Software pricing: three key levers to create value

An EY-Parthenon executive survey shows what leading software providers are doing to protect and generate value through pricing strategies.

In brief

• EY-Parthenon research reveals key pricing strategies that software providers are using for value creation.
• Companies and private equity firms that aren’t embracing these pricing levers risk compromising value.
• Assessing pricing practices against the levers can help organizations narrow in on actions to improve the impact pricing has on their financial outcomes.

The current macroeconomic environment, marked by inflation and higher interest rates, is creating pressure for software providers to carefully examine their pricing strategies and approaches to generate more value.

Figure 1: Level of price increase

The average price increase for customers between 2022 and 2023 was 14%.

Q: What was the average level of your organization’s price increases in 2022 (on a revenue-weighted basis)? What do you expect to be the average level of your organization’s price increases in 2023?

1. Question not shown to respondents who did not raise prices in 2022 and do not expect to raise prices in 2023
2. Weighted average using the midpoints of the choice ranges shown to respondents

Source: EY-Parthenon

Figure 2: Net revenue realization of price increase, 2022

Only 15% of organizations realize a significant impact to net revenue by increasing prices.

Data indicates that price increases alone don’t inevitably result in a net increase to revenue, and organizations continue to grapple with increased costs.

Q: How would you estimate the percentage of your organization’s price increases in 2022 that was realized as a net increase to revenue (i.e., fully passed through to your customer, net of any down-sell, discounts or churn)?

1. Question not shown to respondents who did not raise prices in 2022
2. Weighted average using the midpoints of the choice ranges shown to respondents

Source: EY-Parthenon

Software providers’ ability to realize higher profitability can’t be sustained through price increases alone, and organizations should focus on a combination of the following three practices to improve pricing discipline, as shown in our survey results.

1) Embed price escalators

A primary method that organizations have adopted to support price increases is to utilize escalator clauses in their contracts.

In the survey, more than 50% of executives indicated that they embed price escalators in their contracts, and more than half of companies that use built-in price escalators have them in up to 40% of their contracts. The majority of these executives also reported that they’re using index-linked methodologies, which determine the price of a good or service based on the price of a similar good or service in the market.

Figure 3: Presence of built-in contract price escalators

More than 50% of organizations embed escalators in their contracts.

Q: Do any of your contracts with customers have automatic, regular price escalators built in?

1. Question shown to respondents who offer long-term contracts (~90% of total respondent sample)
2. Price escalator: “Are these contractual price escalators at your company linked to CPI or some other floating price index?”; Typical frequency: “On average, how often do these price escalators raise the price?”

Source: EY-Parthenon

Over half of surveyed organizations use price escalators in their contacts, and nearly half of those link to the Consumer Price Index or another price index. One caveat is that, despite having added escalator clauses to contracts, companies may have IT gaps, which therefore limit the ability for increases to initiate automatically.

2) Tailor contract term changes to drive targeted KPIs

Although our data shows that nearly half of customers prefer one-year contracts, businesses have been attempting to expand contract duration to two years or more to optimize customer lifetime value and reduce cost of sales. Businesses that are successful with this approach offer discounts to entice longer-term contracts, with an average discount per additional contract year of about 6%. Organizations provide buying programs that are typically offered for longer contracts, including tiered pricing structures that help cater to diverse customer needs.

In addition, organizations can benefit from proactively assessing which combination of pricing structure and contract duration leads to the most value. This data can help businesses enact and enforce parameters, including established ranges for discounts.

Software company executives also say that they deploy use-case-based expansion strategies by assessing customer needs and adjacencies and then identifying the most suitable contract option.

Figure 4: Average discount level per additional contract year

The average discount across survey respondents and organization types is just above 6%.

Q: What is the average level of discount per additional year of customer contract length at your organization?

1. Weighted average using the midpoints of the choice ranges shown to respondents
2. Question shown to respondents who offer discounts for longer contracts; excludes “N/A” and “I don’t know” responses
3. In brand perception, budget category not represented due to low base

Source: EY-Parthenon

3) Invest in dedicated resources and add rigor to governance processes

Our survey shows that leading organizations have established dedicated pricing departments or centers of excellence (CoEs) rather than relying on ad hoc pricing practices and techniques. Adding this layer of rigor helps mitigate value erosion caused by misinformed or biased pricing decisions. It’s also common for organizations to employ a preapproved pricing range that enables certain levels within an organization to use their discretion without seeking incremental approval. In addition, pricing departments and CoEs are more commonly using technology to guide pricing decisions.

Organizations are also maintaining pricing discipline through systematic account reviews and conducting ongoing competitive benchmarking. Businesses often complete these tasks on a monthly or quarterly basis.

Figure 5: Organizations with dedicated pricing departments

Organizations are increasingly establishing centers of excellence (CoEs) to add more rigor around pricing practices. More than two-thirds of organizations have established dedicated pricing departments or CoEs.

Q: Does your organization have a dedicated pricing group or department?

1. Indicative as low n

Source: EY-Parthenon

Thanks to Susan Lee and Shane Odegard from Ernst & Young LLP for their contributions to this article.