Should ROI define your Pricing Strategy?

Ghost -

There is an oft-repeated ROI-based pricing sentence I’ve heard over the years which goes something like “Mr Customer, I will aim to deliver you 5x to 10x ROI and in return, I only want [1% to 10%] of the benefits accrued to you”. In theory, this is an attractive approach, customers can get the majority of the value delivered, and we get a small but proportional chunk of change for our value delivered.

This is theoretically very lucrative if the value proposition was actually as strong as many companies suggest. A common mechanism by which this is demonstrated is by doing a study with an external consultant. Forrester’s Total Economic Impact™ Methodology is one such example.

Let’s take a look at ROI claims across a few of these studies. Here is a sampling of what an online search throws up when I searched for Forrester’s seminal report titled Total Economic Impact - TEI:

  • Snowflake: Forrester reveals a customer ROI of 612% and total benefits of over $21 million over three years for Snowflake’s cloud data platform
  • New Relic: Forrester’s interview with an existing customer and subsequent financial analysis found that the interviewed organization experienced benefits of $13,277,754 over three years versus costs of $6,047,192, adding up to a net present value (NPV) of $7,230,562 and an ROI of 120%
  • DataRobot: 514% ROI and Payback within 3 Months
  • Snaplogic: Over a three-year period, 498% ROI $3.9 Million Benefits Present Value $3.3 Million Net Present Value ~6 Months Payback
  • Qualtrics: Forrester Consulting estimates the 3-year benefit of Qualtrics experience management software at $38.4 million – which is an ROI of 633%
  • Twilio: $12.6 million in benefits versus costs of $3.3 million, resulting in a net present value (NPV) of $9.2 million and an ROI of 277%

These numbers remind me of an interview I had with a CEO for a Marketing role, where he kept pushing me to explain the difference between correlation and causation. He was miffed about a phenomenon around how marketing organizations take credit for everything a company did to be successful, where in reality, the software was just one small piece.

What’s going on with these reports is something similar. On the one hand, they may not be able to isolate purely the impact of the software in question, and on the other hand, organizations cherry-pick their best customers to be used in these case studies.

Tomasz Tunguz echoes this sentiment in his own blog, The Siren Song of ROI Based Pricing, “If we reflect on the most successful software companies, the very largest, very few sell based on ROI. What is the return on investment of a Salesforce or a Workday deployment? How do you calculate it? How does an AE defend it? Many times, these ROI calculations assert unquestionable numbers. But most buyers approach these kinds of arguments with scepticism and even cynicism. Sometimes, they have been burned in the past with these kinds of arguments. Other times, buyers recognize that it is almost impossible to measure true return on investment. Switching costs are rarely accounted for in his calculations. Measuring increasing productivity is very difficult. Soft costs “challenge the math.”

The point being that a well-paid consultant can come up with an amazing ROI number, and when your customer does this analysis at the end of the year, the numbers they see will not be this rosy. So, if you base your pricing to be a percent of ROI, you and your organization will then bear the onus of justifying it at year-end.

This is why, while all companies talk about ROI, nearly none use it for pricing.

Don’t get me wrong, ROI is a great tool, but for price justification, just not for pricing!

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This is an edited excerpt from author Ajit Ghuman’s book, Price To Scale. Order now on Amazon.com.