“Imagine you are an expert practitioner in the pricing industry. What macro trends within the software sector should leaders prioritize?”
The above question effectively summarizes what 2024 has been like, particularly with the widespread adoption of Large Language Models (LLMs) and AI by individuals, corporations, and essentially anyone with internet access.
ChatGPT spearheaded this AI revolution, driving companies to invest heavily in incorporating AI into workflows, product roadmaps, and daily operations. This trend has significantly benefited companies enabling AI processing, like NVIDIA, whose stock is up 176% year-to-date (at the time of writing), reinforcing the age-old adage: “Sell shovels during a gold rush.”
However, such investments must eventually show ROI and deliver measurable financial benefits to enhance shareholder value. While companies have rushed to integrate AI features into their offerings, critical questions have begun to emerge:
- How should AI features be priced?
- How should AI features be structured alongside core offerings?
Companies are now racing not only to develop AI functionalities but also to answer these questions and establish sustainable revenue models inclusive of AI. This urgency is driven by the need for continuous growth while avoiding historical pitfalls like the “dot-com bubble” of the early 2000s, which led to widespread cost-cutting and insolvency.
To help businesses address these AI-related challenges and ensure their core pricing strategies remain relevant, we have analyzed the broader software sector trends and identified five key areas for action. Whether you’re a startup entering the market or an established enterprise pivoting its pricing strategy, this article will equip you with the insights to stay ahead of the curve.
Table of Contents
Increasing Financial Pressure to Demonstrate Profitability
The software industry in 2024 experienced significant layoffs, with companies like Intel cutting 15% of its global workforce (~15,000 jobs) and Cisco Systems reducing its workforce by 7%. These layoffs stem from a confluence of factors, including inflation, rising interest rates, the post-pandemic hiring boom, recession fears, and the rapid integration of AI. While AI promises productivity gains and job creation, lagging adoption poses risks to companies’ viability.
For example, IBM cut 3,900 jobs in its marketing and communications division while freezing hiring for roles potentially replaced by AI. Companies have turned to layoffs as a cost-optimization measure, but pricing optimization offers a more effective lever to protect margins and boost profitability.
Opportunity: Build a Sustainable Pricing Architecture
A sustainable pricing architecture aligns pricing strategy with customer willingness to pay. Key components include differentiated pricing for customer segments, discounting guidelines, and processes to manage deviations. Establishing this structure ensures competitiveness while addressing margin leakages.
Opportunity: Standardize Costs and Throttle Usage for AI Features
AI features, while transformative, can quickly add costs—especially when they rely on third-party integrations. For example, an app offering advanced verification might incur higher costs when customers exceed typical usage limits. Implementing throttles and overage fees ensures profitability and prevents margin erosion.
Overcoming Customer Pushback on Price and Aligning with Value
Periods of economic uncertainty magnify the importance of price and value during the software purchasing process. In the B2B context, customers often hold negotiating power, employing tactics like RFP threats or demanding discounts. Without a robust strategy, price increases can fail spectacularly, as illustrated below:
Client Story: Price Escalation Rollback
After four years of no price increases, the new management of our client found themselves addressing immediate profitability concerns. The initial plan was an across-the-board 5% YOY price increase escalator for every new contract or renewal. Missing from that price increase rollout was a plan on how to justify the price increase requirement to existing customers.
The pushback from their customer base was immediate and fierce. They demanded that the price escalator be removed, the scope of work be reduced (a decrease in revenue), or failing that, they would initiate RFP. Even with established, long-standing relationships, many in the decades, about 1/3 of these clients succeeded with rolling back the price escalator.
The client approached Revenue Management Labs after this initial attempt at raising prices. A few things could be improved here:
- Freezing price increases eventually erodes margins.
- Optimize price according to the customer willingness to pay setup on customer segmentation analysis
- Use value-based justifications in pricing communications.
- Empowering the sales team with answers to FAQs, with negotiation guidelines to increase your success rate.
- Optimizing price according to the willingness to pay through segmentation reduces customer blowback.
Looking for more client stories? Read how we helped a software animation company double their revenue by redefining price fencing.Â
Opportunity: Align Pricing with Willingness to Pay
Addressing misalignment requires robust customer segmentation and a value-based pricing strategy. Supporting the sales team with negotiation guidelines and FAQs can also enhance success rates. Techniques such as conjoint analysis and competitive benchmarking can help identify optimal price points and value differentiators.
Simplifying Complex Price Structures to Improve Adoptability
Complex pricing structures slow decision-making and frustrate both customers and internal teams. For one client, setting up a price took two months, requiring over 100 variables to account for scope and labor requirements. The result was poor customer experience and inefficiencies.
Opportunity: Standardize Pricing Structures
Streamlining the pricing process involves identifying critical variables and simplifying calculations. For instance, we helped a client reduce their pricing process from two months to two weeks, increasing their win rate by 5.4%. Similarly, companies like Netflix have demonstrated the power of enforcing structured pricing rules, such as their crackdown on password sharing, which boosted subscriptions and net profits.
Transitioning to Innovative Pricing Models
Outcome-based pricing is gaining traction over traditional user-based or per-license models. This approach emphasizes measurable business impact, such as ROI, aligning pricing more closely with customer value.
Opportunity: Retain Customers with Value-Based Pricing
A client offering AI-driven software struggled with customer acquisition due to its high price point. By demonstrating cost efficiencies (e.g., reducing hiring costs by 15-20%), we helped reposition the product, resulting in a 30% adoption rate increase. Read the full article to learn more.
Democratization of AI
The democratization of AI is reshaping the software landscape. Cloud providers like AWS and Google Cloud offer built-in AI solutions, while pre-trained models enable rapid deployment of custom AI workflows. The result is an “AI SaaS for SaaS” model, where companies pay AI providers to remain competitive.
Opportunity: Differentiate Table Stakes from Value-Adds
Features like chatbots and call summaries, once value-adds, are now table stakes. For one client, monetizing call summaries led to customer pushback as competitors included them in basic offerings. We helped repackage their AI tools, monetizing only prescriptive actions while driving adoption by 12.3%.
