June 24, 2003

Under pressure to cut your software prices?
Here are 17 rules to beat the discount heat

by Bruce Hadley, SoftwareCEO

When times are tough — and we don't have to remind you they've been pretty tough in the software industry for at least two years — there's a natural tendency to cut prices.

Sometimes it's a "hard" cut: Some ISVs have sliced their published price sheets by as much as 10%. Another variation is the "soft," or transitory cut: a time-sensitive, blowout special to try to drum up business.

We've received promos of the soft variety from developers willing to slash up to 80% off their retail price — we're not, as Dave Barry would say, making this up — if only we'll order today. A cut of that magnitude hardly deserves to be called soft.

Then, there's the behind-closed-doors cut: You may not announce any discounts publicly, but when it comes to negotiations with a prospect you're trying to turn into a customer, the scalpels come out. We've been there, and we've seen just how far hungry ISVs will bend over.

Okay, so what's the antidote? What can ISVs do to avoid cutting prices?

To get the answers, we turned to our favorite software pricing and licensing guru, Jim Geisman of Marketshare. Geisman has probably forgotten more about pricing, licensing, and deal negotiation than most of us know — he's that good.

Plus, we checked in with Frank Linsalata, COO of Analytical Graphics (AGI), a software developer headquartered in Malvern, Pa. AGI has worked with Geisman, and has recently revamped its software pricing — some of it upwards.

Here's the advice we gleaned from the two of them; follow these 17 rules, and you should be able to head off most discount disasters.

Discount avoidance rule #1: Don't grasp for a magic number. "There's no right price, and there's no wrong price," Geisman says. "There's a combination of how the products are structured, how the message is structured, who you're talking to, and the financial terms. It's only when you put all that together that you can arrive at pricing that makes sense for your company and your software."

Discount avoidance rule #2: Zero in on the correct prospects. Okay, we know that sounds simplistic; who would try to sell to incorrect prospects? Well, the fact is, lots of ISVs do.

"Make sure you're talking to the right accounts and the right people — those who value what you're selling," Geisman says. "There are lots of things you can do in the sales cycle before you go to price."

Note that Geisman did not say you should aim high. Some software sales should indeed try to reach C-level approval, but not all; others may have better luck selling to the champion who will actually use your software.

The key point in Geisman's advice: Find out who truly values what you're selling, and sell to them.

AGI has followed this value-based advice, and it's paid off, Linsalata says: "We realized our value proposition and determined that many of our products were undervalued."

The company has not done across-the-board increases, but has looked at each product for the value it delivers; price increases initiated or planned range from none at all to 15% on core products to 50% on some lower-cost products. "We have not seen price sensitivity," Linsalata says. "Customers have been willing to pay for the value."

Granted, AGI is in a specialized market — the company's primary product is called Satellite Tool Kit (STK), which it sells to aerospace and defense customers who want to analyze and visualize space-related components — anything that moves around the earth. A typical sale is $50,000, though the entry level is $10,000.

"We don't have a lot of competition, but we're not gouging customers because of that," Linsalata says. "Space has become a vital commodity, time is money, and we have a commercial product that can do the job now in a market that traditionally reinvents the wheel year after year. The urgency of getting software in place to do the job seems to be understood much better lately."

And, Linsalata is counting on AGI's value proposition to stay strong: He's projecting 30% sales growth this year, up from last year's $28.5 million. Founded in 1989, AGI now has 150 employees.

Discount avoidance rule #3: Zero in on the issues that matter to your prospect. "If it's a techie, you don't need to talk price," Geisman says. "On the other hand, you will have situations where you have to quote a price, but leave yourself some wiggle room.

"In the early stages of a deal, a prospect will often say they're looking for a range, not a fixed price. What you need to do is draw yourself a box where the horizontal dimension is functionality or deliverables, and vertical is price.

Once you've ascertained that your product is in the ballpark in terms of functionality, then you can begin to talk price. But it's important to establish functionality first, because people will use price to adjust for product deficiency: You don't have feature X, so you volunteer to give it them for half price.

"If you're weak in a particular area, package that as an option. 'I can give it to you for less — we'll take out feature X.' They end up getting feature Y and Z at a much lower price, and they're happy."

Discount avoidance rule #4: Make sure that your price list makes sense. The litmus test here is whether your price list makes sense to someone outside your company. Sure, you understand it, you wrote it; but does it reflect the reality of your product's use in the field?

"With a good price list, you can show it to them and they'll understand it," Geisman says. "The tier breaks map into what the customer is likely to do, the discounts don't rise too sharply for too little volume, and the discounts are reasonable.

"For example, if someone spends a million dollars, you don't give them 10% off — people that spend a lot of money expect to get concessions."

AGI didn't increase prices across the board; some went up, and some were "rearranged," Linsalata says. "In general the core modules have not gone up in five or six years. What has gone up is the network token.

"You can get a floating version of our software, and there's a premium on that. because it provides tremendous flexibility and value. In the last three years it's gone up from 25% to 50% of the initial price. For example, you can get a node-locked version for $10,000, or a floating version for $15,000."

The moral: AGI figured out how customers were using its software and what mattered, then priced accordingly. To manage the floating versions, AGI uses Macrovision's FLEXlm. "It allows anyone to use our software, but only one person at a time," Linsalata says. "You can empower multiple people to use the software without getting another chair."

The moral revisited: Focus on value delivered today, not past pricing. Many AGI customers see the floating version as an incredible value; if they pay just 50% over the single-seat price, they can provide access to an unlimited number of users. The fact that the price of that privilege has gone up is essentially irrelevant.

Despite the successes, Linsalata says AGI isn't finished tweaking. "We're always trying to do better," he says. "We want to look at multiple unit discounts, and to evaluate dollar volume versus quantity discount schedule. We want to know how we should evaluate very large deals.

"We're a very vertical product; a government agency may come to us and say, 'We want to standardize on STK, but your price sheet stops at 10 units, and we need to outfit 1,000 people.' We need to create a volume discount curve, and we still need to do further analysis to come up with the right curve."

Discount avoidance rule #5: Build the configuration before you talk price. "Let's understand what your needs are" is your opening gambit, Geisman says. Then, drill into detail: How many people are going to be using it? Where are they located? What servers are they running off of? And so on.

This inductive process lets you build a system to the customer's specification. You can then refer to your price sheet and say, "Here's our list prices, and here's what your price will be based on what you've told me."

Then, when the customer comes back and says that's too much, your response, Geisman says, is clean and simple: "I guess I misunderstood; what do you want me to take out?"

Customer: "I don't want you to take anything out."

You: "If you don't want to take anything out, I can't quote a different number."

"Now, having said that, you can always give them a special deal for being a first-time opportunity," Geisman says. "But there should be a window of opportunity on those deals: The more you buy now, the more you'll save."

The point of rule #5 is that you want to throw as much as possible back on the customer before your start discounting. "If you cut price too early in the process, things only get worse," Geisman says.

Discount avoidance rule #6: Get something for everything you give. Discounts aren't always bad, of course; done right, your concession on price can buy greater market value.

"You have to balance every make-or-break negotiation with the opportunity of going out and scouring up new deals," Geisman says. "And, if it's a flagship account — something that will make your mark in an industry — then it's reasonable to ask for publicity in exchange.

"Plus, there are incentive discounts you can give for actively referring you into other accounts. For example, if the customer refers you into another group, you'll give them a 5% credit on their next purchases.

"Or, get more people into the initial deal, and sweeten the price. If anybody leaves, the discounts revert to the previous price level — the discounts only hold as long as the parties stay engaged."

In other words, you must have a have a rationale, a logic, for dropping your price. You don't drop price just because they ask; you make a concession because they offer something in return.

"A lot of customers are unscrupulous, and will just keep asking," Geisman says. "If you don't say no, they'll keep asking. 'No, I'm sorry 50% discounts are for people who order $2 million or more a year.'

"To a certain extent, discount dollars are an investment in something, and you need to get a return. Often, the concession you give buys you the account, or helps to keep a customers around longer. Well, if you're going to buy an account, what's the account worth?"

Discount avoidance rule #7: No discount is permanent. No matter how big the flagship account, no matter how badly you want into a particular site or industry, you should never grant a lifetime pass to a particular customer.

"Never give a 'customer price' — for example, a special price for IBM, another special price for H-P — because that becomes your ceiling for eternity," Geisman says. "Do it for three or six months, never more than a year."

Discount avoidance rule #8: Give away hardware instead of software cuts. The nightmare of discounting is that once you go there, you can't go back. AGI's answer: Keep the software price sacred by being generous with hardware.

"Ours are typically hardware promos," Linsalata says. "Price is a recurring thing; once they know you're willing to go to a certain price, you can't go back.

"With hardware, on the other hand, you either have them to give away or you don't. We offer laptops and flat-panel monitors and projection systems; the laptops work the best. Basically, you want to offer whatever the buyer will think is cool.

"Also, in our industry it's not the buyer's money -- they're usually spending government money. The hardware giveaway becomes government property, and it's a published promotion — it is not a gift."

AGI has also tried promos in which it gave away free training, and although Linsalata says those were "reasonably effective," the hardware giveaways work better.

Discount avoidance rule #9: Don't take the competitors' bait. You're certain to hear it sometime in your software career: The competition charges less; will you match their price?

"You've got two responses," Geisman says. "If it's really an incredible number they're comparing you to, you say, 'Then why are you talking to me? That sounds like such a great number, you should have taken it.'" That may sound cold, but sometimes getting to "no" quickly is a lot more valuable than banging your head on the table to try to get to "yes."

On the other hand, if you want to stay in the game, make sure the rules are your rules, Geisman says. Tell the customer, "I'm happy to match the competition, but only if its a bona fide offer. And according to my boss, that means you need to show me something on the competitor's letterhead outlining their offer."

Who's "my boss"? The rule of negotiation: It's whoever is not in the room with you at the time. If you're a VP, it's probably the CEO. If you're the CEO, it could be your board of directors.

"You can resist temptation altogether if you are at parity with other vendors," Geisman says. "If there isn't' great distance between your offer and theirs, the adjustment is often made on price.

"In those situations, there's not much you can do other than make sure it's apple to apples. Your sales guy must have guidance whether this a deal you want, and if you want it, how badly."

Which gets to the next rule: sales policies.

Discount avoidance rule #10: Create clear guidelines internally. "You need to set up policies that the sales guys can live with and use," Geisman says. "In addition to discount limits, specify the kinds of deals we will discount on; without that, your reps will max out on all of them."

With these guidelines or policies in place, your sales reps will be required to qualify every customer. For example, "Mr. Customer, you've asked for a discount that is beyond our normal guidelines. Would like you to answer a few questions so that I can determine whether you may be eligible?"

The questions to be posed, Geisman says, should help you scope out the potential with this prospect and future ones. For example:

What is your role in the organization?
What are your purchase plans for the coming year?
Can you give me the names of three other people in your organization I can talk to?
Will you act as a reference?

Your questions should set you up for increased sales penetration, or making sales at sister organizations, or both.

Discount avoidance rule #11: Set up a formal review of all discounts. "At the end of the quarter, you have all sorts of deals that have to be — or ought to be — reviewed by Finance," Geisman says. "This is especially true for venture-backed and public companies, all of which coming under more scrutiny."

The goal here isn't to penalize individual sales reps, but to monitor company giveaways in a global sense. From the object view of your accounting department, were all the discounts from the past quarter justified?

The financial point of view raises another valid justification for discounts: revenue recognition. "One of the levers you can play in lieu of a discount is the timing game," Geisman says. "'If you can use these services this quarter, I can recognize the revenue this quarter' — that makes the deal look sweeter, and might justify a discount on the software."

Discount avoidance rule #12: Before you give price breaks, look to bundles. "Under pressure to discount, I would revisit prices, but I might not change them," Geisman says. "Instead, I might look at bundled deals: for example, six for the price of five, and we give you credits for two upgrades next year.

"But the special have got to make sense, and they've got to be something people want. There's no point in creating a six-pack if you've never sold more than three copies to a single customer."

Discount avoidance rule #13: Disrupt the traditional calendar. "We run a lot of incentives, but not off the end of the sales quarter," Linsalata says. "Our incentives are offset from our fiscal year by one month. This keeps people off balance as to when they can apply discount pressure. If you offset your sales and fiscal calendars, customers cannot hold you over a barrel."

Because AGI sells to lots of government agencies, the company also watches the federal budgetary calendar, which ends in September. If price increases are planned, AGI will schedule them for October; this lets government buyers with diminishing budgets take advantage of the lower prices at their September year-end.

Discount avoidance rule #14: Move the discounts to a future date. "Credits against the future are a far better bet," Geisman says. "Those credits for upgrades I mentioned before are an example.

"If you offer 20% off future purchases, or 10% now, which would you rather have? It depends, of course, on whether you want the cash now or the promise of future sales when, hopefully, your cash situation is stronger."

To some extent, future discounts are a negotiation ploy: You get to toss out a big number to show your generosity, but you don't have to cash it in now.

More importantly, however, they can buy customer loyalty: Many customers will view that future discount as a chit they've earned, and they want to stay around to exercise it. Plus, it creates an entry barrier for your competitors.

Discount avoidance rule #15: Preserve your prime price point with "Lite" versions. "It's a legitimate tactic," Geisman says, "as long as you make sure that the price structure is done properly.

"The best way to do that is to have the 'Heavy' product architected properly so that you can slice and dice the offering. For example, you can offer Function X and add or subtract Function Y."

The trick to designing a Lite version is finding the right balance: The constraints should be generous enough that the product is useful, but not so useful that that Heavy version has no value. E.g., if you set the limit on the number records at 5,000, there's no difference between that and unlimited — so what's the point? On the other hand, if the records limit is set to five, you've created a demo, not a Lite version.

Geisman's rule of thumb for Lite pricing: The price of the Lite version plus the upgrade that makes it into the Heavy version should be 10% to 20% more than buying the Heavy version all at once.

"Generally, I wouldn't discount Lite as much as Heavy," Geisman says, "but it depends on what you want to sell. If you want to sell the Heavy stuff, discount accordingly. The Lite product, at maximum discount, should be 2/3 to 3/4 of the price of the Heavy version at maximum discount. If your customer asks why the difference in discounts, the explanation is simple: They are different products."

Keep in mind, however, that lots of Lite versions sink; see Rule #3.

"We created a discount or Lite version of one of our modules, and people didn't want it," Linsalata says. "People kept buying the full version. STK Pro and the Visualization Option make up 45% of our sales."

Discount avoidance rule #16: Don't undervalue your product. This is a follow-up to Rule #15 and a corollary to Rule #1: Nearly every young software company doesn't do enough pricing homework and starts out too low. And if you're not priced right, you'll lose the confidence required to stick to your guns under discount pressure.

Ask yourself: Is yours a must-have product, or are there other ways to accomplish the same solution? Linsalata offers an example of AGI's underpricing, since corrected:

"We developed a particular software tool that could determine if satellites were due to collide with each other or other objects in space. We had some great resources in house, and it was an ingenious tool, but the engineer who created the code said it wasn't that hard. So, we priced it accordingly: $2,500.

"Initially, in fact, we gave it away to a bunch of customers — we were trying to prove to people that we could build this thing. Not many people bought it.

"When we originally set the price, we didn't realize that the engineer who built it is one the brightest people in the world, and we failed to do the business analysis of what this product could do. Since that time, the problem it solves has become more relevant, and we better realize the value proposition, so we've increased the price dramatically. The price has gone up 10 fold — it's now $25,000 — and last year we sold twice as many as ever before.

"One customer was spending nearly $15 million to solve the problem in-house; they turned to us and our products and solved the problem for about $700,000."

If you're in a vertical market, you should always keep in mind what it would cost to reproduce your software, Linsalata says. "Even in a horizontal market, I would want to be on the high end of the price curve, because turning more deals is harder.

"Our average deal last year went from $35,000 to $50,000 over a 12-month span. Some of the increase is due to smoother business operations — we're calling our shots better — and some of it's due to price increases, new products and add-ons, the geopolitical climate, and general market acceptance.

"But our sales cycle is still three months — and after you get over that first hurdle, you want to offer them as much as you can.

"We took the Rolls Royce approach to developing our product — this is the top of the line, and you can't reproduce it cheaply. It would take $220 million in man-years to reproduce our software, and our customers respect that."

Discount avoidance rule #17: Know when to abandon ship. If you're constantly and mercilessly being pressured for deep discounts, it could be that you've got the wrong price, or, worse, the wrong product. If that's the case, you're better off to find another battle.

"If you have a commodity product, and it has no distinguishing marks and features against competitors, and you are not the leader, then get out — or do something to get yourself out," Geisman says. "You don't have the chips required to play the game."

"If you're the market leader, the rules are different. But if you're not the leader, and the only way you can demonstrate your value is to drill into page 12 of your technical manual and show a single screen shot where you're different, you're screwed.

"On the other hand if you've got clear value — and you're not lying to yourself — and you really understand your customers — then you should tough it out.

"If you look inside your heart of hearts, and you're really offering value to your customers, then focus on where your value is strongest, and don't invest where it's weak."