Discounting can be a touchy subject. Sales people often claim that discounts are required to make the sale. Pricing is philosophically opposed to discounts as they undermine profitability and signal lack of pricing power. Marketing worries about how discounts will impact value perception but at the same time desire the increased attention that a well-managed discount campaign can generate. Ouch. How do you manage all of these different imperatives?
In a recent survey by pricing recruiter Chris Herbert, 'sales rush to discount' ranked second as the biggest frustration facing pricing (number one was 'lack of data or bad data'). Patrick Campbell from Pricing Intelligently has recently published an excellent analysis of the cost of discounts and the long-term negative impact they can have on customer lifetime value. See 'A comprehensive data guide to why you shouldn't discount.'
Patrick identifies three characteristics of customers receiving discounts:
- Lower willingness to pay - customers demanding and receiving discounts showed a lower willingness to pay over time (suggesting they perceived the value of the offer to be lower)
- Higher churn rates - customers with discounts often have less loyalty and are more willing to switch out one solution for a cheaper solution when one comes along; they drive the race to the bottom
- Lower lifetime customer value - a direct result of lower prices and higher churn
Given all this, why do SaaS companies discount at all?
One reason is that it is a fact of life in enterprise sales. Whenever procurement gets involved, there is intense pressure to discount. Put yourself in the procurement role for a moment. Your job is to get the best deal for your company and make sure there are alternate sources of supply. The cardinal sin in procurement is that your competitor gets a better deal than you do and one of the best defensive plays requires a discount. Many procurement professionals regard it as professional malpractice not to get a discount. We will share more on how to manage procurement and emerging best practices for procurement in B2B SaaS in future posts. For now, people designing B2B SaaS pricing have to remember to take into account the needs of procurement and build this into pricing and pricing strategy.
There are two other reasons to discount in B2B SaaS: as a strategic investment and to reflect the actual differentiated value for the customer.
Discounts as a strategic investment
Sales often justify discounts as a form of investment. "We need to make a strategic investment in this customer." "This discount will get us a lighthouse account in this sector."
Investments are a good thing. Like all investments, we expect a return. So when we are treating a discount as an investment, we need to be able to say how, when and how much of a return we will get. These critical questions are often skipped in the pressure of closing a sale and giving a discount. In most cases a discount for a specific customer is not an investment, it is an attempt to close a sale that the sales rep is afraid of losing or that is stagnating in the pipeline. If this is the case, let's acknowledge it, and not pretend we are making an investment. We are giving away profit margin, and quite often profit, to win a sale.
There are ways to structure a deal as an investment. The discount can be time bound. One can discount professional services instead of the subscription (the subscription will continue for years, one hopes, and the discounted professional services can be an investment in the configuration and integrations needed to lock the customer in). One can make some explicit assumptions about the other customers that this company will bring in, once established as a lighthouse account. These are all legitimate reasons to discount, but the assumptions need to be stated, tested and tracked (Would you make other investments and then not track them to see if it made a return?)
Investments in winning a segment are generally easier to defend, as long as they are part of a larger plan. The plan can include additional functionality tailored to the segment, marketing messages, and marketing campaigns, and a pricing structure tuned to that segment. In this case, discounting is part of a larger plan. One that will be tracked and measured and the ROI calculated.
Discounting (and Premiums) that Reflect Differentiated Value
I know of one company that has built explicit Economic Value Models (using the EVE methodology) for all of its offers. This company is in the specialty chemical industry and created additives for well-understood chemical processes. It knows the amount of differentiated value it provides relative to the alternatives and has set prices based on the amount of that value it needs to capture for itself. Now for any specific customer, it is possible that the value will be different, lower even, because of the way the customer has configured their plant. In these cases, when there is real evidence that the differentiated value will be lower, it is willing to give a value-based discount. The same company will also modify its formulations for a customer and charge a value-based premium.
Most of us are not that sophisticated and operate in spaces where this level of specificity is impossible (or too expensive to justify). But the principle is the same. If a segment gets value in a different way from the general market then it may warrant its own offer and the price should be adjusted, discounted if necessary, to reflect that value.
This can work well in negotiations with procurement. One sometimes gets a procurement officer who tells you "That functionality does nothing for us, it has no value and we don't want to pay for it." When this happens, call the bluff, and offer to provide the service without the functionality. In my experience, procurement generally backs off, and when they don't, you have reinforced your overall value message.
Ideally, you are designing your offer to make it easy to switch functionality on and off (design for value-based configuration). This gives your sales people the tools they need to negotiate with procurement and your product marketing people the ability to configure offers for specific segments.
Discounting is part of the B2B SaaS world and you are not going to avoid it, especially once you are dealing with buyers who have procurement departments. 'Don't discount' is not practical advice. Instead, you need to manage your discounting.
- When treating discounts as an investment, make sure you know how and when you will get a return on that investment.
- When the discount is meant to reflect the actual differentiated value of the offer, create a version of the offer designed and priced for the segment.
- When dealing with procurement, provide a discount but stand your ground on the value of your offer and be willing to call procurement's bluff when they claim that some part of your offer has no value.