing decisions across all the varied pricing touchpoints.  BCG has proprietary pricing tools such as MSP Pricing Catalyst, which boils down complex data into actionable insights and puts the right price in front of sales teams at the time of the initial quote. This cloud-based software, which can be used with any of the levers described above, continues to provide guidance as companies work with BCG experts to execute a new pricing strategy.

Finally, BCG brings deep expertise in change management, which allows us not just to help tech companies determine what the right price is but also to support them throughout the ensuing transformation. New pricing mechanisms always have implications for other functions—sales and marketing, for example, which need to understand issues such as when and to which customers to offer or not offer discounts. Implementing pricing change also involves changing culture and incentives across the organization. Only such an organization-wide approach to pricing can ensure that companies reap the very large potential gains in margins and profitability from pricing to value.

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