Back in 2008, I posted a framework titled The Pricing Pentagon. The framework identifies the data streams required to enable effective service pricing. That has been one of my most popular posts to date. The framework, originally published in Mastering Professional Services, is becoming more relevant than ever.
TSIA believes technology service organizations will be forced to move off of their traditional cost based pricing models. This change is being accelerated by the trends in technology consumption. As outlined on our book Consumption Economics, we believe enterprises will continue to migrate to models where they pay for technology as they consume that technology. Historically, enterprises paid for all kinds of technical capability up front—some of which they never ended up needing or using. As enterprises subscribe to technology on an “as need basis”, they will begin rethinking how they spend money on the services that surround that technology.
Historically, there were two primary reasons enterprises paid product companies directly for services:
- Reduce the risk associated with implementing new technology (professional and education services).
- Receive insurance the technology will keep running (support and field services).
As we demonstrate in our Service 50 index every quarter, most product companies are very adept at making decent margins providing these types of services. We also know from our benchmarking data that most product companies employ variations of cost based pricing models to determine what to charge for their services. Cost based pricing, we believe, will become an unsustainable services pricing model for product companies. Why? TSIA has the following premises related to services pricing:
- P1: Product companies will face immense pricing pressure on service offerings that are required to stand up and maintain a technology environment.
- P2: These traditional service revenue streams will be declining.
- P3: To offset decline in demand, service organizations will need to identify new service offerings (Business Impact Services)
- P4: To offset pricing pressure, service organizations will need to revise service pricing models.
- P5: To enable value based pricing models, companies need to be proficient at defining the business value customers receive from consuming an offering.
- P6: Technology companies currently have weak (or non-existent) processes for defining and defending the business value customers realize by consuming specific services.
- P7: As customers migrate to consumption based pricing models for technology, they will push for “value realization” pricing mechanisms for services.
- P8: Customer analytics will become a key capability in understanding how customers derive business value from technology solutions.
If you believe even half of these premises, you will agree that traditional cost based pricing will be under pressure. Julia Stegman is our lead researcher on service pricing models. We are collaborating on documenting the data streams, organizational capabilities, and business processes service organizations will require as they migrate from “cost based” to “value realization based” pricing models. For more information on this body of work, contact firstname.lastname@example.org or email@example.com
Tags: pricing pentagon