New business segment case scenario

Ivan asked on Aug 14, 2019

A Health consulting client is currently selling a third party software through his webpage. This client ask our software agency to develop a bespoke development to differentiate his company from the competitors. He also plans that after our company releases the requested development, he can sell the development as part of his current consulting services (as an included “communication tool”). We are analyzing if we should charge a one time fee every time our client sell his consulting services and a monthly/annual fee to provide hosting maintenance. ¿Do you think this is the best solution for our company?

(edited)

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Ivan updated his answer on Aug 14, 2019

Client = software developer

Problem statement:

  • A developer of individual software is asked to provide a communication tool for a specialised consultancy (health sector).
  • The client (software developer) wants to know how to price the new software solution: based on usage (per project), monthly fee -- pricing case.
  • No further objectives are known.

1) Firm:

  • Assumption: as we have no information on clieint's revenue (volume, trends), I suggest, the client is driven solely by business opportunity rather then by declining profits and operational issues.
  • There are no other restrictions known to provide this software (availability of talent, technical restrictions etc.)
  • What constitutes success? We assume the firms seeks revenue maximisation.

2) Industry:

  • I assume the market for consulting and technology services for the clients from the heath sector is thriving. We can clearly see the forthcoming digital transformation of hospitals, insurers etc. and this trend traslates into commercial success for the client.
  • However, higher demand might lead to more firms entering the market and competition becoming more fierce.

3) Product/Service:

  • A new communication tools shall be used by consultants during the project as means of communications with health care customers (hospitals, insurers, ...)
  • The software developer has two options:
    • Provide software as pay-per-use / per-project basis (option1)
    • As monthly subscription (option2)
  • Revenue formula for the option 1: number of projects x fee (annually)
  • Revenue formula for the option 2: subscription fee x 12 months
  • The comparison of these two calculations should be base for the recommendation.

4) Summary and final considerations:

  • The final recommendation should be dependent on the calculation performed in #3
  • Some points, as we have no factual information on the number of projects, calculated fee per project, calculated fee per month etc:
    • Fee per project should be higher, as projects are expected to come irregularly and the developer has to maintain software on its own and keep it operational
    • Monthly subsctiption fee should be subject to the length of the contract as it constitutes promised cash flows and gives certainty

Hope this helps

(edited)

Lin updated his answer on Aug 15, 2019

There are two important concerns other than the profitability analysis as suggested:

1) Does the service have a material cost attached?

For the communication tool development, if the tool needs to be customized for each sales of consulting service, a pay-per-sale pricing model is justified. If the tool is a general model and needs minimum tweaking after the initial R&D and implementation, it may be more sensible to have a bulk one-time initial charge or a subscription model in order to minimize the impact of potential sales fluctuations.

Similarly, for the maintenance service, if the cost of service is primarily attached to the sale of communication tool (i.e. maintenance service is only provided as part of the consulting service project), a pay-per-sale pricing model is more suitable. If the maintenance service is spread out such that it is carried out regularly during the year (e.g. once a month), a monthly/annual fee is more justified.

2) Shifting to subscription model in the long run

In the short term, pay-per-sale model is a flexible option that provides feedback on the client's business performance.

If the client consistently has a low sales number, it may not be profitable for the company to continue providing the communication tool service. Potentially, the company may consider ending this engagement, making a few adjustments to the communication tool and selling it to other interested third-party clients.

If the client has a steady sales number that generates reasonable profit for the company, the company can switch to a subscription model in the long run to secure consistent revenue streams and better capture customer lifetime value by maintaining customer relationships.

The pay-per-sale model is a 'testing ground' to probe into whether the engagement is potentially a profitable one. The conversion to subscription model can maximize the future revenue potential based on the testing results.

Hope this gives you another perspective of the case.

(edited)

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