SoftSummit 2004 Utility-Based Pricing: How To Make It Profitable

1. SoftSummit 2004Utility-Based Pricing: How To Make It Profitable Thomas Nagle, Chairman and CEO Thomas Lucke, Vice President

2. Utility Based Pricing - A Tale of Two Views “Gone are the days when software providers would back up a truck to the company's front door and dump as much software as possible and expect a huge up-front license fee from a customer.” Louis Blatt, Chief Technology Strategist, Computer Associates "For companies that don't experience seasonal variations in how they use IT infrastructure, a lot of this doesn't make sense" John Fowler, Chief Technology Officer Sun Microsystems They Are Both Right!

3. Why On-Demand? • On-demand is not a better model to replace the existing perpetual license model • On-demand is a different model to reach customers, segments and applications where the current model is not delivering enough value • The trick is to profitably manage the two models simultaneously • On-demand pricing can commoditize your business and cannibalize revenue if managed poorly • On-demand can drive significant incremental utility revenue from new customers • On-demand can the lower risk of trial, driving growth in perpetual license revenue as well

4. Not in line with our business goals and metrics for measuring value 42% Maintenance costs are too high 19% 15% Too complex Too rigid 14% 9% Don’t know 1% Other Pricing needs to align with value What is the biggest challenge with today’s pricing models? • Common pricing models fail when: • High variability in use • Uncertain future needs • High initial investment • High performance risk (of a new product or technology) Source: Forrester Research: 156 North American technology decision makers

5. On-Demand Pricing - How To Get It Right? Choose the right pricestructure Set theprice Understandwhere it makes sense • ID value differenceS • Pick price metrics that track value • Assess value created • Set price as discount from value • Identify segments • Understand value drivers

6. On-Demand Pricing - How To Get It Right? Choose the right pricestructure Set theprice Understandwhere it makes sense • ID value • differences • Pick price metrics that • track value • Assess value created • Set price as discount from value • Identify segments • Understand value drivers

7. On-Demand Can Expand the Market Opportunity • Perpetual Model Targets • Economies of Scale • Low variability; high certainty about demand • “Leading Edge” IT High Perpetual license Value of License C E D B A Low Segments • On-Demand Targets . . . • Time to benefit too long • Can’t afford initial up-front perpetual license fee • High variability in usage –High uncertainty about future need • Cost of “lock-in” high • Unwilling to risk purchase of “new” software / technology

8. Value of Use Changes With Each Segment On-Demand Targets High B A Value of Use Use Fee C E D Low Segments Perpetual Model Targets

9. How Is Value Created by “On-Demand” Models? Value Benefit • $ Value from licenses saved • $ Value from shift of capitalized asset to expense • $ Value of risk reduction • $ Value from speed to implementation • Shorten time to benefit • Reduce up-front cost • Reduce risk associated with uncertainty of future needs • Eliminate “lock-in” Reduce risk associated with of “new” software / technology

10. On-Demand Pricing - How To Get It Right? Choose the right pricestructure Set theprice Understandwhere it makes sense • Assess value created • Set price as discount from value • Identify segments • Understand value drivers • ID value differences • Pick price metrics that track value

11. Pick Price Metrics That Align With Value Value can differ even when customers have similar needs High Same Offering, Different Value Value Gamma Beta Acme Low Customers Differences in value can be captured with pricing metrics that are linked to value drivers

12. Case Example – Infrastructure Software Availability Productivity Utilization Reference 1 2 3 4 Low High Low High Complexity, Complexity, Complexity, Complexity, High Activity High Activity Low Activity Low Activity Activity, not environment complexity, was the critical element of value for this infrastructure software. Traditional metrics left money on the table.

13. Metrics Need To Work Across Segments, Be Feasible in the Channel, and Understandable By Customers Tracks Value Metric Filters Segment Differences Measurable & Enforceable Customer Buying Habits & Preferences Channel Capabilities Competition (Reference) Various Price Metrics Recommended Metric(s)

14. Case Example - Identifying the Right Price Metric Flat Monthly Fee Size-Based (Number of Seats) Usage Based (Number of Minutes) Usage Based (Number of Calls) • One-price fits all • Easy to explain and administer • But does not reflect value created • Unique price based on number of seats • Simple • Only imperfectly reflects value • Unique price based on volume of center • Common in telecom • Reflects value • But – a poor comparison, sets transport price as the baseline • Unique price based on calls handled by system • Non-traditional • Tracks value • Highlights agent cost savings, which accrue per call • Key was understanding how value was really created – not just how pricing was traditionally done • Used the metric to define the reference – strategically important

15. On-Demand Pricing - How To Get It Right? Choose the right pricestructure Set theprice Understandwhere it makes sense • ID value differences • Pick price metrics that track value • Assess value created • Set price as discount from value • Identify segments • Understand value drivers

16. Remote diagnosis and repair of system failures $7,800 Training on new system ($20,000) Eliminate systems interoperability problems $14,500 Remote upgrades and maintenance $10,400 Cost of alternative software $4,000 Set Price Based on Economic Value Estimation® Software Example Negative Differentiation Value Revenue-based Positive Differentiation Value $32,800 Economic Value Cost-based $16,000 Reference Value Present Value = Cost reductions over two years (discounted at 10%)

17. Once the Differential Value Has Been Established, Set Prices Based on Strategic Assessment of Price Sensitivity Issues Economic Value 100% COMPETITIVE ENVIRONMENT CUSTOMER EXPECTATIONS PERFORMANCE RISK 75% COMPANY STRATEGY Differential Value FAIRNESS AFFECT 50% PRICE 25% Next Best Competitive Alternative 0%

18. A Simple Pricing Model forces costly tradeoffs P Missed Volume Opportunities Price ≈ Value Revenue Received Missed Margin Opportunities Value Received from Access

19. License Hybrid On-demand A Complex Pricing Model Can Maximize Market Share and Profit P Revenue Received Value Received from Access

20. SoftSummit 2004Utility-Based Pricing: How To Make It Profitable Thank You Thomas Nagle, Chairman and CEO Thomas Lucke, Vice President