Setting the right price for a new product is always challenging – even more so when you deal with a new product category. That was exactly the situation we encountered at Actona technologies.
We came across a problem which hasn’t been solved before. It had to do with accessing files across a wide area network (WAN). Let me explain briefly:
Imagine you have a Microsoft Word document stored on your PC. You double-click on the file name, and within a few seconds the document is open and ready for editing. Now move the document to another computer (i.e. “file server”) located on the local area network (LAN) at your office. Again, double-click on the file name and it will still open within seconds. It may take a bit longer than before, but you will hardly notice the difference.
Now imagine the file actually resides on a computer located in another site, perhaps even across the Atlantic Ocean. If you try to “double-click” on that file, you will be forced to wait minutes before it opens, and the Microsoft Word application on your PC might even “freeze” without even opening the file. The reason is simple: your WAN is much slower than your LAN, and that causes long delays in opening the same file.
We decided to tackle that problem, and developed a solution we named Virtual File Network (VFN). The technology isn’t that important, but the end result is. If you installed our VFN software at each site, then opening files across the WAN would happen faster, much faster. You will feel only a minor difference between opening a file on your PC, compared to opening a file across the Atlantic Ocean.
We tested our VFN product with a handful of potential customers, and they loved it. We realized we had a solution for a problem people care about; we just didn’t know how to price it. Time was of essence. We were a small startup that needed customers, and fast. It was time to set a price for VFN.
At the beginning, we offered VFN as a software package. It was installed on computers the customers already owned. That meant we couldn’t follow any “cost-based” pricing approach. Our cost of goods sold (COGS) was close to zero – a CD and a few documents. We couldn’t establish any pricing strategy based on “reasonable margins”.
There were no other products on the market that offered a similar function. At least not at the time we contemplated how to price VFN. Without any competitors to compare ourselves to, we couldn’t adopt a comparative based pricing approach. Essentially we were left with a “value-based” pricing approach. We faced a dilemma: how do we establish the value of VFN in the customer eyes?
We could have taken the approach of calculating the “productivity gains” from speeding the process of opening files. For example, let’s assume a user opens 30 files a day remotely, and saves about a minute each time. If an employee hourly rate is $50, than savings 30min a day amounts to $25/day, $125/week, $6250/year. We could have developed a financial model around these assumptions and calculate ROI to justify our product pricing. But there is a problem with that approach… It’s called “soft ROI”.
In most organizations, “productivity gains” and “time savings” fall under the ‘soft ROI’ category. Companies have no assurance that time saved in opening remote files will actually translate into increased revenues or higher net profits. The extra time may just as well be used for taking longer coffee breaks… Financial buyers definitely prefer to see ‘hard ROI’. They are looking for a tangible connection to revenues or cost savings.
It became clear that calculating the value of VFN based on time savings and productivity gains will make justifying its price during a sales process very difficult. We had to take a different approach. The clue came from a question we asked a prospective buyer: “If you didn’t use our VFN product, how would you solve your problem?” The customer explained that he would have to upgrade the speed of his network links. That upgrade would have cost him around $10,000 per month for international links, and around $1,000 per month for domestic links. Granted, it was a few years ago, but premium network links cost money even today…
We had our answer: VFN helps customers avoid spending extra money on premium network links; here’s a hard ROI for you. We could have developed an elaborate pricing model based on network link types, but we opted for simplicity. We wanted our product to pay for itself within 6 months or less. With domestic premium links costing about $1000/month it meant VFN should be priced at $6,000 or less. We set the price for $4,995 per site. It worked.
But our pricing dilemma didn’t end there. Our assumption was that VFN will be bought by customers who need to open files from a distance. For example: engineering companies with development teams spread around the globe who share design files amongst themselves. While we found customers who met those criteria, we soon realized they represent only a small portion of the companies out there.
We had to expand the range of problems we address with VFN, and re-examine our value-based pricing strategy. Fortunately, we came across a much bigger problem our technology could address. It was a time when companies started to actively “consolidate” their information technology (IT) infrastructure into fewer, larger locations called “datacenters”. Consolidation of servers into fewer datacenter locations improved the ability to manage and support them, and significantly reduced operational costs.
However as companies started migrating more computers and servers from remote offices to their datacenters, users at those remote sites started feeling the pain of network delays. Corporate IT teams faced a tough choice: leave those servers out there and continue to incur high operational costs, or ‘consolidate’ those servers, saving costs but facing the wrath of end users and their management.
We stepped right into that consolidation conflict. We realized we can help corporate IT “have their cake and eat it too”. Our technology enabled them to consolidate remote servers into datacenters while ensuring good performance for their end users. Voila – hard ROI that applies to just about any company out there.
We decided to re-position the product and change its name to Wide Area File Services (WAFS). We also reexamined its value proposition. Our “new” WAFS product helped companies succeed in their datacenter consolidation initiatives. Therefore, its value stemmed from the fact we helped eliminate the costs associated with continuing to deploy, maintain and manage file servers at remote sites.
We calculated the costs we saved with our WAFS product: the server hardware, related software licenses, ancillary equipment (e.g. backup tapes) and came up with pretty significant number. And it was all ‘hard ROI’. The new pricing we set for our WAFS product was more than double its predecessor – VFN. Interestingly enough, we had more potential customers, a much bigger market opportunity and higher revenue potential.
In this example, pricing strategy was closely tied to the product value proposition and the customer problem it addressed. As the market evolved, competitors entered the space and volumes grew. Pricing strategy required doing also competitive analysis and margin calculations. But value-based pricing remained the foundation on which the product price was set.