Wednesday, September 17, 2008

Demystifying Technology Pricing

Once you have gotten to the stage of the technology you need and the vendor from where it will come, the next issue is to determine the price. Interestingly enough the more one delves into technology pricing models the more the reality of no set pricing becomes the norm. How vendors arrive at their price list runs from complex modeling to what the market will bear. However, looking at pricing from the buyer perspective there are some touch points that can greatly affect the price. There are many factors that will drive the price-point for the desired technology; this can be broken down into two main classes, the buyer and the vendor demographics. It is the vendor and the buyer demographics that begin to formulate ‘the price’.

Right from the starting gate, the vendor will need to know the size of the buyer organization, amount of current or intended use of the technology whether or not the buyer will need training or what other technology services will be employed. It is at that point the vendor consults their ‘price list’. Basically this ‘price list’ can be highly scientific or epitomize subjectivity in the wildest sense. The vendor price list could be built on market analysis, profitability or basically random numbers pulled out of the air. The astute buyer will always get the best price once they understand how their chosen vendor has built their ‘price list’.

The main divisional breaks on technology pricing are: hardware/software/consulting and public vendor/private vendor. These main breaks in pricing models will determine how much flexibility the buyer has with getting to a palatable price. These divisional lines sit along a continuum, the most rigid pricing of which is hardware/public company vendor and the least rigid is from software/private companies. The addition of consulting/services places the price for those services more along the continuum, rather than the extremes.

The production of hardware technology is built upon verifiable research and quantifiable components. The vendor is well aware of their variable and fixed costs of production, therefore they are cognizant of their break-even points in production. To this knowledge, add the ‘motivation’ of shareholders as in a public company and the profitability lines will be established; which infers the margins. With these strongholds on pricing, hardware technology from publically traded companies doesn’t lend itself to large discounting.

Where hardware technology organizations provide consulting/services, this is the area where the buyer can negotiate strongest. Very often the hardware vendors will loosen the reins on service margins to maintain hardware margins. To the buyer, keep in mind that empirically most vendors will charge between 2.0 and 3.5 times their cost of providing the service. The buyer’s strongest position comes when the buyer knows the vendor has idle consulting resources; as the vendor has a sunk cost with their labor pool.

The pricing model is radically different in the software technology realm. The production of software bears with it a certain number of hours of planning, programming and ultimately testing. All of these hours are verifiable and quantifiable and therefore a cost of production of the software can be derived. These costs represent fixed or sunk costs, and the company bears these costs whether one software copy is sold or one million copies are sold. Notice how different this is from hardware pricing; with software the costs are recognized when the software is built – no matter how many copies are sold. While with hardware, there is a certain fixed up front cost on the research side, however once in production each until attracts a cost. The buyer is more likely to achieve a better price if they know the vendor has considerable inventory, new models are about to be released or the purchase time is nearing the vendors fiscal year end.

The buyer should now recognize that the pricing points for software have tremendously more flexibility than those of hardware purchases. This price point flexibility is further enhanced whether the software company is public or private. Publically traded software companies have a strong external influence to meet shareholder expectations and therefore are less likely to entertain or sustain deep discounting; this is where the demographics of the purchasing organization can have tremendous influence. For the buyer, the best time to get to the right price would be through knowing about the vendor. The buyer should make it a point to find out the vendor’s year end, often four weeks to the vendor’s year end, and less so near quarter end, will make the difference between the ‘price list’ and the ‘best price’.

The buyer’s best pricing will be derived from privately held software companies. These companies tend to be smaller and often do not have a grasp of the cost of software production. To that end, they could essentially discount the software to nothing simply to ‘get the deal’. Where the buyer’s switching costs are high, a nil price on the software shackles the buyer to the vendor. This shackled relationship may or may not be in the best interest of the buyer and it must be a source of further investigation. Since the privately held enterprise may not be legislated by strong external forces, like shareholders, the concept of quarter and year-end periods are not that important to getting to the ‘right price’.

More often with software companies than with hardware companies, a considerable amount of revenue is the result of additional services. To the software company, consulting and services may be their only sustenance between sales. The services could be anything from training, data conversion to expert consulting. Like with services provided by hardware vendors, software vendors tend to offer services at 2.0 to 3.5 times the costs they incur in providing those services. As these costs represent sunk costs to the software vendor just like with the hardware vendor; this becomes an area where the buyer can realize the greatest savings.

Your responsibility to your organization goes beyond getting the right tools; it is getting the right tools, the right training and all at the right price. Recognize that the price list is only a suggestion and the right price comes down to how well the buyer and vendor can ‘work’ together on closing the deal. Keep in mind there are so many contributing factors to price; which far exceed the elementary view of “price”, as professed by economist Adam Smith.

“The real price of every thing ... is the toil and trouble of acquiring it as influenced by its scarcity”.

Adam Smith
The Wealth of Nations (1776)

Wednesday, September 03, 2008

When two becomes one; partnering?

The acquisition of enterprise level software or simply software for a specific use in one’s organization is much more than dropping the Amex card at Best Buy. It never ceases to amaze me how such enormous, even jugular, purchases are handled at a very cursory level. More consideration is spent on the price and the contact than on the relationship. That is like spending more time negotiating the price of the car than choosing the car!

I am not sure where the problem lies, whether software companies have commoditized their product offering so the only differentiating factor is the price or the buyer is simply not connected with what they are getting involved with. Organizations really need to slow down on their technology acquisitions and realize what they are doing is forming a relationship with the vendor.

A relationship is a connection between two parties; they can take many different forms and are unpredictable in their duration. However, the vendor purchaser relationship, especially of enterprise technology, should be viewed as a major undertaking. From the purchaser’s perspective, they are entrusting the vendor with vital elements of their operation both now and into the future. Therefore, there should be many many more questions other than price. The vendor, who is in the business of building the technology, must realize that they must stay attuned to their customer’s needs and therefore not only follow the trends but strive to be ahead of the curve.

Organizations who fail to under take a process of due diligence when acquiring technology are really compromising the competitive advantage of their organization both now and into the future. Keep in mind, price and contracts are static. How the vendor works at the relationship will go on long after the contact is signed and monies paid.

Ideally organizations should connect with 3-5 vendors who produce the type of products/functionality they are interested in. Then, as discussed last week, have a list of requirements graded 1-5, must have to a nice-to-have. At this point, the firm should look at the top 2-3 vendors and begin the due diligence process.

The due diligence process should quickly reveal whether the technology vendor is focused on their products of today and if they have vision of tomorrow, or even if they will make it to tomorrow. Remember the market leader today could be the market laggard of tomorrow. Following are a list of some major things the purchaser should rank vendors by:

The company’s economic viability now and into the short term; this is readily accessible with credit reports or public filings if they are a public company. What are the plans of the future of the company (product diversification, internationalization, etc)?

What are the skills, experience and composition of the vendor’s staff? What is the staff turnover and why?

What is the vendor’s current technology base? What are their plans for adopting new technology platforms?

How many new releases, not upgrades or bug fixes, the vendor produces per year? Who determines what goes into the future release? Is new functionality confirmed by a consensus or a regulatory board?

Is the vendor certified with the tools or processes they are using (ISO, Microsoft, SAP, etc)?

What is the timeliness on which the vendor will respond to a warranty issue? How are warranty issues reported?

Is the vendor’s customer service available when my business is open?

Does the vendor provide project management to get the technology up and running at my facility? If so, what type of training/certification does the project management team require before they are able to go out in the field? Does the vendor offer configuration services to ensure that the technology will work properly in my organization?

The type of questions one could ask could go ad infinitum, however, it is imperative to get a good understanding of who your technology provider is and will they be around to provide you solutions into the future. Before either side begins to think of the contract, they must understand if their aspirations and dreams are in alignment anything less is a recipe for a costly disaster.

Remember negotiating a contract is easy; cutting a check is easier – trying to get broken technology fixed – will cripple your organization one way or another!