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 ecnolog providers overnment artnerslliances egulations latorm providers over Platform nance etor egal etailers ata service providers ustomer aterial vendors anuacturers loud Product nfra ervice structure areouseogistics ament aintenance service ecurit otare vendors nerg 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