Impact Pricing Podcast

Ep173: Value-Based Pricing in the Subscription Economy: Why It’s Hard to Perfectly Align Value, Usage, and Pricing with Ed Arnold

 

Ed Arnold works as an Advisor at Ibbaka, a software provider for high growth companies that helps optimize planning and execution of key growth initiatives while improving company performance. He was the VP of Products at LeveragePoint for 10 years, and was able to work with the pricing legend, Tom Nagle.

In this episode, Ed talks about the future of value-based pricing in the subscription economy as he discusses how product-led growth companies achieve their initial growth which later on leads to big wins.

 

Why you have to check out today’s podcast:

  • Understand why pricing in value is the key in very clever segmentation in terms of creating user profiles in the market
  • Find out how product-led growth companies grow from being a small enterprise to being loved by a bigger market
  • Discover companies that are product-led growth businesses and realize how much they’ve grown since day one

“Understand how your customer gets value from using your product, not from buying it; not in terms of what the product offering is in terms of features, but how they actually use it.” 

Ed Arnold

           

Topics Covered:

01:03 – Who is Tom Nagle?

01:41 – How Ed got into pricing + creating a tool and working with Tom Nagle

03:07 – Explaining what LeveragePoint is

03:50 – Future of value-based pricing in subscription: Value as a differentiator in the market

07:11 – Buying vs. negotiating a price: Knowing what you’re after

11:43 – Product-led growth practice as a brilliant strategy for business

13:55 – What Ed and everybody else likes about PLG – instant gratification

17:43 – Life-changing benefits of Slack

19:15 – Aligning pricing metrics

21:34 – Why usage-based pricing frustrates Mark

23:41 – Changing and having more than one pricing metric

27:13 – Ed’s piece of pricing advice for the listeners

28:06 – What Ed thinks about behavioral economics

 

Key Takeaways: 

“If you’re thinking about what sort of animal you’re hunting in the enterprise game, those are the whales. I think value is the only way you can differentiate yourself in the enterprise market.” – Ed Arnold

“No corporate buyer ever heard of Slack until thousands of people in their company were already using it. So, in a sense, the business employee is a consumer, and that’s how product-led growth companies are getting that initial growth. They’re making it so ridiculously easy for people to start using it before the corporate procurement folks or even IT departments have any idea that they’re using it. That’s what makes that model so, so attractive for investors.” – Ed Arnold

“We like to talk about three types of metrics. And you got to link those three together. Ideally, if you can link those three together, you’re in Nirvana, because your price is aligned with value and it’s aligned with usage and everything is great.” – Ed Arnold

“When it’s the right thing to do, and it makes sense, it does pay dividends. But it’s tough. And I think it’s really a leap of faith and doing it.” – Ed Arnold

 

People / Resources Mentioned:

Connect with Ed Arnold:

Connect with Mark Stiving:   

Full Interview Transcript

(Note: This transcript was created with an AI transcription service. Please forgive any transcription or grammatical errors. We probably sounded better in real life.)

Ed Arnold

Understand how your customer gets value from using your product, not from buying it; not in terms of what the product offering is in terms of features, but how they actually use it.

[Intro]

Mark Stiving

Welcome to Impact Pricing, the podcast where we discuss pricing, value, and the future relationship between them. I’m Mark Stiving. Today, our guest is Ed Arnold. Here are three things you’d want to know about Ed before we start.

He’s an Advisor at Ibbaka. He was the VP of Products at LeveragePoint for 10 years, and hopefully you know who that company is. And probably my favorite thing about Ed – he got to work with Tom Nagle.

Welcome, Ed.

Ed Arnold

Thanks, Mark. It’s pleasure to be here.

Mark Stiving

Hey, for anybody who doesn’t know, who’s Tom Nagle?

Ed Arnold

Tom Nagle? He is the legend in the pricing strategy world, wrote probably the most famous book, Pricing, The Strategy and Tactics of Pricing, I think in its sixth edition. Anyone who knows anything about pricing, or pretends to, should have a copy of that book.

Mark Stiving

Yeah. I actually taught from that book when I was a professor a hundred years ago. He’s always been high on my list.

Ed Arnold

Yep, and you see his influence everywhere, whether or not people give him attribution.

Mark Stiving

Yeah. So how did you get into pricing?

Ed Arnold

It happened when I was at the Monitor group, when I was working with Tom Nagle, because at the time, Tom and his team were part of the strategic pricing practice there. At that time, I was a product manager. I was creating e-learning products, based on the Monitor group, IP. Monitor had this idea of getting into the software business, and we could do a whole separate show on why consultants should not go into the software business, but anyway, they wanted to do that and we were cranking away. And then they said, “Hey, Ed, we want to do an e-learning course on this strategic pricing stuff with Tom Nagle.” And so, we started working on it, and I very quickly came to the decision that I did not want to make this into an e-learning course. I wanted to create a tool where people could actually make pricing decisions. And that’s how I got started.

Mark Stiving

Is that where LeveragePoint came from?

Ed Arnold

Yes. What happened was, a variety of things happened, but basically, the head winds from the financial crisis in the late 2000s, forced Monitor to try to shed some costs. So, all the software groups, we were one of probably a half dozen software entities within the Monitor group. So, we actually had the opportunity to spin out as an independent company.

Mark Stiving

Nice.

And so, I’ll try to explain LeveragePoint and then you correct me when I’m wrong. I realize you don’t work there anymore, but LeveragePoint is a company that allows, or is actually a software application that allows companies to try to document the value that they’re offering and be able to communicate that value to potential buyers. How was that?

Ed Arnold

Very good, very good. I’ll also say that we were the first SaaS value-based pricing software company back when SaaS wasn’t as big a deal as it is. So, we were the first, and actually, it created a whole category. Now, there’s at least two or three other companies that are also in that same business.

Mark Stiving

Nice. Well, speaking of SaaS, that’s what we’re going to talk about today. I always ask people, what are they passionate about, what do we want to talk about, and you have said the future of value-based pricing in the subscription economy; one of my favorite topics.

Ed Arnold

Right.

Mark Stiving

So first off, wide open softball, what do you think about the future of value-based pricing in the subscription economy?

Ed Arnold

I think it’s the new frontier, a new frontier not only from the point of view of a customer- based to adopt the base pricing, but also changing the nature in the direction of how value-based pricing will evolve in the future, because of it being a SaaS subscription world.

Mark Stiving

So, there’s lots of questions that I always have when we think about subscriptions and value-based pricing. It seems like a lot of companies are going, I’m going to use the word fixed fee, in value-based pricing, meaning they’re not negotiating individual prices, that you get to see it on the webpage and you can buy one of these three packages or this many users. So, does that detract from the concept of capturing more value from our customers, or does that add to it?

Ed Arnold

Well, what’s really interesting about those pricing pages, Mark, and we’ve all seen them, right? The three or the five tiers. And the example that I always like to use is Salesforce. So, Salesforce was sort of in many ways an inspiration for LeveragePoint. I wanted to grow up to be like a Salesforce company. That last year, doesn’t have any prices on it; never does.

Mark Stiving

It’s almost always labeled enterprise.

Ed Arnold

Enterprise or negotiated, there’s always some kind of word in there that means call us and we’ll talk. And that’s, really, if you’re thinking about what sort of animal you’re hunting in the enterprise game, those are the whales, right? So, the whales get that pricing, and it’s really interesting.

In the subscription world, especially with product-led growth, which is all about selling the product without a salesperson the product is actually selling itself, that works really well in those earlier tears, right? Because the value is immediate with the user. And if you think of all these successful case studies, like Slack, for example. Slack was around free for years, right? Until it built up, and now, it’s become sort of de facto software.

What’s interesting is that when it gets to that certain threshold, I don’t know what the number is in terms of the number of users or the size of the organization, then it kind of flips into classic enterprise value, just like any other large manufacturing company. And a lot of companies are grappling with that right now in the subscription space, especially those that are trying to compete with the giants, the leaders in the space. And I think value is the only way you can differentiate yourself in the enterprise market.

Mark Stiving

So, I think that makes sense. I’m just going to think out loud for a second, Ed, and then think with me, if you don’t mind.

We can take these enterprise companies, and let’s say they’re worth multiple millions of dollars to us in revenue, and so it makes all the sense in the world to negotiate, to sell value, do all the things we would with a traditional product.

Ed Arnold

Right.

Mark Stiving

And then as we start to come down market, there hits a point where we say, “Look, it’s okay that I’m not capturing every dollar from my customer because I’m automating the process, I’m making it easier for them to acquire and grow.”

And so where do you think that line is? How do we make the decision on when we switch from “buy at this price” to “hey, we’re going to negotiate with you”?

Ed Arnold

I’m not sure, honestly, Mark, but I know that land and expand is in everyone’s vocabulary in that market, right? So, this idea is that you do want to have all your customers grow to whatever level they’re comfortable with according to whatever your ICP is, your ideal customer profile. But if you are really going after enterprise – a large enterprise, which I think many companies are – you’d want them to grow to that higher tier, that highest tier.

Now, there may be some markets where there’s a limit to how far that subscription can grow, right? But that’s a strategic decision about where does your growth come from, right? Like, where in the addressable market. And it’s kind of interesting in our work at Ibbaka.

A lot of times, we do an analysis of what their average accounts are. First week, we ask them, and then we look at their CRM, and it’s amazing what you see when you actually look at the real data. You’ll say, well, what’s a typical account? And they’ll throw out the ones that they like to talk about, the big success stories.

When you actually look at the averages, you see a lot of small-ish accounts that are kind of stuck and not growing. So, understanding what sort of critter you are really hunting. Are you going after a deer? Are you going after a whale? Or are you just shooting a lot of squirrels? Sorry to use that gross analogy.

Mark Stiving

Lifting analogy. Yes.

Ed Arnold

Yes. Well, it’s popular in some sales literature. But it’s like, what are you going after, and what do you actually have in your collection right now? That’s really interesting, because if your service model is somewhat high touch and you’ve got a lot of counts that are below the cost, too expensive to serve, then you got a problem, right?

So, that’s why investors love product-led growth companies, because they grow very, very fast, and they scale very quickly and cheaply. But again-

Mark Stiving

The idea is that there’s very low if any cost to serve an individual customer.

Ed Arnold

Not directly. Yeah, but it’s all in the software. I mean, that software is being improved every day, and they’re spending lots and lots of money on it.

And so, I did a talk with a virtual product camp last summer, where I was comparing product led growth to the expansion of fast-food industry in the 1960s. And I said, basically, the leading PLG companies were really following McDonald’s model, which is standardize the offering, economies of scale, invest in the backroom operations to make it as efficiency, own your supply chain, and push, push, push, push. And that’s exactly what product-led growth companies are doing and why they had such great, great growth.

Now, when you get a market that gets saturated with competitors, which is what’s happening now in the B2B SaaS world – these competitive market spaces are getting very concentrated. If you look at a market map for marketing automation, I don’t know, it’d be like 10,000 individual dots on that map right now. What is going on there? You sort of run out of market. That’s why I think pricing in value is going to be really key in very clever segmentation in terms of user profiles.

Mark Stiving

So, one of the things, as you were talking, that struck me is in this world of product-led growth, it makes so much sense to create a new product, and then we go after startup companies or smaller companies, SMBs, because the big enterprise companies aren’t going to buy from us. They don’t trust that we’re going to be around in a year, and there’s a million reasons why.

Ed Arnold

Yeah.

Mark Stiving

And so, to build this almost no cost to serve a customer, be able to get into a startup or SMB type marketplace, and grow quickly, not negotiate, not have salespeople, this is just a brilliant business model. And then one day, you get to grow up and play with enterprise.

Now, the opposite, though, I don’t think is very easy, because I actually work with several clients who started in enterprise, and they have such a high cost to serve, such a high implementation cost. They can’t see how to let go of that and get down into the product-led growth and no cost to serve a customer.

Ed Arnold

Yeah. No, it’s tough, and we’ve worked with clients that say they want to be product-led growth, but when we look at what they’re doing, we’re saying, “Nah, don’t even try.” I mean, you have to completely change your business model to make it work.

But what’s really interesting, Mark, is that – and this actually came out in the pricing conference that you and I both recently attended – the blur between B2B and B2C, I mean, they’re kind of merging, right? So, when you think, for example, like with Slack, no corporate buyer ever heard of Slack until thousands of people in their company were already using it, right? So, in a sense, the business employee is a consumer, and that’s how product-led growth companies are getting that initial growth. They’re making it so ridiculously easy for people to start using it before the corporate procurement folks or even IT departments have any idea that they’re using it. That’s what makes that model so, so attractive for investors. It’s like you’re sort of tying up the users before the corporation’s even are aware of it. To me, that’s a sign of a brilliant product strategy.

Mark Stiving

Yeah. So, what I often find interesting is that we look at these strategies, product-led growth or subscription, we say, “well, that’s the future”, and then I take a step back and I say, “well, that actually works well with this type of product, but it doesn’t work well with that type of product.” So, I would challenge you to put together a subscription model for caskets. Or if you think about product-led growth, the reason Slack or Calendly, these companies, are so successful, is because individuals get value from the product by themselves. I don’t need the company to adopt it. I don’t need a ton of people to have it. I get value. And then when a lot of people inside a big company have adopted this, now all of a sudden, it makes sense to build an enterprise and let’s socialize it, let’s get it communicating the company.

Ed Arnold

Yeah. I mean, what I like about product-led growth is this idea of instant gratification. The user has to get value, even if it’s free.

Mark Stiving

Yup.

Ed Arnold

The user has to get value with it in the first 15 minutes. Now, that’s a really high hurdle for any software product designer, me included. And we’ve fallen short of that, right? Where it’s like, oh, no, you have to have the training, we have to have this and you have to have that. And you may sell the person who bought the software, but then, you’d go back and look at the subscription and say, “Well, wait, only 5% of the users ever logged in.” Yeah. I mean, it’s really understanding what that use case, what that job to be done is, and allowing someone to very quickly download it, try it, use it, and get value out of it quickly. Like, you can go through the whole buying process and the first usage hurdle in 15 minutes, right?

And I mean, I think all of us have had examples of that, especially when you’re trying to get something done and you don’t want to go through corporate to buy a software package, and hey, I just want something that can do a roadmap, right? So what can I use as a premium where I’ve got all these business contacts that I need to organize and do an email campaign – all of those like tasks that people just want to get done quickly; the product-led growth companies figured that out, and especially if that is based around team collaboration, virtual team collaboration, which is one of the reasons why Zoom and Slack and etc. have really taken off. That makes it even more valuable. That gives it more of a philosophy.

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Mark Stiving

Yeah. I think Zoom, and Slack, and Calendly are three great examples of things that you can pick up and use and get value from really quickly.

Ed Arnold

Yeah, and I use all three, and have. And it amazes me when people don’t use those things, right?

Mark Stiving

I don’t use Slack.

Ed Arnold

Oh, yeah. Well, we use Slack a lot, and it’s funny, I mean, where I’m working at Ibbaka. And I have clients now that- I believe that you got to meet clients where they are, right? So, if they want to talk by the phone, you talk on the phone; if it’s Slack. A lot of clients, younger, more tech savvy, they want to communicate in Slack, right? So, things that will take the whole structure of communication has changed. And sometimes I’ll bring it up in some of the meetings I have and say, “Well, how do you know that?” Well, I was just Slacking with this person over the last three days, and we were having this running conversation about something, and that developed a relationship that would not have happened in the old days. In my old, old days as a consultant, you flew out and you spent weeks living at the client office, right? Those days are over. Now, it’s all through Slack. And I’m more happy with that.

Mark Stiving

I’m sure, someday, a client will ask me to do that, but until that happens, I’m happy not using just another software application.

Ed Arnold

Try it. It will cut your emails down, so it’s not additive. It will make you more efficient.

Mark Stiving

No worries.

Ed, this is always fun. What else do you think is hard about pricing and subscriptions? What do we get wrong?

Ed Arnold

I think a lot of it, the number one thing is what is your pricing metric?

So, what we like to do is we like to talk about three types of metrics. There’s the pricing metric, how you charge for something. There’s the usage metric, how you keep track of how much I’m using. And then the most important one is the value metric, how much value do I get from it? And one of the truths about value is that you get value by using stuff. If you buy something you don’t use, you get zero value. So, it’s really understanding how people get value out of software. And so, you got to link those three together. Ideally, if you can link those three together, you’re in Nirvana, because your price is aligned with value and it’s aligned with usage and everything is great. Really hard to do.

So, what’s really the predominant pricing metric right now in software and subscriptions is user per user, right? A very unimaginative metric. And one that often doesn’t align with value, right? And I’ve had these conversations at LeveragePoint. “Yeah, we signed up a thousand people, got a great deal, but only three people logged in, or 10 people logged in.” I said, “Yeah, but those people who did just created $100 million worth of value for your company. So go figure.”

So that, to me, is one of the big issues in subscription pricing. It’s really aligning with the right metric.

Recently, after a lot of effort, I got one of our clients to switch their metric from user to something else. I can’t reveal what that is, but it made all the difference in terms of how they position themselves on value. So now, they can measure this based on actual usage and value. And so, those three things are aligned.

Mark Stiving

Nice.

So, I want to say that I love the fact that you use pricing metric and value metric the way you do. I also love the fact that you added usage metric, because I’ve never used the word usage metric, and I love that. I think that makes a ton of sense.

Ed Arnold

Yeah. Well, usage-based pricing is making a big comeback, man.

Mark Stiving

So, I’m a little frustrated by usage-based pricing.

Ed Arnold

Yeah.

Mark Stiving

In the sense that all it is choosing a usage as your pricing metric.

Ed Arnold

Yeah. It’s really hard to do, because it’s like the old phone bill, right? Remember the old phone bills when they had like 50 pages?

Mark Stiving

Yup.

Ed Arnold

And for a product manager, we hated that, because it discouraged people from using it, like turn down the heat, don’t use that as much. You don’t want to do that, right? You want to make it all you can use as much as you want. But in some in some areas, I know Amazon does usage quite effectively. AWS uses that quite effectively. So, in some markets, in some products, depending on how it’s being used, then it makes sense. But for most businesses, it does not.

Mark Stiving

It’s not that I hate usage-based pricing. It’s that I’m frustrated by the fact that it’s suddenly become this really big deal. All it is, is a subset of a pricing metric.

Ed Arnold

Yeah, but you’ve lived long enough where all that is new is old. So, for a lot of folks who never saw it before, yeah. If you start decreasing the last 10 years, you probably never heard of it before.

Mark Stiving

Yeah. Well, so are you going to pay Netflix by the movie that you watch?

Ed Arnold

Well, there you go, right? I know what I would do. I mean, the interesting cable, like don’t get me started on Comcast, right? But you got 200 channels and there’s nothing to watch, right? I would pay dearly to have just 20 channels that I would love to watch, but I want to be able to pick each one individually. I want to be able to start and stop them whenever I want to. But then, that true usage-based pricing model that I would like to see in cable will never happen.

Mark Stiving

Yeah.

Ed Arnold

Will never happen.

Mark Stiving

I want to take you back to something you said a second ago, because it’s something I’ve never heard anyone else talk about yet, and that is when you got someone to change their pricing metric from usage to something else

Ed Arnold

From per user

Mark Stiving

Yeah. How hard was it to make the change?

Ed Arnold

Oh, it was really hard. I mean, it took weeks, if not months, to move the needle on that one.

Mark Stiving

I mean, if the CEO says let’s do it, there’s tons of things inside the company that now have to shift.

Ed Arnold

Yes. No, I mean, it was hard, but I’m very proud of it because it was the right thing to do. But it took a lot of convincing and up and down the line in the organization. And so, it’s a big change management one. But like I said, when it’s the right thing to do, and it makes sense, it does pay dividends. But it’s tough. And I think it’s really a leap of faith and doing it.

Mark Stiving

Yeah. Have you seen – and I can imagine, but I can’t picture an example in my head of a company using more than one pricing metric. It’s almost like if I buy a car, I can take a loan or I can lease it.

Ed Arnold

Yes, there is a software company that I recently ran into. Quick Days is the company, it’s one of these low code platforms, and I think they give you the option of doing things by the application or by the user. So, there are some software that are starting to experiment with that, in certain markets.

Mark Stiving

Yeah, it’s an interesting thought. But ask yourself, how does that relate to value? And are we really capturing the value from our customers, then?

Ed Arnold

Well, you would really need to do the analysis on the value, which means really understanding what Nagle would call the value drivers and how those value drivers line up with those different metrics. So, you have to do the homework on that, and it’s different for every customer.

I mean, when we used to build value models, in the early days of LeveragePoint, we used to use the pricing metric, the value metric, which was ridiculous in some cases. So, for example, if I was working with a commodity supplier, not commodity supplier, but like a material supplier, and they sold things by the kilogram, it was kind of funny to say it’s $3 per kilogram of value and worth pricing. Its price is $10 per kilogram and the value is $3. It didn’t make sense, right? So, what does an organization understand in terms of value? Well, per year make sense. You know what I mean? So even though our material is more expensive per kilogram, the end result is you’re going to get this much more profit per year.

And so that was the first inkling that you needed to have multiple metrics and you switch between the two, but if you could link them together and it makes sense, like the old example that everyone hears about – aircraft engines. Everyone in the pricing world has heard that one, power by the hour. That’s a perfect example of value, usage, and price perfectly being aligned. But trying to do that for other businesses, trust me, it’s really hard to get those three to line up perfectly.

Mark Stiving

Yup, understood.

Ed, we are almost out of time, but I got to ask you the final question. What’s one piece of pricing advice you’d give our listeners that you think could have a big impact on their business?

Ed Arnold

Understand how your customer gets value from using your product, not from buying it; not in terms of what the product offering is in terms of features, but how they actually use it. And it’s usually multiple stakeholders. So, understand value from those multiple perspectives. A lot of times, customers underestimate the value they get out of your solution, because they don’t bother to measure it, right? It works. But just go through that thought exercise of what it would cost if they took that out and replaced with nothing or your competitor. You should know that. That’s the number one thing.

Mark Stiving

Okay. So, I’m going to ask you another question. First off, I love your answer. I thought that was great. And the answer that you gave kind of implied in opinion, and I’m going to ask you, because I want to know. You said, not how your buyers buy. So, what do you think of behavioral economics?

Ed Arnold

I’m fascinated by it. It’s kind of a new subject for me. But what it means to me is that in your customer’s head, there’s a left and a right brain thing going on. So, there’s the rational and then there’s the perception. And value is perception. It’s whatever the customer believes it is. And they’ll come up with the logic to justify after the fact. So that’s what behavioral economics does and it shows, but actually breaks that down into how you could use that to understand what value is. So, I think you need to take that into account as well. I think that more comes into play when the customer is actually making the purchase decision. Even if you convince them that there’s a lot of value in something, if they feel personally, they’re at risk for taking it on, that will hold them back, and that’s part of what the behavioral economics tells you, that I’ll stick with something that I know stinks, but at least they won’t get fired for it.

Mark Stiving

Nice. I think we’re kindred spirits. We think a lot alike in almost everything we discussed today, which was pretty good. And my opinion is value and behavioral economics are essentially two very different things, and we have to think about them differently. You really can’t do just one.

Ed Arnold

Yeah.

Mark Stiving

Never do a price increase and communicate it poorly to your customers. You would communicate as well as you could, which is behavioral economics.

Ed Arnold

It is. And you’ll see a lot more on the B2C side of the fence. I mean, I think it’s a lot about perceptions and behavior. On the B2B side, I mean, it’s much more skewed towards the rational and the economic, but it’s still there. And so, it never goes away, so you need to take it into account.

Mark Stiving

Ed, thank you so much for your time today. If anybody wants to contact you, how can they do that?

Ed Arnold

Best way is through my email. So, it’s Ed, E-D, dot Arnold, A-R-N-O-L-D @ibbaka.com ([email protected]), and Ibbaka is I-B-B-A-K-A .com

Mark Stiving

I’m glad you spelled that because I would have spelled it incorrectly.

Ed Arnold

I may have. We may have to fix that in post, but I’m pretty sure that’s correct.

Mark Stiving

Episode 173 is all done. Thank you so much for listening. If you enjoyed this, would you please leave us a rating and a review?

And speaking of reviews, Ensaneeee via Apple Podcast wrote:

“Practical and relevant. This is an absolutely amazing podcast. It provides real people talking about real-world problems. I’ve implemented many of the discussions in this podcast into my organization, and the value is felt immediately.”

Thank you Ensaneeee. I hugely appreciate it.

And if you have any colleagues who are interested in pricing, please share this podcast with them. If you have any questions or comments about the podcast or pricing in general, feel free to email me, [email protected].

Now, go make an impact.

 

Tags: Accelerate Your Subscription Business, ask a pricing expert, pricing metrics, pricing strategy

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