Pricing of digital products and services in the manufacturing ecosystem
From cost-based to value-based pricing 02 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
Executive summary 04 The traditional vs. digital approach to pricing 06 Pricing strategies in a digital ecosystem 12 Key considerations for strategic pricing decisions 18 Next step: How to get the pricing right? 20 Legal considerations 22 Conclusion 24 Endnotes 26 Contacts 28
03 Executive summary
Digital products and services are becoming their specific role within the network in a increasingly important for discrete broader sense rather than relying solely manufacturers looking to complement on internal supply chains when it comes to their core business, stabilize profits and pricing and positioning their digital prod- generate new revenue streams. Today’s ucts and services in the market. industrial companies already generate 20–30 percent of their profits in the after This white paper addresses these chal- sales and service business, and the trend lenges, focusing on the pricing of is toward more digital solutions. To exploit digital goods and services in discrete the value derived from digitalized products manufacturing. The objective is to help and services, manufacturing companies manufacturing companies better under- need to understand what makes digital stand the pricing mechanisms in a digital products and services unique and how the ecosystem and to identify potential pricing market dynamics are changing in the new, scenarios for their digital business: platform-driven manufacturing ecosystem. 1. How do pricing mechanisms work in a Digital products and services differ digital ecosystem and why are traditional fundamentally from traditional industrial pricing approaches no longer feasible? products, mainly in terms of their cost structures and the customer's willingness 2. What are the common pricing strategies to pay. On the one hand, this requires and models for digital services and what us to rethink pricing strategies based on special role do platforms play in this traditional economic theories that are no context? longer valid. On the other hand, it allows industrial companies to implement inno- 3. What are the key considerations for vative pricing strategies and models, such strategic pricing decisions and how as pay-per-use, subscriptions or freemium, can manufacturers identify the right which are already well established in the pricing strategies and models for their B2C context and can be adapted for the business? B2B environment as well.
In addition to specific product characteris- tics, the changing roles and rulesets within the ecosystem are important factors for manufacturing companies to consider. They need to focus on the underlying market dynamics of the ecosystem and
04 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
05 A traditional vs. digital approach to pricing
Digital technologies are giving manufacturing companies the power to transform traditional products into digital products and to launch innovative offerings by digitalizing their products and services.
Cutting-edge technologies are unlocking By now, most companies are well aware huge potential for manufacturing that digital products and services have companies, whether it is efficient process huge potential, and more and more compa- designs at the shop-floor level, continuous nies are making the transformation from monitoring of complex supply chains or the pure manufacturer into integrated service innovative market offerings that result from provider a key element of their competitive the digitalization of products and services. strategies. And yet many manufacturing The latter is particularly promising for companies still find it difficult to design and discrete manufacturing companies facing position their digital offerings in the market. higher cost pressure from the demand side Why is it so difficult for manufacturing and lower margins in their core business. companies to realize their potential in the That makes digital products and services digital age? an important business for manufacturers to complement their core business, stabilize profits and generate new revenue streams. Today’s industrial companies already generate 20–30 percent of their profits in the after sales and service busi- ness, and the trend is toward more digital service offerings.
06 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
Challenging competitive landscape Changing roles and rulesets in the relevant players in a typical manufacturing Evolving from pure manufacturer to manufacturing ecosystem ecosystem that need to be considered integrated services provider involves new Compared to linear customer-supplier rela- when pricing digitalized products and types of competition, and handling this tionships, modern manufacturing compa- services in the market. more complex competitive landscape is a nies operate within a broader network – major challenge for companies within the the manufacturing ecosystem. We define an There are various mechanisms that play ecosystem. In addition to competition from ecosystem as a complex system involving an important role when pricing digital other manufacturers, new players such as different players that interact with each products and services in this broader independent service providers, platform other within a network. Each player fulfils manufacturing ecosystem. On the one providers and software companies are a specific role within these ecosystems hand, you have to rethink pricing strategies becoming more relevant. This is a particu- and contributes to the overall value of the based on traditional economic theories larly important factor when it comes to network. Ecosystems are complex due to that are no longer valid and adapt them to positioning your own digital products and varying business and operating models, the changing roles and rulesets within the services in the market. Innovative pricing the convergence of OT and IT and the ecosystem. On the other hand, you have to strategies and models can help to prevent increasing importance of digital manufac- implement innovative pricing strategies and competition from becoming too intense turing solutions such as smart products, models, such as pay-per-use, subscriptions and to achieve greater differentiation in the digital monitoring solutions, digital field or freemium pricing, which are already well market. services (repair, maintenance and support) established in the B2C context and can be and cyber security. Fig. 1 shows the adapted for the B2B environment as well.
Fig. 1 – Players in a typical manufacturing ecosystem
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07 The traditional approach to pricing Manufacturing companies typically choose one of three pricing strategies (see Fig. 2). However, what looks quite simple in theory is often not as trivial in practice, so firms need to weigh the advantages and disadvantages of each pricing strategy by considering multiple market, product and customer-related factors.
Cost-based pricing Value-based pricing A cost-based pricing approach, especially The value-based approach to pricing has a the most common form, cost-plus pricing, strong customer orientation and is based is a very simple system. You calculate the on an assessment of the particular costs marginal costs of a product and add the and benefits of a specific market offering. markup that is typical for the industry, We define customer value as any technical, which is quite easy to implement and economic or social benefit that derives ensures that your costs are covered even from purchasing a product or service. if sales volume is low. What a cost-based A value-based pricing approach allows pricing strategy lacks, however, is a consid- companies to become more customer- eration of the customer and competitor centric and adapt their prices and products dimensions. This prevents companies to align more closely with customer needs. from extracting additional surplus from In order to succeed with a value-based customer groups that exhibit differences in pricing strategy, however, firms need deep their willingness to pay. insight into customer perceptions of price, value, opportunity and risk when buying a Competitive-based pricing product and a clear understanding of how A competitive-based approach to pricing is much specific customer groups are willing much more complex and calls on firms to to pay for a product or service. consider the value of its brands as well as product quality and differentiation. Pricing in discrete manufacturing Even though there are quite tangible Depending on these factors, companies advantages to a value-based pricing can choose a strategy of pricing below approach, cost-based pricing is still wide- the competition or above the competition spread among discrete manufacturing (premium pricing) and decide to either companies. Current developments in focus on selling higher volumes at lower industrial manufacturing, from price wars margins or generating higher margins at due to intensive competition to high pricing lower volumes. pressure from the demand side, have prompted many manufacturing companies to place even more focus on internal supply chains. It is only reasonable as a result that these companies would also focus their pricing strategies on internal supply chains to ensure their production costs are covered – even if this means they neglect the customer’s perspective and the true value of a product or service.
08 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
Fig. 2 – Generic pricing strategies
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“Value-based pricing is not only about higher profits, it is also about a better understanding of the value of products and services, competitive differentiation and customer relationships.“ Marcel Mehdianpour Senior Manager | Industrial Products & Construction
09 The digital approach to pricing Cost structure Digital platforms In order to unlock the potential of the Digital products and services are costly to Over the last few years, discrete manufac- digital age, companies will also have to produce but cheap to reproduce; in other turing industries have experienced a shift adapt their pricing strategies to the new words, companies may incur high fixed or from products to platforms, which has digital ecosystem. Pricing mechanisms even sunk costs for digital products and enabled them to transform from a pure that worked well for traditional industrial services, mainly in terms of development manufacturer into an integrated service products in the past are no longer valid in efforts, but the marginal cost of production provider. Digital platforms have become an ecosystem with digital products and will remain low. This allows companies to increasingly important as a result and are services. They differ fundamentally from scale digital offerings to a broad customer now seen as the “business model of the traditional products, especially in terms base at almost zero cost for each additional future” when it comes to interaction with of their cost structure and the difficulty of customer. By contrast, traditional goods customers, industry partners and end assessing the true customer value of digital in discrete manufacturing industries users. We define these digital platforms product and service offerings. In contrast generate high unit costs – and these costs as intermediaries that connect different to traditional markets, the complexity of are essential for direct cost/cost-plus parties within an ecosystem and allow the digital ecosystem means we have to pricing strategies. What does this mean for them to complete transactions and interact factor new mechanisms and economic strategic pricing decisions? With negligible with one other. Compared to a traditional principles into our strategic pricing deci- production costs per unit in the digital envi- supply chain in which the interactions sions. ronment, the cost-based pricing approach are linear – from suppliers to customers is no longer feasible. Digital products and – it is much more complex to manage a services have to be priced according to network and find your sweet spot within their value and each individual customer’s the ecosystem. You will have to factor in willingness to pay. the new market dynamics, new players and new ways of interacting and conducting Customer value transactions in order to succeed. While traditional goods and services have quite a tangible customer value, it is much Platforms are strongly impacted by more difficult to assess the customer value network effects; in other words, the value of digital products and service offerings. of the platform for one side of the network Digital products and services are being depends on the number of users on the defined more as experience goods on other side. Network effects in regular today’s market, i.e., customers have to markets can lead to market failure, because experience the product before they can the benefits (or costs) associated with them determine the price they are willing to pay. are independent of the market mecha- This ex-post determination of value is quite nisms. In a digital ecosystem, by contrast, common for digital services, especially network effects encourage a “winner-takes- when it comes to data-driven product solu- it-all” dynamic and boost the market share tions, where customers do not know what of certain players while pushing other they will receive in return for the data until players out of the market. To be successful, they receive it. As a result, manufacturers companies within a platform ecosystem need to be in a position to understand and need to design their pricing in such a way analyze the benefit variables customers are that allows them to internalize the network willing to pay for. They must also select a externalities driving the overall value of a pricing method that enables customers to platform. experience elements of the product as an incentive for purchase. If companies consider the benefits derived from additional users in the network as it sets the prices for its products and services, these positive effects are no longer external and start working through market mechanisms. This also calls for a multi-sided pricing approach that accounts for distinct players within a network ecosystem and is crucial to reach critical mass with a platform.
10 Key takeaways
1. Digital products and services are costly to produce but cheap to reproduce. With this cost structure, traditional pricing approaches are no longer feasible and companies need to price their digital products and services according to their value, not their cost.
2. Digital products and services are seen as experience goods. To get the pricing right, companies must therefore understand the benefit variables customers are willing to pay for. They also need to choose a pricing method that allows customers to experience the product.
3. It is vital for companies to focus on the ecosystem in a broader sense rather than internal supply chains. They need to design their pricing in a way that allows them to internalize network effects that drive the overall value of a network.
11 Pricing strategies in a digital ecosystem
A value-based pricing approach relies on different pricing strategies and methods to help companies differentiate themselves from competitors and extract additional surplus from customers.
In the previous chapter, we outlined the A value-based pricing approach, by changing roles and rulesets involved in contrast, puts the customer first by the transition from a pure manufacturer assessing and analyzing the specific needs to an integrated services provider within and perceptions of specific customer the ecosystem. But what does it mean to groups. During the second and third move from a cost-based approach to a step, the manufacturer sets the price by value-based approach to pricing for digital matching the customer's perceived value. products and services? And which pricing The company can then use that target strategies and models in particular are price to calculate the maximum allowable aligned with this pricing objective? production cost to secure a sufficient return on investment. At the end of this From cost-based to value-based pricing process, the manufacturer designs the Fig. 3 compares the process of a cost- product by prioritizing precisely the benefit based and a value-based pricing approach. features that the customer sees as highly Following a cost-based approach starts valuable. with designing a product or service that has pre-defined features and a fixed scope. In the second and third step, we calculate the cost of this product and set the price by adding an industry-specific markup. In the fourth step, we present the product to the “Harnessing emerging technologies to customer, who will weigh their perceived value of the product against the price. digitalize products and services does Provided the customer’s willingness to pay exceeds the product’s price, he or she not always guarantee success, because will initiate a purchase and the product is delivered to the customer. it doesn’t mean that customers are actually willing to pay for them.” Florian Ploner Partner | Industrial Products & Construction
12 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
Fig. 3 – Cost-based vs. value-based pricing
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What does this mean for discrete manu- • to deploy their pricing strategies across a facturing companies that provide digital broader range of customers and markets products and services? Providing value- while identifying high-value customers added digital services helps manufacturing • to establish long-term and more companies become more customer-centric. interactive relationships with extended Compared to a linear supplier-customer product lifecycles relationship in pure B2B environment, broadening your scope to include the • to capture the maximum value of new greater digital ecosystem means involving and innovative product and service a particular set of players in the process offerings, resulting in higher profits and from an early stage in the value chain. A more attractive market offerings value-based pricing approach allows manu- facturing companies:
13 Pricing strategies Differential pricing Versioning With a value-based pricing approach in With differential pricing or price Versioning is when a producer sells mind, questions arise as to which pricing discrimination, companies will charge a different versions of a similar product strategies and methods will make your different price for the same or at least that vary in terms of quality or features at value-based pricing approach more a similar product, depending on the different prices. The idea behind versioning effective. The perceived value of products individual customer's willingness to pay. is to let customers sort themselves into and services can vary considerably, We can distinguish between three different groups, which each exhibit a systematically especially as industrial systems and the types of price discrimination: different willingness to pay for a specific requirements of individual customers product or special features of a product. • First-degree or perfect price become more complex. In order to This strategy enables companies to avoid discrimination refers to the case in which determine the actual willingness to pay of the problems associated with first and a seller charges a different price for each diverse customers or customer groups, third-degree price discrimination, e.g., unit sold. The price is therefore equal to companies can deploy differential pricing determining the exact customer value the demand price for that unit. strategies and innovative pricing methods for specific product characteristics or to maximize profits and revenues. • Second-degree price discrimination segmentation issues. To achieve an refers to the case in which a seller effective versioning strategy, however, charges different prices depending companies must identify those product on the quantity of goods, scope of characteristics that are highly valuable services or other characteristics, such as for some customers but less important product quality and features, time and for others. Companies will be able to convenience. determine the surplus those high-value customers are willing to pay without • Third-degree price discrimination or disregarding low-value customers. multi-market price discrimination refers Manufacturers can implement versioning to the case in which a seller sets different across different dimensions, including prices for different customer groups, i.e., delivery times, product quality, product based on the market segment. features, the scope of services and Though this may sound relatively easy maintenance as well as convenience. in theory, the way you implement a differential pricing strategy will depend on Example: We can find an example of a a number of different requirements. For typical versioning strategy in the Siemens perfect price discrimination, sellers need industrial automation portfolio. Siemens to know the exact demand price for each offers different versions of automation unit. This will require access to detailed systems and industrial control software data about the customers’ individual depending on the complexity of the benefit variables, which is often not feasible customer’s industrial supply chains and due to asymmetric information within the level of automation. This is also a good market or ecosystem. For third-degree example of how digital offerings such price discrimination, companies must be as software solutions can complement able and willing to segment the market the traditional core business of physical based on exogenous variables, which industrial components.1 often disregards individual customer requirements.
There are, however, two special cases of second-degree price discrimination – versioning and bundling – which may help to overcome those problems. They are both also particularly relevant for the manufacturing industry, where it is possible to combine tangible products from the traditional core business with value-added and individualized digital services.
14 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
Bundling services, especially price-sensitive Dynamic pricing Bundling is when a company sells multiple customers. Second, customers will provide Dynamic pricing is when a producer goods or services at a package price. We their own service and maintenance charges different prices based on current distinguish between “mixed bundling”, infrastructure and handle services in house. market demand. In contrast to differential which involves selling goods and services Third, customers will turn to independent pricing, the prices do not vary between in a bundle as well as individually, “pure and often less-expensive service providers. different customers or customer groups, bundling”, in which a particular set of goods The latter is especially important the more but based on market dynamics, customer and services can only be acquired as part services go digital, because it allows non- demand and/or time. of a package, and “customized bundling”, manufacturing companies, in particular big which allows customers to combine the technology players like Amazon and Google, Example: Airline pricing is a prominent particular set of products and services they to enter the market and provide technology example of this strategy, in which the price need into a bundle. and software solutions for industrial of an airplane ticket depends on how many applications. free seats are available in the aircraft. The In addition to economies of scale and manufacturing industry might also be able reduced transaction costs, the main benefit A pure bundling strategy, i.e., selling to rely on a dynamic pricing strategy to of bundling is to reduce the disparity in the certain products and services solely extract a surplus for industrial products in customer’s willingness to pay. The more as a package, reduces competition high demand. goods that are bundled together, the more and enables companies to keep both elastic the demand will be near the mean. products and services in a single hand. The customers who would have previously The unique nature of bundling means that only bought the specific products that they even service-averse customers will want see as highly valuable might now consider to leverage the additional value-added purchasing a bundle with additional services as long their perceived value of products and services as long the overall the core products is high enough and value of the bundle exceeds the price. exceeds the price of a bundle. In order to Companies that follow this strategy are extract a surplus from different customer able to increase revenues and profits by groups, which differ systematically in their selling additional goods and extracting demands for service and maintenance, additional surplus. companies can combine their bundling strategy with versioning strategies as well. In manufacturing industries, bundling can be implemented in different ways: Example: ABB provides a good example of a successful bundling strategy that combines • Product bundling: selling a set of multiple physical components with digital services. industrial goods or components in They offer digital solutions such as intelligent industrial systems. monitoring and diagnostics, cyber security, • Product and service bundling: intelligent controls as well as digital field selling traditional industrial goods in services for their industrial components.2 combination with certain services. This also includes digital solutions that However, the customers of many complement their core business. manufacturing industries find it more convenient to make specific and targeted • Service bundling: selling a set of (digital) purchases. That means companies need services by offering a comprehensive to pursue an intelligent bundling strategy service, monitoring and maintenance plan. with a clear idea of the market in which Bundling promises to become increasingly customers perceive product or service important for manufacturing industries, bundling as particularly valuable. One especially when we consider how the common way to overcome this issue is to market and competitive landscape in the pursue a mixed-bundling strategy that industry is changing. If you sell products allows companies to tap into the additional and services individually (non-bundling), willingness to pay of customers who want one of the following scenarios will generally holistic product and service offerings, but emerge. First, customers will skip service without neglecting customers with specific intervals and avoid purchasing additional demands.
15 Pricing models Pay-per use/pay-per-outcome Subscriptions In addition to the pricing strategies we have A pay-per-use or pay-per-outcome A subscription pricing model is when outlined in the previous section, companies approach charges the customer for the customers pay a fixed price in recurring must consider another key issue to make actual usage or outcome of a product or intervals, e.g., on a weekly, monthly or their value-based pricing approach as a service. This often involves leasing or yearly basis, in order to obtain access to effective as possible – selecting the right renting products instead of purchasing a product or service. As is the case with pricing and payment model. What we them outright. A pay-per-use or pay-per- the pay-per-use model, companies do are currently seeing in manufacturing outcome approach is feasible as long not sell the product outright, but rather industries is a shift from traditional pricing as the OEM can effectively measure the grant access to use a product or service. models, such as price lists and pay-per- product or service outcome and deploy The difference between these two models instance based on time and material, to remote technologies to maintain access is that a subscription model is based on innovative pricing models from pay-per-use to its product or services in the customer a regular fixed fee that depends on the and pay-per-outcome to subscriptions and/ environment. The key benefit of a pay- actual amount of use. Subscription pricing or freemium pricing models. These pricing per-use or pay-per-outcome approach is models are quite common in the area of models, which we all know quite well from that this pricing model focuses on what digital services, because it is quite easy to the B2C environment, have one thing in is valuable for the customer. It also allows grant or deny access to a digital solution, common – they are more flexible, scalable companies to turn their fixed costs into even for short payment periods (cancelable and convenient than traditional pricing variable costs, thereby reducing their monthly). models. Why shouldn’t companies that financial risk and increasing their scalability operate in a B2B environment capitalize and flexibility. Example: A typical example of this pricing on the benefits of innovative pricing and model in the manufacturing industry payment models as well? Example: One successful example of a is in the area of digital field services, bundled pay-per-use model outside the e.g., predictive maintenance or remote consumer goods business is the “TotalCare” monitoring, service and support. model of the turbine manufacturer Rolls Customers buy a subscription along with Royce. In this model, Rolls Royce allows an industrial product or solution from customers to use its aircraft turbines and the core business. This is often combined also provides additional services such with versioning in that manufacturing as maintenance, monitoring and repairs. companies offer multiple packages that The company still owns the turbines vary based on the scope of services, and charges the airlines only for the maintenance intervals or enhanced actual usage. Selling flight hours rather functionalities. than aircraft turbines is a revolutionary approach to pricing that has multiple benefits for both sides. Rolls Royce, on the one hand, can increase its volume of customer services and avoid competition from independent providers in the high- margin service business. Airlines, on the other hand, can capitalize on this pricing model to monitor their exact costs per flight hour and shift their focus from capital expenses to operating expenses. As an extra bonus, this pricing model also offers great opportunities for OEMs to position additional digital services within the product bundle.3
16 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
Freemium pricing/Tiered pricing Ecosystem pricing Key takeaways A freemium pricing model is when a A third dimension of a value-based pricing producer offers a free version of a service approach comes into play when you 1. A value-based pricing approach and a premium version in exchange for a consider the increasing dominance of combines different pricing strategies fee. This pricing model involves second- platform businesses within the ecosystem. and innovative payment models that degree price discrimination as a type of These industry platforms bring together focus on customer value rather than versioning. Freemium is the right model for multiple groups of players, including costs. digital products and services or platform manufacturers, technology and software 2. To price products and services in business models that want to avoid the vendors as well as independent service line with their value, manufacturing typical problems facing experience goods providers and end customers, offering companies can leverage differential and to reach a sufficient user base by customers a one-stop shop for industry- pricing strategies such as versioning utilizing network effects. While a freemium specific solutions. Platform providers can and bundling to extract additional model only has two different versions, a leverage this broad set of different players surplus. tiered pricing model could offer multiple to increase the overall value of the platform packages with different prices depending and generate profits from multiple revenue 3. Manufacturing companies move on the scope of services. streams. In order to unlock this potential, from traditional pricing models such platform providers must implement a as price lists to more flexible, scalable Example: The freemium model is often multi-sided pricing strategy that allows and convenient pricing models such utilized by software vendors, offering a them to internalize the network effects as pay-per-use, subscriptions and/or basic version with limited functionality and driving the overall value of the platform. freemium pricing models. certain restrictions for free and charging a Pricing mechanisms work in a linear fashion 4. Platform providers need to fee for the premium version with enhanced in traditional markets, but there are several implement a multi-sided pricing functionality and fewer restrictions. One dependencies that need to be managed in strategy that factors in potential possible application in the manufacturing the pricing mechanisms within a network. network effects and interdependcies industry could be digital monitoring The pricing strategy for one customer between different players in the solutions for industrial components, group may affect the pricing strategy and ecosystem. i.e., the OEM offers a limited number of value of another customer group, i.e., it dashboards for free as a fixed bundle with might be more profitable to subsidize the core product and provides additional specific customers and generate a larger dashboards in the premium version. user base of other customers willing to pay higher prices.
Example: Imagine an IoT platform that enables interactions and transactions between digital service providers and end customers for a wide range of applications and/or smart products. As a platform provider, you might find that the best way to maximize profits is to subsidize one group of end users by charging a price below marginal costs in order to generate a larger user base. That will, in turn, attract service providers to the platform, who are willing to pay for and to compensate for these losses on the customer side by charging a much higher price from the supply side.
17 Key considerations for strategic pricing decisions
To identify the right combination of pricing strategies and pricing models, companies must consider the following set of factors related to the company, ecosystem and market environment.
Fig. 4 – Factors that affect strategic pricing decisions
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18 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
Price decision criteria market that is platform-driven and highly Key takeaways There are multiple factors affecting the concentrated, companies perform better strategic pricing decisions of manufacturing when they choose a different pricing 1. To get the pricing right, companies companies that operate in ecosystems (see model than their competitors, even if this need to understand the interplay Fig. 4). In the first dimension, companies means choosing a less than optimal pricing between company, ecosystem and have to consider their internal go-to market strategy. On the other hand, they need to market environment and the way strategy and the ability of specific pricing analyze how they are integrated into the they plan to deliver the value of a strategies and models to help deliver the ecosystem and how they cooperate and digital products and services to the value proposition to the customers. In collaborate with third parties. This latter customer. the second dimension, i.e., the business point is even more important for manufac- 2. An appropriate pricing strategy ecosystem, companies need to analyze turing companies that not only sell digital must be aligned with a company’s how the company is integrated into the goods and services but also own the plat- go-to market perspective and able to ecosystem and how they can improve the form. In this case, the company will have to support its successful positioning input-output ratio with the right pricing manage the complexity of the network as within the ecosystem. strategies and models to support the well as the distinct groups of players within company’s role within the ecosystem. In the network, which often requires a multi- 3. Companies need to understand the third dimension, i.e., the market envi- sided pricing approach. It is particularly their specific role as integrated ronment, companies need to understand important for companies operating in an service providers, platform providers how the entire network creates value for ecosystem with strong direct or indirect and/or platform owners within the customers and which market and customer- network effects to select a pricing strategy ecosystem. This will help them related forces affect its internal go-to and model that enables them to unlock develop a successful pricing strategy market strategy and its positioning inside the potential of those external effects. The that enables them to creat value with and outside the ecosystem. presence of network effects favors specific the network and also internalize types of pricing models, such as freemium external effects. Company-related factors pricing or bundling. It is important to take 4. To implement innovative strategies The company-related factors can relate these into account in the pricing model such as value-based or dynamic to the product itself, e.g., the complexity, design, for example when determining the pricing, companies must have an features and costs of a product, or to number of different versions. in-depth understanding of – and the strategy and operations, e.g., the business ability to monitor – external market and operating models or the competitive Market-related factors dynamics and customer and differentiation strategies. The latter Market-related factors include current requirements. is particularly important when it comes to market trends, external market forces as strategic pricing decisions. Competition well as competitors and service providers drives prices and profits close to zero, outside the ecosystem. Those factors especially in those markets that are highly are especially important when it comes commoditized, and companies cannot to dynamic pricing models focused on succeed without setting themselves apart extracting additional customer surplus from the competition either through based on market-related factors such product or price differentiation. This is as demand, availability or delivery times. why it is so important for manufacturing If they want to capture that additional companies to understand how their own surplus, companies need to understand products differentiate from those of their and monitor market dynamics in order competitors. Companies that are unable to implement their pricing algorithms to differentiate their products or services effectively. They also need to factor in the have to find the right pricing strategy or customer’s understanding of how the model to compensate for this. ecosystem works, i.e., how it creates value for them and what value they ascribe to Ecosystem-related factors the specific variables of a digital product To get the pricing right, companies need or service. By identifying those benefit to align their pricing strategy with their variables, companies can refine their role specific role within the ecosystem. On the within the ecosystem and prioritize those one hand, they need to think about their high-value attributes that customers are competitive position within the ecosystem. actually willing to pay for. In a competitive environment, especially a
19 Next step: How to get the pricing right?
To find the right pricing strategy, companies need to conduct a comprehensive pricing strategy assessment and commit to refining their strategy on a continuous basis.
As a multi-disciplinary, end-to-end provider Understanding the manufacturing Identify, evaluate and set pricing of professional services, Deloitte can help ecosystem strategy your business identify and implement In the first phase on the way to a successful The second phase serves to identify and the right innovative pricing strategies. We pricing strategy, you will acquire a deep prioritize factors that will affect your pricing combine our industry knowledge with understanding of your market, the broader decisions in order to pinpoint, evaluate and technological expertise and deep insight ecosystem as well as the customer and implement the right pricing strategies. This into regulatory, tax, legal and risk factors product environment. This includes … includes … to support your business transformation. • … a market analysis to identify the trends • … identifying the factors related to To ensure that you get the pricing right, we and dynamics on your market that are your market, ecosystem, products and recommend conducting a comprehensive relevant for strategic pricing decisions customers that impact pricing decisions assessment of your pricing strategies based on agile principles for strategy devel- • … an ecosystem analysis to identify key • … prioritizing price-decision factors and opment. This will enable your business to players within the network along with product characteristics as you evaluate achieve quick results and stay flexible in their role, positioning, product portfolio, different pricing strategies and models; response to changing market dynamics. pricing strategy and business models and then using the prioritized factors to identify the right pricing strategies • … a customer analysis to identify high- Pricing strategy assessment value customers and develop customer • … creating a comprehensive report of the Our approach to pricing strategy assess- profiles that capture their precise price strategy assessment that includes ment has three key elements – analysis, requirements and benefit variables recommendations on short-listed strategy and refinement (see Fig. 5). The strategies to enable further decision- objective of the first phase is to understand • … a product analysis to determine the making the broader manufacturing ecosystem, degree to which your product attributes including market characteristics, key are aligned with customer requirements • … validating and designing the selected players, customers and products. In the pricing strategies along with our second phase, strategy development, proposed implementation roadmap we focus on identifying and evaluating different pricing strategies and models based on the relevant pricing-related factors. The third phase, which we call refinement, focuses on price, product and portfolio reassessment to adapt pricing to the changing ecosystem, market and customer requirements on a continuous basis.
20 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
To ensure a pricing strategy succeeds, it is vital for companies to gain market transparency and monitor customer, product and price developments on an ongoing basis.
Fig. 5 – Pricing strategy assessment
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21 Legal considerations
If companies want to achieve a successful, marketable digital business model, there are several legal issues they must consider related to pricing strategies and models as well as value chain considerations for digital products and services.
The implementation of successful and protection regulations in the development As part of a company’s analysis of its digital marketable digital business models gives phase of a new product or service and to ecosystem and the subsequent devel- rise to various legal issues. These are in ensure that all relevant technical features opment of business models and pricing part directly related to the pricing strate- are already implemented in this early systems, another issue of legal significance gies and models themselves and in part to stage to ensure compliance with Data is the extent to which generating data value chain considerations for digital prod- Protection law. is part of production, supply chain and ucts and services. There are also specific customer relationships. After all, as we legal issues closely related to the relevant We also need to consider another concept outlined above, the method of value crea- business models that must be assessed on related to the changing mechanisms of tion by means of digital transformation is a case-by-case basis. digital value-added processes in this different to that with traditional products. context. In many digital business models, From a legal point of view, therefore, the The so-called Product and Service Develop- companies are not only creating value fact that a company can transfer (customer) ment Compliance Process requires a legal through the price strategies and price data to its warehouse as part of the remu- analysis for every new product or service models actually applied. Depending on neration for a service or as a means of under development to ensure that all the business model, companies can also payment warrants a detailed analysis. The legal requirements are duly recognized create considerable value when customers decisive legal issue here is whether there is and technically implemented at this pay in part for some of the services an assumption that the customer's service early stage. This includes, for instance, provided by sharing their personal data is against payment or free of charge. A conducting a risk assessment, in which the (more on this in more detail below). It customer providing his or her personal relevant company seeks to identify and should be noted here that establishing data can also be understood as a kind of analyze potential (future) events that may a so-called Data Warehouse can be a service against payment. The legal impli- negatively impact its business model and considerable asset for a company, which cations of this would be, for example, that businesses. From a legal point of view, the may – in the context of a Big Data analysis the company would have various disclosure company must then make its decisions or similar – lead to new business areas obligations towards customers in a B2C based on its ability to tolerate the risks and opportunities for added value. It rather than the B2B context. identified in the risk assessment. is therefore of crucial importance for a company to clarify its rights related to all These issues lead to further legal implica- The concept of a Product and Service of the data it collects. The company must tions in connection with digital business Development Compliance Process is ensure that it owns all of the necessary models, pricing strategies and pricing provided for by law, for instance, in Data rights to this data, that the data has been models. Depending on the model in Protection law which expressly regulates stored in the Data Warehouse without question, companies must adhere to the the principles of Privacy by Design and legal infringements and that the data can legal requirements regarding pricing and Security by Design. Legislators have made be used for comprehensive analyses and transparency. In particular, customers it a legal requirement to observe data linked to other relevant data. must obtain a transparent presentation of
22 all fee components so that they can make informed decisions. This is particularly true for the payment terms and fees for recur- ring services; Competition law can also set certain limitations for their design. There are also legal issues related to price adjust- ments during a contract period, in the case of subscriptions or continuous service relationships, for example, which are only possible under strict legal conditions. In this context, companies must also adhere to special requirements that apply to the way clauses are phrased in the Terms and Conditions (T&Cs), e.g., with regard to the company's performance determination rights. This is because companies are subject to strict limits in terms of a unilat- eral change of services. The question also arises as to the transparency requirements and the ability to amend a service, for instance, in the event that products and/ or services are bundled. Companies must conduct a thorough legal analysis if they intend to change the individual components of a service during the current contract term without changing the price.
Finally, companies are also subject to certain legal obligations related to the integration of payment services into a digital business model, both in terms of the internal relationship with an external payment service provider and in terms of the external relationship with a customer.
23 Conclusion
To get the pricing right, manufacturers need to align innovative pricing strategies for their digital products with the changing mechanisms in the broader manufacturing ecosystem.
The objective of this white paper is to help In the first section, we compared the In the second section, we outlined manufacturing companies better under- traditional vs. digital approach to pricing. potential pricing strategies and models that stand pricing mechanisms in the digital This highlights the difficulties associated support a value-based approach and help ecosystem and to provide an overview of with traditional pricing strategies when align the digital products and services with potential pricing strategies and models products and services are digitalized as the new mechanisms in the manufacturing for digital products and services that are well as the new market and pricing mecha- ecosystem. aligned with the changing roles and rule- nisms in the manufacturing ecosystem. 01. A value-based pricing approach can sets in the manufacturing ecosystem. 01. Digital products and services are costly combine different pricing strategies and to produce but cheap to reproduce. innovative payment models in order to A cost-based pricing approach is no shift the focus from cost to customer longer feasible with this cost structure, value. so we have to price digital products and 02. To price products and services services according to their actual value. based on their value, manufacturing 02. If we define digital products and companies can leverage differential services as experience goods, two pricing strategies such as versioning things are key for getting the pricing and bundling to extract additional right. First, companies need to surplus. understand the benefit variables 03. Manufacturing companies should move that customers are willing to pay for. from traditional pricing models such as Second, they need to select a pricing price lists to more flexible, scalable and model that enables customers to convenient pricing models such as pay- experience the product. per-use, subscriptions and/or freemium 03. Manufacturing companies are facing pricing. changing market dynamics as a result 04. Implementing a multi-sided pricing of the new, platform-driven ecosystem. strategy will enable platform providers This is a highly complex ecosystem, to consider network effects and because of the larger number of interdependencies between different players interacting with each other players in an ecosystem. within the network and because of the presence of network effects. To get the pricing right and find their sweet-spot within the ecosystem, companies should focus more on the ecosystem in a broader sense than on their internal supply chains. In other words, they need to design their pricing in such a way that will enable them to internalize those network effects that drive the network's overall value.
24 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
In the third section, we considered In the fourth section, we presented various factors that can impact strategic our comprehensive pricing strategy pricing decisions. Companies need to assessment to help identify and implement consider a complex set of company-related, appropriate pricing strategies in a digital, ecosystem-related and market-related ecosystem-driven environment. Our factors in order to get the pricing right. approach to pricing strategy assessment has three key elements – analysis, strategy 01. Manufacturing companies need to and refinement – and involves agile prin- understand the interplay between ciples for strategy development. In this company, ecosystem and market process, we combine Deloitte’s industry environment and determine how they knowledge with our technological expertise plan to deliver the value of a digital and deep insight into regulatory, tax, legal, product or service to the customer. and risk factors to support your business 02. The right pricing strategy is one that transformation. is aligned with the company’s go-to market perspective and can help them The white paper closes by considering legal successfully position themselves within aspects that are relevant when pricing the ecosystem. digital products and services in the manu- facturing ecosystem, including Product and 03. Manufacturing companies need to Service Development Compliance, data understand their specific role as an protection, privacy and security as well as integrated service provider, platform legal requirements regarding pricing, trans- provider and/or platform owner within parency and competition law. the ecosystem in order to develop a successful pricing strategy that enables them to create value with the network while also internalizing external effects.
04. To implement innovative pricing strategies such as value-based or dynamic pricing, companies need an in-depth understanding of – and the ability to monitor – external market dynamics and customer requirements.
25 Endnotes
1. Siemens, Automation systems, available at https://new.siemens.com/global/en/ products/automation.html.
2. ABB, Advanced Digital Services, available at https://new.abb.com/process-automation/ process-automation-service/advanced-digital-services
3. Rolls Royce, TotalCare, available at https://www.rolls-royce.com/media/our-stories/ discover/2017/totalcare.aspx.
References
Bakos, Y., & Brynjolfsson, E., Bundling information goods: Pricing, profits, and efficiency. Management science 45(12).
Kotler, P., Armstrong, G., Principles of Marketing, Person Education.
Shapiro, C., Varian, H. R., Information rules: A strategic guide to the network economy, Harvard Business Press.
Siggelkow, N., Terwiesch, C., 5 Questions to Consider When Pricing Smart Products, Harvard Business Review.
Shapiro, B., P., Jackson, B., Industrial Pricing to Meet Customer Needs, Harvard Business Review.
Varian, H. R. (1995). Pricing information goods.
26 Pricing of digital products and services in the manufacturing ecosystem | From cost-based to value-based pricing
27 Contacts
Florian Ploner Klaus M. Brisch Christoph Beuter Partner | Deloitte Partner | Deloitte Legal Director | Monitor Deloitte Industrial Products & Construction Digitale Wirtschaft, IT/IP Strategy & Business Design Tel: +49 (0)151 58076549 Tel: +49 (0)151 12141829 Tel: +49 (0)151 58001932 [email protected] [email protected] [email protected]
Marcel Mehdianpour René Knab Senior Manager | Deloitte Consultant | Deloitte Industrial Products & Construction Industrial Products & Construction Tel: +49 (0)151 58070453 Tel: +49 (0)151 58078082 [email protected] [email protected]
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Issue 11/2020