Pricing Segmentation Best Practices for XaaS

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Pricing_Segmentation.jpgThe unique inventions and service offerings of entrepreneurs can captivate us, yet even the most innovative solutions and services can struggle when managers fail to set prices that simultaneously attract customers and produce profit. Though pricing is a complex concern for businesses in all industries, it is a particular point of confusion in XaaS industries, where "anything as a service" requires pricing versatility that cannot be achieved with more traditional price structures.

The XaaS framework offers buyers the benefit of accessing consistently updated services that match their specific needs at any given time in a way that is easily consumable. However, this flexible sale of services means that rather than offering one specific price to a customer at the time of sale—with the opportunity to set up recurring payments—XaaS pricing must include multiple choices at the outset, as well as the option to add or subtract service options over time. These service options may be flexibility in the software itself or value-added services that increase utilization or optimize outcomes.

Most XaaS pricing models require the use of segmentation if companies want to maximize both profit, and customer satisfaction. Creating a segmented pricing mechanism can be much more complicated than it seems, but in most cases that effort pays off in spades.

What is Pricing Segmentation?

Pricing segmentation is the process of offering the same product at alternate prices regardless of the costs associated with distribution and production. These price segments usually represent groups of customers that derive different levels of value from the offering. For example, Office 365 functionality can be had for $5 per month in their “Essentials”, online only, offering. Office 365 Business Premium is $12.50 per month, that includes a download of the office application onto your device. In the XaaS industry, price segmentation often means looking at various factors, such as the features involved in a given service, the usage rate of specific customers, the quantity of services being purchased, and flat-rate pricing to eliminate the "customer surplus"—or the difference between what a customer is willing to pay for something, and what they're actually asked to pay. 

Although price segmentation can increase overall profits and revenues for XaaS companies, it can only work when the customer feels that the difference in price is justified. (Tweet this!) That is, there is perceived step change in value delivered. For instance, a XaaS business couldn't simply charge one price for "rich" customers, and one price for more "price-sensitive" customers. Instead, the segmentation that is used must convince customers that they are paying a specific price, for a specific reason. This is why prices are often segmented according to factors such as:

  • Product Attributes (For example: premium programs vs. standard programs)
  • Product Value
  • Consumer Behavior (How often the customer pays for the service, or how much of a service they pay for)

Note I used the term “perceived” in describing value above. Perceptions of value can be as important as actual value differences. As a result, for example, brand value can be a significant driver of willingness to pay.

Segmenting XaaS Prices by Service Quality and Value

In order to create segmentations in a XaaS pricing strategy, the company must first establish the flat-rate fee for their services, or service packages. A customer can only recognize the presence of a "bargain” offered in a service bundle, for example, if they know the prices of each service within that bundle on an individual level. 

Using value-based pricing that considers both the current competitive market, and the price-sensitivity of available customers, it's possible to generate a basic idea of where typical prices should land before segmentation. This will give companies an insight into which of their customers fall into the definition of "bargain hunters", and which consider quality to be more important than price. Once a flat-rate fee is established for certain services, it will be easier to differentiate between offerings that are "premium" in terms of price, and those that appeal to customers with a lower budget. 

Most of the time, customers that are willing to pay the most for a XaaS offering will want a unique set of features for their money. (Tweet this!) This typically means that most XaaS providers provide a combination of "standard" and "premium" packages that allow customers to segment themselves according to the quality of service they hope to achieve. This pricing model allows companies to differentiate prices in tiers based on the upgrades and services that might be available to customers. 

Value offers a useful way to segment pricing because not everyone needs the same results from your product. For example, a company that is willing to spare no expense for the best possible XaaS solution is likely to pay extra for a package marketed as "premium", while a small budget company will stick to services at a lower price in an attempt to lower the risk associated with the purchase. As long as you can prove that the offerings at a higher price level also offer more in perceived value, your customers will segment themselves accordingly.

One warning sign to keep an eye out for is if a majority of customers purchase a single offering and other offerings are wanting for customers. This suggests the management team has work to do in better defining the segments underlying the price segmentation. Price segmentation is only viable if customers perceive real value differences between offerings.  

Another word of caution is to not underestimate customers’ willingness to pay. Look at cable television for example: if we pay $100 per month for standard service, that is roughly 14 cents per hour. We will also pay $50 for a prize fight that lasts at most 2 hours, which ends up to be $25 per hour, making the latter price to be 178x the former. The willingness to pay price range is often broader than managers believe, and this is the true power of price segmentation!

XaaS Price Segmentation by Consumer Behavior (Capacity/Usage)

Another common way to segment pricing in XaaS industries is to establish discounts and pricing levels according to the behaviors of your consumers. (Tweet this!) After all, the manner in which your customers buy your product will give you an insight into their willingness to pay more, or less for a particular solution. Most of the time, customers buying in bulk will be more price sensitive, which means that your price segmentation solutions may have to include a lower price when a certain capacity is exceeded

In the same way, many customers believe that if they use the same services frequently, they should receive a discount. For instance, many XaaS companies offer discounted pricing levels to customers who sign up for subscriptions, in comparison to those who simply purchase one-off solutions. XaaS companies also frequently segment their prices according to consumption, offering pay-as-you-go solutions to customers who prefer to pay for items according to how much of that resource they use, rather than paying for a service on a monthly, or yearly basis. In a usage based pricing strategy, a provider may charge a flat rate for all resources used, according to how many times they're used, or charge different rates for various components of a service. 

Segmenting XaaS Prices

Though price segmentation is complicated, the best options for XaaS companies generally involve segmentation according to quality, usage, and capacity. (Tweet this!) Though there's no right or wrong way to segment your own market, you'll often find that, depending on your business, you may need to use a little creativity, and a lot of research to find a pricing solution that meets your needs, and the needs of your consumers. 

About the Author

tim_matanovich_headshot.jpgTim Matanovich is president of Value and Pricing Partners (VPP), a TSIA Consulting Alliance Partner and winner of the 2012 Recognized Innovator Award for Excellence in Consulting. VPP specializes in technology pricing where services are an important part of the value prop. Tim may be reached at tim@valueandpricing.com.

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Topics: pricing, x-as-a-service (XaaS), cloud, services pricing, subscription-based offers

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