Venture Capitalist at Theory

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2 minute read / Sep 11, 2019 /

The Siren Song of ROI Based Pricing

Selling based on ROI (return-on-investment) sounds great. A salesperson lays out an iron-clad case for how the customer will make 5x or 6x or 10x their initial investment in a piece of software in three years or less. The champion will use ROI math to assuage upper management and procurement’s concerns. Or so the thinking goes.

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 skepticism and even cynicism. Sometimes, they have been burned in the past making kind 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.

Most of the time, I advise companies to move away from ROI based pricing for all the reasons above.

Second, a true ROI based sale, one in which startup captures a fraction of the incremental revenue, is a tough place to be. At the beginning, it seems to align incentives of the buyer and the vendor. The more revenue the buyer generates, the greater the fee for the vendor.

But there are challenges in renewal. Every year, the buyer will ask you, “what have you done for me above and beyond the baseline we established last year?” The pricing model invites a deflationary renewal conversation. Unless you’re able to keep up a manic pace of product innovation.

There are some cases where ROI based sales are effective. Software that eliminates entire teams or infrastructure products may slash costs. Hardware is often sold like this. The more the market is commodified, the more effective an ROI based sale is.

But workflow software or collaboration software or other kinds of productivity based software typically are sold on the promise of the future; digital transformation; competitive advantage; or more intangible forms of efficiency.

For those kinds of businesses, selling that promise is far more effective, more lucrative and more credible.

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