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Adopt the ABA Revenue Model

Are you in the process of establishing or growing an early stage web business?  If so, I thoroughly recommend the ABA revenue model.

What is it, I hear you asking?  It’s the “Anything But Advertising” approach.

Over the last twenty-four months we have detected a shift in the type of technology start-up being established in London.  For whatever reason (and I suspect a $100bn initial public offering may have something to do with it), the proportion of B2B versus B2C businesses seems to have changed markedly.  A number of commentators have already noted the number of “Global Vice Presidents of Sales” floating around the Old Street roundabout – usually residing in start-ups with two other employees (one a President and the other an Executive Vice President).

I read a nice set of statistics recently on LinkedIn’s blog that demonstrates the dangers of assuming eyes plus hours equals cash – an assumption that I fear underpins a lot of these start up businesses:

  • LinkedIn users spend an average of 18 minutes a month on the site. Facebook users spend 6.4 hours a month.
  • LinkedIn gets $1.30 in revenue for every hour those users spend on site. Facebook: 6.2 cents.

Surprising, aren’t they?

How to monetize website based business is something we’ve debating at Rapid Innovation Group recently – and I was pleased to find earlier that we are not alone in this debate, with this Wharton professor expressing a similar ABA preference.  However, other than Professor Clemons no one seems to be addressing this issue.

So why wouldn’t you depend on advertising revenue as your main source of funds, other than on the basis that Facebook cannot make substantial amounts of money from it?  Firstly (and sadly), when things go bad in the economy advertising revenues tend to get hammered – and secondly, how many other businesses (starting with Google) are trying to make money from the same source?  Yes, the answer is lots.

I do not have a definitive answer for you, but what I will say is this: if you are creating or seeking to grow a business, you need to be looking for sustainable revenue streams.  If you are providing a product or service that is to be used day in, day out, you do not want to be dependent on the vagaries of wider economic performance for your end of quarter sales figures.  Identify another way of extracting value from your customers early on, have a rational reason for setting your pricing point, and then stick to your guns.

Examples you should be considering:

  • Do people go to your service on a regular basis?  Then use a subscription model
  • Do your customers want different amounts of something each time they visit?  Then use a transactional model
  • Do your customers need to understand your service before they can see value?  Then use a no-charge-but-I-need-your-credit-card-details-in-advance trial model

Whatever value your service or product provides, please do not kick off into the market on the basis that your customers might be interested in a General Motors Chevy Cruze or a package holiday to Spain as a result (unless you are selling cars or Spanish package holidays)!

Pricing models and points are difficult issues for early stage businesses to address – but they set the tone for the business over the coming decade, and demark your limits of growth to an extent – so make sure you get them right!

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Insights from a complex negotiation

Most readers of this blog will be interested in getting to the point that a current client finds themselves in, so I thought I’d record the process we are working through to resolve it.

Picture this: you’ve found an enthusiastic sponsor, got them to buy into your proposition ….. you then find they have opened an opportunity bigger than you could have dreamed of (or given them credit for!).  The opportunity is business changing …. it smashes that sales target ….. the world is about to take a serious change for the better!

You’ve dealt with the sponsor and business user all the way through the sales process, everything makes sense …. then you hit (corporate) reality – an unhappy procurement function.  Why are they unhappy?  Your sponsor decided (almost certainly correctly) that if they were involved early on they’d kill the whole thing stone dead – and the business needs your software so they didn’t want it killed off early.

The call is set up, the agenda point is ominous – “commercial discussion”.  That’s where we find ourselves today.  Time for some scenario planning.

Position-based negotiation – a brief segue 

Just like in position-based warfare, you either win or die in your trench.   Positioned-based negotiation is the same – and thus to be avoided unless you have nowhere to run!

Back to the point

What will come up?  In reality there are actually very few things that procurement can say / do.  They either need to tick a due diligence box to say they checked it all out and understand it – or they are going to try and beat you down on price.

As I see it, there are only really three start points you should prepare for:

  1. The price is too much
  2. They don’t like the pricing structure
  3. Justify the whole piece

The price is too much

So let’s start with the first point – the price is too much.  The price is too much?  How is that possible, we spent all that time with the business users who hold the budget working through it and making it the right fit.  How can it suddenly be too much?

In my experience it can be too much because: a) procurement has a corporate target for reducing initially quoted prices e.g. everything down by 10%; b) the budget that the sponsor and business users identified got spent and they weren’t aware of it; or c) procurement isn’t particularly evolved in this corporate and is spectacularly unimaginative when it comes to negotiation!

So how to respond?  Remembering to avoid a position based approach (“it’s the best we can do”), ask a question: “why is it too much?  We have spent time with X and Y, who confirmed the budget was available, so you need to explain this to us”.  It’s a killer – now the procurement person has to explain their rationale for their statement – if they aren’t coming clean, try a couple of other questions: “do you have a corporate target? Has the budget been spent elsewhere?”  This puts you in the driving seat as you are now asking the questions.

We don’t like the pricing structure

This for me is a classic.  I have a tendency to specialise in subscription-based businesses – I like the model, as it lowers the cost for users to adopt and provides the business with on-going revenue to pay its employees and further develop the software.

However, subscription-based software isn’t old hat to everyone – in fact, some people still think that all software is sold on a license / maintenance basis.  This is not good, because you might have to explain the whole rationale of subscription based software to them, and then break the news that they won’t even own it – and some procurement departments hate not having something they can take away (even though in the long term they are totally powerless to develop it in house!)

There are several ways to address this:

  1. That’s our business model – take it or leave it (bad position-based start!)
  2. The pricing structure is like this because it reflects how we deliver the software – a lot of our costs are in on-going development for your benefit, as well as server space to deliver it across all those different geographies
  3. Give them a quick calculation of the license / maintenance cost – hey, if they want to buy it like that then why not!  So your £50k per annum software is now £127k (£115k+£12k) year one and then £12k for the following two years.  Obviously that’s good for my cash flow and bad for yours, Mr Procurement, plus we won’t be able to deliver you with any of the development benefits over the three years because we are going to have to create a separate instance of the software for you on another service, and once that’s in place we won’t be able to tinker with it in case something goes wrong and affects your business
  4. Ask them why they don’t like it – then knock off all the responses with the standard SaaS arguments – it won’t make them look good, so hopefully they will stop making stupid points fairly quickly!

Justify it…..all of it

This has to be the worst one …. not because you can’t do it, but because it takes so long to do.  You have confidence in your pricing, otherwise you would not have put it in front of them, and you’ve probably already been through this with the sponsors and business users – so it’s just tedious.

Do get some practice in beforehand though – time spent in preparation is time well spent.  In all likelihood the question that keeps coming up as you go through will be “why is that like that?  And why is that like that?”   As I said before, you have confidence in your pricing …… you are just going to have to spend a long time explaining it.  And there’s always the risk that either “that’s too much” or “I don’t like that” is going to come up – if so, I reference you back up to the previous two sections.

Final Thought

Generally you don’t get to a negotiation unless the customer wants to work with you.  Keep that in mind….and you’ll have a successful outcome – and lastly, the only business worth winning is profitable business!

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10 questions to ask yourself about pricing

I met a number of entrepreneurs at the Internet World event at Earl’s Court a few weeks ago, which was attended by both B2B and B2C technology firms. I came across business model ideas that ranged wildly from free-to-use to freemium to software-as-a-service to licence plus annual maintenance.

However, a lot of entrepreneurs admitted that they were at best unsure that they had the right pricing model and at worst making it up for each opportunity.

When we discuss pricing with our clients these are some of the typical questions we go through:

  1. What are your business objectives? – e.g., win your first 10 big customers/build a user base/win a first customer in a new territory
  2. What are your buyer’s constraints? - what level of budget can be signed off without making your customer’s buying process too arduous?
  3. To what will you be compared? – is your buyer more accustomed to signing cheques for million-dollar infrastructure or thousand-dollar training budgets?
  4. Will your buyer’s budget typically be operational or capital expenditure? – e.g., a software-as-a-service model won’t be appropriate if your buyer signs off budgets on a one-off, project-by-project basis rather than on a recurring basis
  5. What are your cash flow requirements? – when do you need to get cash in to sustain the business?
  6. Who else is involved? – is it possible to make your product or service free for one set of users whilst another set pays? For instance, eBay charges its sellers so that its buyers can use the service for free
  7. How does your cost of delivery scale? – what advantages of scale can you derive from higher volume orders?
  8. How does your value scale? – how much opportunity is there for up-selling to the same customer
  9. What are the different components of your solution? - is it more effective to charge separately for training, installation, configuration or is it better to wrap everything into a single price?
  10. What have you told your investors about pricing? – although this may not be the most important factor in your process it is worth flagging up

See our other posts on pricing for further ideas on this topic.

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Should your pricing be based on perceived value?

I’ve written several posts on the ideas behind value-based pricing for entrepreneurs. I argued here that although value-based pricing makes sense it is often best to link your pricing to something else.

During preparations for a pricing study that one entrepreneur asked us to look into, one of my colleagues noted that there is a difference between the actual value and the perceived value of your product or service.

To make the distinction clear, we at RIG just like any other professional services are reminded that the only metric that matters is perceived value: it is of little use in a professional services relationship to be valuable if your client does not recognise it.

There are also countless examples of products that have prices correlated to perceived value rather than actual value. Nobody tries to work out whether an iPad will make them £500 more efficient or effective before spending the same amount of money – and not knowing the actual value doesn’t stop people wanting one. The actual value of a Lottery ticket can be calculated and millions each week are still happy to part with a full £1 or more because of the thrill that it might be their lucky week.

If your product or service has a great deal of emotional appeal beyond its functionality then you may be able to extract a price that is higher than the actual value. But if the emotional appeal subsequently stops (for instance, if your brand is somehow compromised) then the high prices will become unsustainable overnight. On the other hand, if your product or service is more about helping customers to be more effective or efficient then you might end up with a higher price by linking it closely to its actual value.

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Change your vocabulary to win bigger deals

Vocabulary and analogies are important when explaining your product or service to a potential buyer.

CRM Market Analyst, Lauren Carlson argues here that marketing automation firms, Marketo and Eloqua have adopted the term Revenue Performance Management (RPM) primarily in order to “get above the noise of a crowded marketing automation market” and to “gain the attention of C-level executives.”

Responses to the blog in the comments section vary in tone from evangelical (“RPM really is about transformation; it’s a business strategy that requires an alignment of resources, processes and technology” – from Eloqua’s Director of Product Marketing) to sceptical (“RPM is just a hollow term that was invented by two vendors in an attempt to make their value propositions seem more ‘strategic’ in nature”).

But there is no shame at all in couching your proposition in vocabulary that makes sense to your buyer. If your product or service is for everyday consumers then avoid technical language. For instance, as Venture Hacks’ Naval Ravikant recounts in this excellent video on preparing for fund-raising, the proposition for Gmail was to create “a web-mail system that didn’t suck.”

Similarly, if your buyer is a C-level executive then you should explain how it is relevant to her in terms such as risk and competitive advantage. If your product or service does not have any impact on these sorts of issues then you should avoid setting pricing levels that require an executive-level conversation.

If Revenue Performance Management means anything beyond the familiar ideas around marketing automation and Customer Relationship Management then I suggest that it should be a methodology for an executive-level Chief Revenue Officer, whose responsibility is to optimise the revenue generated through a mix of direct or inside sales and channel partners or licensees.

This role requires an understanding of the science of revenue generation, which involves many moving parts (marketing, sales, partner management, PR, etc.). The analysis and reporting of these moving parts are complex matters and I can envisage a valuable role for automation here.

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Choose your customers

One of the topics I like to discuss with prospective RIG-ers at interview is what the first steps are that they would undertake to plan the demand generation (i.e. marketing) strategy for one of our typical earlier stage clients. I describe this ‘typical’ client as having the following characteristics:

  • A market ready B2B SaaS offering
  • One paying customer
  • A recent angel investment with the objective of driving sales and marketing

There are numerous mechanisms, processes, and strategies in planning the initial stages of an effective marketing effort for such a company. However, I try and guide the discussion to the central tenet of any successful plan – the fact that you need to begin by choosing your customer. This becomes remarkably obvious to the candidate when I tell them, but it is non-the-less a vital step in any marketing strategy.

The key of course, is how to invest limited resources to maximise chances of market traction. In order to do this, you want to sell your solution to an organisation which has:

  • A problem / opportunity which your product solves / enables them to exploit better or cheaper than alternatives
  • An awareness that this problem / opportunity exists
  • Available budget

Now you have chosen your customer, in which markets do you find them? What is the best way to reach them? How are you able to articulate your proposition in such a way that it is most compelling? How do you make it more compelling than going with a competitor, doing nothing at all or doing something in house? How should you price the solution and what is the anticipated return on investment? How do you navigate the complex sale?

Once you have found a way to do it, how you codify this process to drive both repeatability and visibility for the purposes of revenue predictability? What are the key hires and what can be done to ensure the optimal candidate is recruited and able to perform? When is more investment required? Would growth objectives be better met if partnerships were formed in certain areas? How are the best partners found and what management processes are needed to reduce the risks of failure?

These are all the challenges we not only advise our clients on, but actively execute for them, and they are all areas that I will cover in future posts.

At this stage in the interview, the candidates are always suitably fired up about our business!

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Top 10 revenue concerns of a £1m tech company

I was asked today to put together what we thought were the ten most important revenue issues that challenge B2B technology companies with a turnover of around £1m. Typically these organisations have a couple of sales professionals, some sort of marketing support, and perhaps a small Account Development function, all reporting to a CEO or Country Manager.

In no particular order, this is what we came up with:

  1. Reducing sales cycle – What are the key factors that determine sales cycle and how do I make measurable improvements in each one?
  2. Marketing effectiveness – How many leads do I generate for each pound spent on each different marketing activity? What is the optimal mix for my situation?
  3. Account management – How do I ensure that my customers will actively recommend me to their contacts? How can I drive this in a systematic way?
  4. Account development – What is the most effective way of upselling to existing customers?
  5. Pricing – How do I ensure that I am not leaving money on the table? How can I maximise my return within my prospects’ procurement constraints?
  6. Sales distribution model – How can I reduce the risk of having to rely on one stellar performer? How can I encourage sharing of best practice within my sales team? What other sales channels should I invest in?
  7. Sales process and sales team design – How do I ensure that the structure of my sales team is aligned with my sales process? How should I define roles within the sales process? How should I hire for each role?
  8. Lead generation – What is the most effective combination of ‘push’ and ‘pull’ marketing activities? When should I move more resources from outbound to inbound lead generation?
  9. Market leadership strategy – How can I develop a strategy that will capitalise on market trends whilst taking out the competition? Where should I look to carve out a leadership position?
  10. New market entry – What is the most effective approach to a new market? How can I use my successes in existing markets to develop new ones?

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Interview about pricing in the Financial Times

Last week I was interviewed by the Financial Times’ Enterprise Correspondent, Jonathan Moules about pricing strategies for entrepreneurs.

The interview followed the themes around pricing that have been developed in this blog such as the fundamental idea that pricing should follow from your overall business objectives, and the concept that there are three key independent axes to a pricing framework which can be considered in isolation.

The article was published in the 24th/25th April edition of Financial Times Weekend in the Money section and it is available online here (requires free registration to view).

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How to set a pricing level for partners

The majority of the posts about pricing on this blog have focussed on setting a price at which to sell your product or service directly. The fundamental idea of creating a whole pricing framework that reflects your overall business objectives still stands when you sell indirectly through a partner. However, the objectives for selling through a partner will almost always be different from the objectives for selling directly with your own sales team.

Some typical objectives you’re likely to think about for a partner strategy are:

  • To reduce the overall cost of sale
  • To provide 10% of your overall revenue target in Year 1
  • To build a predictable and scalable medium-to-long term source of revenue
  • To allow the partner to make a good profit from reselling your product or service
  • To make it easy for the partner to sell to its customer base

Taking this as the starting point you can then think about how this affects your pricing level (how much), model (when), and structure (by what).

Considering here how much you charge, it has to fit in with the rest of the partner’s offering. If your partner’s core business is selling paper with annual value of £1000 to each customer then trying to get the partner to sell £1000 printers alongside the paper won’t make sense. It will dilute the impression that the partner’s customers have of the core business.

By the same token, asking the partner to resell paper clips with a maximum annual value of £10 probably doesn’t make sense either because it won’t be worth the partner’s time.

I’ve seen three alternative structures work well for growth-stage technology companies. First, you can tell the partner to resell your service at any price they can get and you take a fixed percentage of every deal; second, you can fix the price that you want for each deal and allow them to make whatever profit they can above that price; and third, you can tell them you want a guaranteed £x in Q1, £y in Q2, and so on, and they can sell as much as they like at whatever price.

Your choice here will depend primarily on how confident you are in the partner’s ability to reach your expectations and on how well-established the partner is compared to you.

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Article on pricing published in BusinessXL magazine

A short piece I wrote on pricing strategies has been published in BusinessXL magazine, available online here.

It was written in response to an article entitled The Art of Pricing by Michael Jackson (the British Venture Capitalist not the revered King of Pop) in BusinessXL’s November issue and blog.

Jackson’s concern was that entrepreneurs rarely put aside the time necessary to work out a pricing framework that effectively supports their businesses’ objectives. My comment focuses on the limits of value-based pricing, about which I originally wrote in this blog here.

Pricing is so often done in an ad-hoc way even though investing the time to do it properly can have a huge impact on revenues.

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Putting a value on the elimination of risk

Imagine that you hire someone to come around once a day in the afternoon and clean all the toilets in your building. The cleaner works for £10 an hour and it takes five hours per day so the cost to you is £50 per day.

A technology firm approaches you with a robot cleaner that can do exactly the same job. The robot’s value to you is then £50 per day, because you no longer have to pay the cleaner. If the technology firm offers you the robot for anything less than £50 per day then the price should be acceptable.

This is the basis of value-based pricing that looks at tangible or certain or past costs: assume that the existing solution is 100% satisfactory; calculate the costs that are removed when using technology instead of the manual process; and set the price accordingly.

The other way to think about value-based pricing is to look at intangible or uncertain or future costs. Imagine that there is a very small risk of some highly-damaging infection with the current practice of cleaning five hours per day, and that the risk would be negligible if you cleaned every hour.

If you wanted to eliminate the risk completely then one solution would be to hire a cleaner every hour, say £240 per day. But practically speaking the risk is tiny, and you’ve never been affected before, so £240 per day is probably too much. However, if the same technology company said that its robots could not only clean but also eliminate this risk of infection then its value rises to £240 per day.

In other words, the technology company assumes that the existing solution is well below 100% satisfactory and considers the cost of scaling up the current processes to hit 100%. This is a much clearer way of putting a value on the elimination of risk than try to argue that there is a 0.01% chance per day of a £1m disaster.

Assigning a value to the reduction of a very small risk is notoriously difficult and unreliable. Try arguing that the maximum speed limit on motorways should be 5 mph less because of the marginal difference in the risk of motor accidents. However, that does not mean that it has no value at all, so think about the costs of eliminating the risk using existing practices.

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