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1、June 2023Technology,Media&Telecommunications PracticeThe art of software pricing:Unleashing growth with data-driven insightsSoftware companies struggling with shrinking margins can unlock the power of pricing by considering five actions for profitability in a market focused on efficient growth.This

2、article is a collaborative effort by Christian Fielitz,Mohit Khanna,Michelle Nguyen,Varshik Nimmagadda,and Paul Roche,representing views from McKinseys Technology,Media&Telecommunications Practice.One lesson for software companies has become abundantly clear during the last 18 months:pricing needs t

3、o be on the C-suites agenda.Before then,the industry had been growing so fast for over a decade that executives and investors tended not to view individual product margins as an overriding concern.Now,however,that has all changed.After years of rapid growth,the industry faces economic uncertainty,in

4、creased capital costs as interest rates rise,and a still-competitive talent market with accelerating wage growth.In the last year alone,84 percent of publicly listed software companies saw their valuations drop,and more than a quarter experienced a decline of more than 50percent.The message from the

5、 market is clear:top-line growth alone is not enough.Investors are increasingly pivoting from valuing growth at all costs to focusing instead on efficient growth.In this new era,the software companies that thrive will be those that grow revenue and margin simultaneously.Given these conditions,the le

6、aders of software companies increasingly push pricing to the top of their agendas,viewing it as a critical lever to grow efficiently and capture value.To understand what specific actions software companies can take to get the most out of pricing,we surveyed 184 software companies decision makers to

7、learn how executives are thinking about their pricing strategy.We also looked at how outperforming software companies within this group have differentiated their pricing strategies.This analysis uncovered a set of pricing practices that correlate highly with growth rates(see sidebar,“About our resea

8、rch”).1 McKinsey analysis of S&P Global data.2 The 2022 State of Software Pricing survey was conducted in late 2022 to capture a holistic and up-to-date perspective on major pricing trends.About our researchTo better understand how software executives and decision makers are thinking about evolving

9、their pricing functions,we surveyed 184 software executives and decision makers across company sizes:small and medium-size enterprises(SMEs),with$50 million to$200 million in annual revenue(29 percent of the total sample);midmarket,with$200 million to$1 billion in annual revenue(27percent);and enter

10、prise-level companies,with more than$1 billion in annual revenue and in at least five geographies(43 percent).These executives represent both software pure-play(51 percent)and software-hardware hybrid(49 percent)providers.Their companies products are applications(51 percent),application development

11、and deployment(35 percent),and infrastructure software(14 percent).And they are based in regions around the world:North America(79 percent),AsiaPacific(10 percent),Western Europe(6 percent),Latin America(4 percent),and the Middle East(1 percent).We further divided respondents into lower-growth(0 to

12、30 percent)and higher-growth(greater than 30 percent)groups based on their self-reported year-over-year revenue growth rates;63 percent of SMEs were higher-growth,compared with 48percent of midmarket and 36 percent of enter-prise-level companies.We looked for significant correlation of certain prici

13、ng-related decisions and actions with company growth rates,and we assessed whether readiness and maturity of com-panies pricing infrastructure also correlates with growth.Through our analysis,we found that these patterns generally hold across company sizes.2The art of software pricing:Unleashing gro

14、wth with data-driven insightsFive actions to strengthen software companies pricing practicesRespondents at most of the software companies in our survey(85 percent)indicate that they plan to drive value through price adjustments over the next two years but lack the infrastructure to capture the long-

15、term benefits of pricing and sustain its impact.Worse,many companies also lack the tools and capabilities needed to build this foundational infrastructure.Respondents at about three-quarters of the software companies we surveyed say they lack a dedicated and centralized division to oversee pricing d

16、ecisions and guidance,relying instead on ad hoc approaches.Yet almost all our survey respondents say they plan to alter their pricing in the near term.Roughly half say they expect to increase renewal prices and tighten discounting,while just under 40 percent say they plan to increase list prices and

17、 drive higher contractual increases at renewal time.Another 12percent say they expect to reduce prices to disrupt the market.Only 6 percent say they plan to maintain business as usual.How can companies achieve these kinds of aspirations?To help answer that question,we examined the various pricing ac

18、tions taken by our survey pool of companies and identified five core approaches that are used more at higher-performing companies and,based on our own experience,generally help produce stronger profits and growth.Invest in a centralized pricing functionThe case for investing in pricing functions has

19、 never been more straightforward.In fact,our research has shown that a long-term pricing advantage can account for 15 to 25 percent of a companys total profits.Investment in the pricing function can take many forms,including head count,training,and organizational systems to enhance pricing accuracy

20、and agility.Despite the apparent advantages,software companies are generally underinvesting in pricing functions.Only about 49 percent of software executives say they increased investments in their pricing functions in the past year,and even fewer(12 percent)have established a pricing capability-bui

21、lding team to model and spread optimal pricing approaches across the entire organization,especially to frontline sellers.Nonetheless,investment in pricing functions is quickly accelerating,and higher-growth companies are dedicating more head count to developing their pricing functions.Higher-growth

22、companies are 1.4times more likely than companies with lower growth rates to devote more than ten full-time employees to product and strategic pricing.The higher-growth software companies we surveyed also have at the core of their pricing infrastructure a specialized organization that can provide ac

23、countability to and ownership of critical pricing decisions.This kind of pricing“control tower”can serve as a mechanism to enforce deliberate and consistent processes around pricing decisions,manage risk,and provide pricing guidance to frontline sellers.Invest in pricing infrastructure and capabilit

24、iesHiring alone,of course,is not enough.From our broader work with companies that sell to large enterprises,we know the advantage of training sales employees to make pricing decisions that are beneficial in the long run,instead of the more common practice of making concessions to try to close deals

25、as soon as possible.Such concessions often include signing multiyear contracts with capped annual price increasessometimes even no annual increases or ad hoc discounts.Our survey found that pricing guidance and enablement for the front line is seriously lacking.More than half(57 percent)of responden

26、ts say their companies lack adequate sales training in negotiation to communicate and support price changes,and 42percent say their company provides no deal-level pricing guidance,a shortcoming that may allow an unnecessary loss of value.Providing this level of guidance relies on access to insights,

27、which in turn requires investment in pricing 3The art of software pricing:Unleashing growth with data-driven insightsanalytics capabilities.Reluctance to invest in these aspects of the pricing function can impose a high cost.For example,despite the preponderance of multiyear contracts in the B2B spa

28、ce,our research shows how surprisingly common it is for companies to lose value from existing customers on contracts that lack mechanisms for annual price hikes.Over 85 percent of respondents indicate that their companies had a contract annualized price increase that fell below the United States yea

29、r-on-year inflation rate in 2022.Setting minimum price increase thresholds for renewals can safeguard margins,yet only about a third of respondents say their companies have incorporated such pricing guidance into their renewal infrastructure.Recently,a global IT services provider achieved an approxi

30、mately 5 percent increase on earnings before interest and taxes by setting up a pricing negotiation recipe and library of documents and reference materials to help frontline sellers conduct negotiations with key accounts.Sellers had been given a pricing target but were unsure how to broach the conve

31、rsation with clients outside of the renewal cycle,so the company armed them with content and tools.These include a fact base to illustrate how price adjustmentsor the lack thereofhave been out of step with inflation and their clients own price adjustments.Other content consists of talking points for

32、 responding to potential clients objections.In addition,capability training programs were tweaked to align with how adults learn;the new design includes short,optional,and interactive sessions with role playing,rather than compulsory full-day sessions packed with theoretical information.The new form

33、at commands better attendance,as sellers spread the word and encourage others to attend.In another example,a large enterprise software player with a massive installed base was struggling to monetize renewals pricing,especially in the current high-inflation,high-uncertainty environment.To address thi

34、s issue,the company set up a pricing control tower with resources including deal desk support,analytics,strategic pricing,marketing,legal,IT,and customer success.The price control tower drove an incremental 3percent price adjustment by ensuring focus on four key elements:1.Value messaging.The compan

35、y created customer-specific messaging on the value derived from core products and tied it to product investments made by the company.For example,customers who used extensive advanced search capabilities received messages that showcase investments in AI to improve search tools.2.Price reporting on re

36、newals.Dashboards were built to provide real-time information to the C-suite on renewal pricing uplift.3.Contract analysis.The company analyzed contract terms and conditions for all upcoming renewals to understand price clauses(such as price increases not being written into contracts)and came up wit

37、h a strategy to change customer contract terms(such as offering one-time discounts to customers willing to have an annual price escalator clause added to their contract).4.Pricing system changes.The company identified and prioritized key system changes to eliminate pricing roadblocks.For instance,th

38、ey identified a cohort of about 1,000 customers that were on automatic-renewal plans in which the renewal rates were lower than target and whose churn risk was low,and as a result,were able to bring prices in line with targets.Inform pricing guidance with advanced analytics or AIAn option software c

39、ompanies can consider for differentiating their pricing strategies is to employ sophisticated,data-driven approaches that align pricing options more closely to customer preferences.Higher-growth companies lead the pack in pricing analytics capabilities:they are 1.7times more likely than lower-growth

40、 organizations to integrate advanced analytics into their provision of pricing guidance to frontline sellers.Most companies,though,have taken a more cautious approach to investments in pricing 4The art of software pricing:Unleashing growth with data-driven insightsanalytics capabilities.Many softwar

41、e companies we surveyed havent yet embraced core analytics tools(Exhibit 1).Only about a quarter of respondents say they have tools to provide descriptive analytics(the ability to report pricing performance and results),and almost as many have diagnostic analytics(the ability to diagnose underlying

42、reasons for pricing results and trends).And fully 15 percent of respondents say their companies have no pricing analytics capability whatsoever.Companies that lack the new advanced analytics tools emerging for pricing use cases are missing out on capabilities to forecast pricing results(predictive),

43、anticipate customers unique needs and behaviors(prescriptive),and continuously improve artificial intelligence(AI)models based on purchasing patterns(self-learning).Software companies also tend to hold back on investing in other analytics tools,such as pricing and KPI dashboards.These could enable c

44、ompanies to establish organization-wide transparency over pricing performance,but only 38 percent of respondents say their companies have pricing dashboards to track these metrics and inform pricing decisions and broader sales strategies.The higher-growth companies in our survey sample are catching

45、up:44 percent of respondents at these companies say their companies are leveraging sophisticated pricing dashboards.Such tools could help software companies identify sources of lost Exhibit 1Current pricing analytics capability,1%of respondents(n=184)Usage of advanced analytics or AI to provide pric

46、ing guidance,7%of respondents(n=184)1Question:How would you describe your organizations current level of pricing analytics capabilities?Capability to report pricing results and performance.Capabil-ity to diagnose underlying reasons for pricing results and trends.Capability to use statistical and pre

47、dictive models to tell what pricing results are likely to be achieved in the future.Capability to constantly refne predictive models,and determine the best course of action.Capability to use AI and machine learning to uncover new pricing insights on questions you didnt necessarily think to ask.Quest

48、ion:Do you leverage advanced analytics or AI to provide pricing guidance?Source:McKinsey B2B Pricing Decisionmaker Survey,Aug 2022Few software companies have advanced pricing analytics capabilities,but a majority of higher-growth companies leverage advanced analytics.McKinsey&CompanyCore analyticsLo

49、wergrowth(n=96)Highergrowth(n=88)Advanced analyticsNone15412182526Cognitive or self-learningPrescriptivePredictiveDiagnosticDescriptiveNoNoYesYes345766431.75The art of software pricing:Unleashing growth with data-driven insightsvalue at the customer and product levels by tracking real-time price cha

50、nges,allowing the pricing center to continuously iterate and refine its overall strategy.In our experience,companies that develop and implement a successful pricing analytics journey focus on the following actions:Invest in dynamic deal scoring to empower the front line.Software companies that inves

51、t in dynamic deal scoring have experienced four to ten percentage-point increases in return on sales.Far from the early,rudimentary approaches to control of discounting in software companies,dynamic scoring tools leverage sophisticated machine-learning(ML)algorithms to provide real-time information

52、on the quality of discounts to frontline sellers,are integrated directly into the companys cost per quote,simplify approval processes,and link frontline compensation to the quality of deals.Ensure that reporting systems can isolate pricing impact.As software portfolios get increasingly complex,it ca

53、n become difficult to isolate the impact of pricing.One large information services software player was able to improve price realization of existing customers by 3 percent in part by creating transparency in price reporting.Build an analytics-based price-setting engine.The velocity of new software p

54、roduct and feature introductions has accelerated with,for example,monetizable APIs and add-on or third-party partnerships,but the price setting has not kept pace with them.Sophisticated players have invested in developing semiautomated approaches to rapidly gather and analyze customer and competitor

55、 input that can inform pricing for new products and features.Align pricing metrics more closely with valueThe most popular pricing metric at respondents companies continues to be seat based(based on number of users),with roughly 40 percent of respondents indicating that their companies use this as t

56、heir primary pricing metric.Seat-based metrics can certainly be the right choice for a subset of companies,especially upstarts that prioritize sales velocity.Seats are easy for customers to understand and accept,especially given that this pricing metric has long been the most prevalent.However,for m

57、any businesses,using seats as the primary metric comes with serious downside.This approach is not scalable to support future growth in revenue per customer.Also,this kind of metric is not auditable in some casesfor example,with shared licenses or credentials.Oftentimes,seats are not directly linked

58、to value either.Consider an analytical product that has 100 users at an enterprise company,with three power users accounting for 95 percent of the usage.Beyond the initial three licenses,the value to the company would not increase consistently as more users are added.The higher-growth software compa

59、nies in our survey recognize these deficits.Fully 97 percent of respondents at these companies say they expect their pricing metric to evolve in the near term.One shift we are seeing is companies exploring usage-based metrics,driven partly by the increasingly popular pursuit of product-led growth an

60、d the potentially significant revenue growth that such a model can bring(Exhibit 2).However,usage-based pricing is not necessarily the right strategic move for every company.Depending on the product,usage may not be the sole determinant of the value the product provides to customers.Oftentimes,a pro

61、ducts value comes simply from access to that product.Also,shifting to usage-based pricing requires a multi-month,cross-functional transformation.This includes preparing sales and customer success teams and upgrading back-end systems to help customers predict how much capacity they will need and be c

62、apable of refunding them when predicted estimates dont match actual usage.Given variations among companies,software executives who want to investigate changing their pricing metric may want to resist the urge to follow popular trends.Instead,they should consider what matters to customers.To set the

63、right price metric,6The art of software pricing:Unleashing growth with data-driven insightsbegin by examining where value comes from for your customers.Consider the following set of questions as a method to identify the right pricing metric for your specific software product:Is the metric under cons

64、ideration linked to the value customers derive from the product?Is the metric scalable?Is it auditable?Is it predictable?Is it acceptable to customers?Simplify pricing and packaging structuresCustomers,according to classic economic theory,tend to prefer choice.However,a proliferation of options,in t

65、he form of bundles,add-ons,and customized pricing,also has a downside.Too many options create complexity and confusion for sellers as well as buyers.For sellers,this complexity may lengthen the sales process and hamper companies ability to control unnecessary discounting and its negative financial i

66、mpact.Over the past three years,the average number of buying personas per software customer has increased from one to four.In addition,the average software company also offers Exhibit 2Estimated primary pricing metric change,1%of respondents(n=184)Note:Figures may not sum to 100%,because of rounding

67、.1Question:In your estimation,how will your primary pricing metric change?A metric tied to the value a product creates for a customer(eg,revenue increase,cost reduction,ROI,etc).A metric tied to an available corporate metric(eg,annual revenue,number of employees,number of customers,amount of R&D spe

68、nd,number of beds,etc).A metric tied to the customers number of devices(eg,number of computers,terminals,handsets,units,etc).Source:McKinsey B2B Pricing Decisionmaker Survey,Aug 2022Software companies are moving toward usage-based metrics,with higher-growth and systems infrastructure software compan

69、ies leading the way.McKinsey&CompanyAllHigher growth(n=88)Systems infrastructuresoftware(n=25)5737108983213413937112212720154No changeUser-basedUsage-basedCapacity-basedHardware unitbasedOutput-basedCorporate metric-based7The art of software pricing:Unleashing growth with data-driven insightsmore th

70、an seven pricing schemes(for example,perpetual,subscription,pay as you go)and ten-plus separate pricing metrics(such as per seat,usage based,or outcomes based).Many end up with highly complex pricing architecture.For instance,one software player offers more than 15price metricsincluding per host,per

71、 gigabyte of data ingested,per million log events,and per thousand tests runand more than 20 different price points for those metrics.It is no wonder their customers describe their bills as complex,impossible to predict,and often much higher than expected.Companies with simpler pricing and packaging

72、 structures(such as three simple tiers for pricing and good/better/best packaging with fewer than five add-ons)are nearly 30 percent more likely to report having effective pricing and discount controls than companies with extremely complex pricing and packaging,our research shows.Simplicity also tra

73、nslates to greater likelihood of high growth,courtesy of faster sales velocity,less customer confusion,and ease of control and reporting on discounts(Exhibit 3).However,simplicity comes with trade-offs.Companies targeting customers in commoditized software subsectors often find that simplicity encou

74、rages price-comparison shopping and drives lower price realization.Exhibit 3Complexity of pricing and packaging structures,1%of respondents(n=88)1Question:How complex is your packaging and pricing structure?Source:McKinsey B2B Pricing Decisionmaker Survey,Aug 2022Higher-growth software companies are

75、 more likely to have simpler pricing and packaging structures.McKinsey&CompanyExtremelycomplexModeratelycomplexComplexity of pricingand packaging structureHigher-growthcompanies,%shareSimple0204060801008The art of software pricing:Unleashing growth with data-driven insightsTo simplify pricing and pa

76、ckaging,it can help to understand“value-adding complexity.”This means identifying areas where pricing and packaging complexity does not deliver incremental customer value and targeting only those areas for simplification,versus pursuing simplicity at all costs.Additionally,when companies have multip

77、le discrete products that necessitate different individual metrics,it can be beneficial to wrap these disparate metrics into a single“token or credit”that acts as a secondary,all-encompassing price metric to drive simplicity without sacrificing the link to value.Tie sales reps incentives to pricingP

78、ricing-specific incentives can help software companies align sales efforts with the overall pricing strategy.As the case study in Exhibit 4 illustrates,this approach can encourage sales reps to negotiate the best possible pricing outcomes for the company.Despite the advantages of pricing-related sal

79、es force incentives,53 percent of respondents to our survey report that their companies have no pricing-related sales force incentives.Once again,higher-growth companies are ahead of the curve:they are 50 percent more likely than their lower-growth peers to adopt pricing-specific sales incentives fo

80、r their reps.In practice,this involves introducing upside and downside multipliers or one-time bonuses,depending on the specific business context,that are tied to pricing decisions.For instance,a Exhibit 4Web Exhibit of AI-driven discount pricing impact,percentage-point improvement(vs historical bas

81、eline)per weekSource:McKinsey Enterprise Software Case StudySales compensation incentives correlate strongly with software companies pricing performance.McKinsey&CompanyFiscal weeks1015202529AI-basedguidancelaunchedUpside/downsidemultipliers on salescomp activatedDownsidemultiplierson sales compdeac

82、tivatedDownsidemultiplierson sales compreinstated0.40.60.30.74.04.04.86.94.15.74.36.55.45.24.71.70.10.81.42.79The art of software pricing:Unleashing growth with data-driven insightsB2B software company leveraged AI to give its frontline sales force discount guidance on live deals but did not activat

83、e multipliers on sales compensation tied to meeting the discount threshold.Unsurprisingly,the guidance had a negligible impact on deal outcomes.Another B2B software and services company tied its sales compensation to margin targets but not to specific pricing actions.The result was that sellers foun

84、d ways to achieve margin targets by changing the product mix,rather than pulling on cost levers,to sell more higher-margin products.In contrast,a robust sales incentive strategy minimizes the potential for misaligned incentives,so the salespeople reap the benefits of pricing-related incentives in a

85、sustainable manner.Pricing capabilities as competitive edgeActing now to rethink pricing strategies can help software companies propel efficient growth and stay competitive in a pricing market that is rapidly maturing.Even in less turbulent times,software leaders can push for more strategic pricing

86、agendas by setting specific pricing targets for revenue leaders and empowering the sales force with incentives to tailor customer-specific price strategies.Furthermore,building a dedicated and mature pricing function helps software companies adapt quickly to shifting market trends and customer needs

87、 in order to capture the full value of their product and services.The following steps offer a starting point for software companies looking to get ahead.Step 1:Prioritize pricing nowCompanies can immediately elevate pricing to the top of the corporate strategic agenda by assigning a specific owner f

88、or pricing.That role should have a direct reporting line to the C-suite.To act on this priority,leaders should incorporate pricing into strategic business reviews and set specific pricing targets for revenue leaders.Step 2:Stand up a SWAT team over the next month or twoOver the next one to two month

89、s,companies can maximize short-term pricing realization by standing up a pricing SWAT team with the following responsibilities:Develop a segment-based methodology for renewal pricingfor example,by creating tiers of price increases based on elasticity of each customer cohort,building a value narrativ

90、e to support price increases,and establishing a price control tower to monitor price realization.Set up an infrastructure to enable tracking of renewal pricing.Tie sales incentives to specific pricing targetsfor example,with sales performance incentive funding formulas(SPIFFs)if a sales compensation

91、 redesign is not easily achievable.Step 3:Align pricing and packaging to value within a yearOver the next six months to a year,companies can embark on a customer-backed,data-driven journey to align pricing and packaging to value.The journey would involve the following multiple steps:Explore alternat

92、ive pricing models that might be better aligned to value and more scalable,such as usage-based pricing.Understand list prices in relation to willingness to pay,and adjust price points to match value perception.Invest in advanced analytics capabilities to track pricing performance and provide pricing

93、 guidance for the front line.10The art of software pricing:Unleashing growth with data-driven insights Simplify and optimize packaging,including the introduction of add-ons that contribute to value creation.Systematize corporate-level pricing policies and terms and conditionsfor example,by baking in

94、 annual adjustments that link the consumer price index to current and future contracts.By building and capitalizing on new technologies,tools,and capabilities to support sophisticated pricing operations,software companies can implement new pricing models and strategies to promote efficient growth at

95、 a time when the price of inaction on this front is soaring.Scan Download PersonalizeFind more content like this on the McKinsey Insights AppDesigned by McKinsey Global PublishingCopyright 2023 McKinsey&Company.All rights reserved.Christian Fielitz is an associate partner in McKinseys Hamburg office

96、;Mohit Khanna is a partner in the Bay Area office,where Paul Roche is a senior partner;Michelle Nguyen is an associate partner in the New York office;and Varshik Nimmagadda is an associate partner in the Washington,DC,office.The authors wish to thank Karin Lauer,Nikhil Sane,and Rohan Taneja for their contributions to this article.11The art of software pricing:Unleashing growth with data-driven insights