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As Web 2.0 Influences SaaS, Pricing Must Move to Pricing 2.0

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  rev. 25/04/2008        

By Jim Geisman and John Maruskin, Principals, MarketShare Inc.

Until recently, B2B SaaS applications have been based on relatively simple economic models.  A SaaS vendor would develop an application and outsource hosting:  A customer would pay for access to the intellectual property according to the value delivered.

SaaS pricing was straightforward:  Ensure that revenues were sufficient to pay the hosting provider, fund current and future product development, cover marketing costs, and have enough profit left over to make the business worthwhile.

But SaaS business models are getting more complicated as SOA spreads and the influence of Web 2.0 applications increases. As SaaS applications become more Web 2.0-like, these applications will consist of a collection of SaaS-delivered components - "mashups" comprised of intellectual property from multiple vendors.

Some SaaS vendors will serve the role of primary application providers. Others will serve as component suppliers. Finally, if traditional licensing is an indicator of the future, some vendors will assume both roles depending on the application and the customer.

Enter Pricing 2.0

Dealing with the intersection of Web 2.0 and SaaS will require more disciplined pricing on the part of SaaS vendors regardless of the role they assume in the supply chain. We'll call this more disciplined approach Pricing 2.0...

SaaS application vendors, who combine their own IP with that of others, will see their cost structure change. When component suppliers charge on a per "delivery unit" basis (e.g. user month), there will be less money available to fund development, marketing, and profits. If a component supplier charges a lump-sum for their IP, application development costs - current and future - will rise. Finally, when component suppliers charge on some other basis, like an annual subscription, profits will be reduced.

In thinking about pricing vendors with SaaS-delivered components will likely need to deal with any or all of these costs.

SaaS component vendors, who supply component IP to others, will see their revenue model change. Component suppliers will likely work with application vendors who want to be charged in the ways described above. Therefore, the component supplier will be pressured to change their preferred business practices and charge application vendors according to the way they want to pay for the component IP.

Further, the component supplier will be under severe pricing pressure since their IP may well be viewed as just another cost element eating away at the application vendor's gross margins or profits. A component supplier's ability to resist these pricing pressures will depend on how much they contribute to the value delivered by a SaaS application.

SaaS component suppliers whose "share of value" is high will be in a stronger position to impose the payment scheme they prefer and to withstand the pressure of price-focused negotiations. Where the "share of value" may vary across their customer base, the component supplier will need to accommodate different licensing metrics, price points and billing schemes. All of these issues point to using a highly focused, methodical approach to pricing.

SaaS vendors who offer both applications and components to broaden their addressable market will face the challenges of the application vendor as well as those of the component supplier. Executing on both will be a significant management challenge and will require extreme pricing discipline. Success will mean tightly integrating pricing with other elements in an overall economic model.

Successful, long-term-profitable SaaS vendors - at the application or component level - will need to address some of the Pricing 2.0 issues described above. The issues we've raised above are an outgrowth of three principles that are the underpinnings of Pricing 2.0.

First, a SaaS vendor must understand the overall value they deliver to their customer so they can charge appropriately. This also means recognizing the value of the IP that others may bring to an application.

Second, "share of value" is an important measure for both application vendor and component supplier. For the application vendor, "share of value" may help establish what portion of the overall payments to share with the component supplier. For the component supplier, "share of value" may be useful for determining negotiating power, setting price metrics, levels and discounts.

And the final Pricing 2.0 principle is ensuring that pricing is flexible and can respond to rapid and continuous change. With shorter product lifecycles, easily accessible technology, and the rapidly increasing acceptance of SaaS, product prices will need to be continually monitored and adapted to market conditions.

med_As_Web_2.0_Influences_SaaS_Pri         ©2012 Managing Energy Inc.