STRATEGIC PRICING GROUP INC. SoftSummit 2004 Utility-Based Pricing: How To Make It Profitable Thomas Nagle, Chairman and CEO Thomas Lucke, Vice President

© 2003 Strategic Pricing Group, Inc. 2 Utility Based Pricing - A Tale of Two Views Gone are the days when software providers would back up a truck to the company's front door and dump as much software as possible and expect a huge up- front license fee from a customer. Louis Blatt, Chief Technology Strategist, Computer Associates "For companies that don't experience seasonal variations in how they use IT infrastructure, a lot of this doesn't make sense" John Fowler, Chief Technology Officer Sun Microsystems They Are Both Right!

© 2003 Strategic Pricing Group, Inc. 3 Why On-Demand? On-demand is not a better model to replace the existing perpetual license model On-demand is a different model to reach customers, segments and applications where the current model is not delivering enough value The trick is to profitably manage the two models simultaneously –On-demand pricing can commoditize your business and cannibalize revenue if managed poorly –On-demand can drive significant incremental utility revenue from new customers –On-demand can the lower risk of trial, driving growth in perpetual license revenue as well

© 2003 Strategic Pricing Group, Inc. 4 Pricing needs to align with value What is the biggest challenge with todays pricing models? Source: Forrester Research: 156 North American technology decision makers Not in line with our business goals and metrics for measuring value Maintenance costs are too high Too complex Too rigid Dont know Other 42% 19% 15% 14% 9% 1% Common pricing models fail when: High variability in useHigh variability in use Uncertain future needsUncertain future needs High initial investmentHigh initial investment High performance risk (of a new product or technology)High performance risk (of a new product or technology) Common pricing models fail when: High variability in useHigh variability in use Uncertain future needsUncertain future needs High initial investmentHigh initial investment High performance risk (of a new product or technology)High performance risk (of a new product or technology)

© 2003 Strategic Pricing Group, Inc. 5 On-Demand Pricing - How To Get It Right? Identify segments Understand value drivers ID value differenceS Pick price metrics that track value Assess value created Set price as discount from value Understand where it makes sense Understand where it makes sense Choose the right price structure Set the price

© 2003 Strategic Pricing Group, Inc. 6 On-Demand Pricing - How To Get It Right? Identify segments Understand value drivers Assess value created Set price as discount from value Understand where it makes sense Understand where it makes sense Choose the right price structure Set the price ID value differences Pick price metrics that track value

© 2003 Strategic Pricing Group, Inc. 7 On-Demand Can Expand the Market Opportunity High Low Value of License Segments A B C Perpetual license D E On-Demand Targets... Time to benefit too long Cant afford initial up-front perpetual license fee High variability in usage –High uncertainty about future need Cost of lock-in high Unwilling to risk purchase of new software / technology Perpetual Model Targets Economies of Scale Low variability; high certainty about demand Leading Edge IT

© 2003 Strategic Pricing Group, Inc. 8 Value of Use Changes With Each Segment High Low Value of Use Segments A B C Use Fee D E On-Demand Targets Perpetual Model Targets

© 2003 Strategic Pricing Group, Inc. 9 How Is Value Created by On-Demand Models? Shorten time to benefit Reduce up-front cost Reduce risk associated with uncertainty of future needs Eliminate lock-in Reduce risk associated with of new software / technology $ Value from licenses saved$ Value from licenses saved $ Value from shift of capitalized asset to expense$ Value from shift of capitalized asset to expense $ Value of risk reduction$ Value of risk reduction $ Value from speed to implementation$ Value from speed to implementation $ Value from licenses saved$ Value from licenses saved $ Value from shift of capitalized asset to expense$ Value from shift of capitalized asset to expense $ Value of risk reduction$ Value of risk reduction $ Value from speed to implementation$ Value from speed to implementation Benefit Value

© 2003 Strategic Pricing Group, Inc. 10 On-Demand Pricing - How To Get It Right? Identify segments Understand value drivers ID value differences Pick price metrics that track value Assess value created Set price as discount from value Understand where it makes sense Understand where it makes sense Choose the right price structure Set the price

© 2003 Strategic Pricing Group, Inc. 11 Pick Price Metrics That Align With Value High Low Value Customers Acme Beta Gamma Same Offering, Different Value Differences in value can be captured with pricing metrics that are linked to value drivers Differences in value can be captured with pricing metrics that are linked to value drivers Value can differ even when customers have similar needs

© 2003 Strategic Pricing Group, Inc. 12 Case Example – Infrastructure Software 1234 Low Complexity, High Activity High Complexity, High Activity Low Complexity, Low Activity High Complexity, Low Activity Availability Productivity Utilization Reference Activity, not environment complexity, was the critical element of value for this infrastructure software. Traditional metrics left money on the table.

© 2003 Strategic Pricing Group, Inc. 13 Metrics Need To Work Across Segments, Be Feasible in the Channel, and Understandable By Customers Tracks Value Segment Differences Measurable & Enforceable Customer Buying Habits & Preferences Competition (Reference) Metric Filters Various Price Metrics Recommended Metric(s) Channel Capabilities

© 2003 Strategic Pricing Group, Inc. 14 Case Example - Identifying the Right Price Metric Flat Monthly Fee One-price fits all Easy to explain and administer But does not reflect value created Size-Based (Number of Seats) Unique price based on number of seats Simple Only imperfectly reflects value Usage Based (Number of Minutes) Unique price based on volume of center Common in telecom Reflects value But – a poor comparison, sets transport price as the baseline Usage Based (Number of Calls) Unique price based on calls handled by system Non- traditional Tracks value Highlights agent cost savings, which accrue per call Key was understanding how value was really created – not just how pricing was traditionally done Used the metric to define the reference – strategically important Key was understanding how value was really created – not just how pricing was traditionally done Used the metric to define the reference – strategically important

© 2003 Strategic Pricing Group, Inc. 15 On-Demand Pricing - How To Get It Right? Identify segments Understand value drivers ID value differences Pick price metrics that track value Assess value created Set price as discount from value Understand where it makes sense Understand where it makes sense Choose the right price structure Set the price

© 2003 Strategic Pricing Group, Inc. 16 Set Price Based on Economic Value Estimation ® Reference Value Positive Differentiation Value $32,800 Economic Value $16,000 Negative Differentiation Value Remote diagnosis and repair of system failures $7,800 Eliminate systems interoperability problems $14,500 Remote upgrades and maintenance $10,400 Training on new system ($20,000) Cost of alternative software Cost of alternative software$4,000 Present Value = Cost reductions over two years (discounted at 10%) Revenue- based Cost-based Software Example

© 2003 Strategic Pricing Group, Inc. 17 Once the Differential Value Has Been Established, Set Prices Based on Strategic Assessment of Price Sensitivity Issues Differential Value Next Best Competitive Alternative 0% 25% 50% 75% 100% Economic Value COMPETITIVE ENVIRONMENT CUSTOMER EXPECTATIONS PERFORMANCE RISK COMPANY STRATEGY FAIRNESS AFFECT PRICE

© 2003 Strategic Pricing Group, Inc. 18 P A Simple Pricing Model forces costly tradeoffs Revenue Received Revenue Received Value Received from Access Value Received from Access Missed Volume Opportunities Missed Margin Opportunities Price Value

© 2003 Strategic Pricing Group, Inc. 19 P A Complex Pricing Model Can Maximize Market Share and Profit Revenue Received Revenue Received Value Received from Access Value Received from Access On- demand HybridHybrid LicenseLicense

STRATEGIC PRICING GROUP INC. SoftSummit 2004 Utility-Based Pricing: How To Make It Profitable Thank You Thomas Nagle, Chairman and CEO Thomas Lucke, Vice President