Value-based Pricing: Powering the Internet of Things

Companies expect the Internet of Things (IoT) to spark nearly $500 billion in extra sales and more than $400 billion in cost savings annually for the next five years, according to a recent study by the auditing firm PwC. But how can companies take advantage of this technological development? Deutsche Telekom is helping to limit the initial risks for the customer with an innovative new pricing model.

Just a few years ago, networking machinery and industrial equipment were unaffordable for many companies. But as the technology has developed and become more standardised, the use of IoT solutions has become simpler – and considerably cheaper. Even many firms without specialised IT or networked industry know-how are now able to take advantage of the IoT in their daily business and help drive its distribution.

New technologies are normally purchased at a fixed price per connected machine. But this isn’t optimal for many customers. If they are unable to achieve their IoT revenue targets, they are forced to write the endeavor off as a bad investment. So Deutsche Telekom’s M2M unit is introducing value-based pricing (VBP) to help avoid such pitfalls.

The concept of value-based pricing

It’s really quite simple. A product costs as much as it is worth. And what determines the value? The actual benefit it brings its user. That is the foundation of value-based pricing.

Normal pricing models are based on such things as manufacturing costs and profit targets. Or, as in the case of competitive pricing, on what the competition is charging. Contrary to these models, VBP is judged on the value added for customers, meaning that a positive impact on production or service operations must be achieved.

As a result, manufacturers set the prices for products entirely differently when using VBP. Customers and producers determine together when signing a contract the factors that measure the success of their IoT solutions. These factors – which could be an increase in gross income or lower operating costs – must then be monitored constantly.

The advantage? Compared to other models, VBP increases customer loyalty, and the financial risk and the financial profit are shared by the provider and the customer. The main drawback is that the data used to determine the value of a product is often difficult to obtain. Deploying it can also end up adding extra initial costs – for internal billing and financial processes – and customers can also see differences in prices as being unfair should VBP be made public.

Value-based pricing for IoT

Deutsche Telekom is introducing this innovative pricing concept for products related to networked machinery, Industrie 4.0, and the Internet of Things. This means a solution will not be priced by networked device, but rather on its successful application. A benchmark figure, called “zero-point indicator” by Deutsche Telekom, will be used to determine the profits gained or costs saved. As the solution provider, Deutsche Telekom receives a predefined percentage as payment.

The benefit for the user is clear. If a solution fails to produce the desired outcome, the customer pays nothing. This means the customer’s investment risk of deploying an innovative technology is significantly lower compared to traditional pricing models. Should an IoT solution prove profitable, both sides gain. And since this concept couples the user’s success to Deutsche Telekom’s own financial interests, customers will have a partner at their side doing everything it can to ensure that a project achieves results. Companies only just beginning to deploy IoT solutions can benefit especially from VBP because with success-based pricing they take on no risk.

Trust required

However, VBP can only work when there is absolute trust between the provider and the customer. To determine the added value of an IoT technology to a company, the provider needs access to sensitive information. Depending on the zero-point indicator chosen, that could mean granting insight into business procedures, profit figures, and more.

That requires a change of mindset for many customers for which they will be rewarded with increased productivity and greater service satisfaction. But nobody will be forced to share company data – Deutsche Telekom offers VBP only as a potential alternative to regular cost-based pricing.

Everyone benefits from VBP, including the provider and developer of IoT technology. Although the provider carries the risk that he will not be paid should his products bring no extra value to his customers, he can use this experience to improve his solutions and make them more effective in the future and participate from the value they bring to the customer. So VBP is part of a long-term strategic approach. It can help make the increasingly competitive IoT segment more profitable. Since customers pay not once, but continuously, their trust in the longevity of a product’s quality grows. VBP is a very customer-oriented approach to business, increasing client understanding, service, and loyalty.

Two examples of value-based pricing

Value-based pricing can be used in a variety of sectors. For example, one could imagine a virtual health marketplace using IoT technology to link patients, doctors, and medical devices more effectively. The efficient exchange of information saves this fictional company €3 million in processing costs. A VBP contract would set aside for example 20 percent, or €600,000, of these OPEX savings as payment for Deutsche Telekom.

Another IoT example is the networking of industrial production machines. In this imagined case, gross profit could be used as a zero-point indicator. The customer makes €2 in additional revenue per unit of 100,000 machines and saves €500,000 with the solution, adding €700,000 in value to the company. As the solution provider, Deutsche Telekom receives for example 20 percent, or €140,000, of the increase in gross profit.

Dr. Alexander Lautz, Senior Vice President M2M, Deutsche Telekom