How to create pricing models for smart connected products?

Connected products have been very successful, new products such as freezers, airplane engines, coffee machines, to agriculture sensors are doing well.  Many product managers are figuring out how to capitalize on the opportunity, however, a major challenge is to forecast the revenue potential.  There clearly seems to be a market for internet-connected products, but at what price point? What kind of pricing structure is feasible for my users?

This article will help you think through: ‘how much can you charge for your connected product idea’ and ‘what kinds of pricing models should you consider’.  This is based on over a decade of experience (Esprida IoT) helping companies launch connected solutions and support remotely controlled devices.

Connected Products Overview

Connected Products or Smart Products refer to common physical products that have been enhanced with Internet of Things technology (including hardware, communications, and software systems) that are connected to the cloud.  A comparison: a traditional coffee maker will make a cup of coffee at the press of a button.  A ‘smart’ coffee maker automatically makes coffee when you wake up (based on your smartwatch); it also introduces new revenue streams to re-order coffee beans, it can send you promotions for new coffee brands, it offers’ high-end calibration features on a smartphone to change brew times or coffee temperature.

Present day coffee machines- Your phone can now make a perfect coffee. The first Bluetooth connected Nespresso machine and its app offers additional benefits such as capsule stock management, schedule brew, machine assistance and care.

A new pricing model for any product is a huge change that needs to be thought through carefully.  When you are changing a product pricing model, you have to think through:

  • Will pricing model be accepted by my sales team?
  • Will pricing model accommodate commissions for resellers, distributors and partners?
  • Will existing customers accept the new pricing model?
  • Should I focus on early adopter customers or main stream customers?
  • How do I forecast a recurring revenue stream?

Value Creation

When thinking about pricing a traditional non-connected product, companies typically base decisions based on the price of a product, unit quantities and unit margin. When thinking about the new connected products with recurring pricing models, you have to think about the lifetime spend of your customer – not only an individual transaction.  It changes the sales & marketing focus towards building a long-term customer relationship and monetizing over the lifetime also known as the Lifetime Customer Value. This is an important concept to consider while thinking about pricing your IoT product. The right approach is to figure out how to create and capture value over the users’ lifetime use of the product or the product family.

Just by adding connectivity, your product can create value in new ways that was never possible before but before we go over pricing structures, it’s important to understand what value can be created;

Convenience Many smart products allow consumers to control machines from their smart phones.  A smart door bell provides enhanced ability see who is at the door and unlock your door without getting off your couch.  Consumers are willing to pay $240 for that convenience compared to a traditional doorbell.
Visibility Real time information can cause changes to human behavior, improving your bottom line.  For example: a dashboard that monitors machine throughput have been shown to change the behavior of machine operators.  When machine operators go on-break, or run the machine at a slower setting, they don’t have to wait for a supervisor to notice, the entire team will be notified via the public dashboard that turns yellow or red.
Control Many connected product concepts enable the owner to control equipment in a much more granular way and enables them to make their processes a lot more efficient.  For example, a freezer manufacturer provides restaurant chains to lock/ unlock the freezer door if the freezer hasn’t been working (i.e. no power) for 6 hours; and control freezer temperature/ humidity/ compressor settings.  This control means there is less training, better audit controls, automatic process notifications based on a malfunction.  The temperature control also helps them balance energy costs with food and freshness.
Brand Perception Some consumers (e.g. tech enthusiasts) want to have the latest technology.  It’s important for them to maximize optimization in anything they do.  One example that’s worked well for this group is the latest Series 3 $500 + smart watch from Apple.
Monitoring Knowing what’s happening in remote locations is extremely important in many service oriented businesses.  Suppliers of food stock, fuel, construction material, service parts for remote facilities can quickly save money just by knowing if a service truck roll is needed urgently or if a service truck roll can wait until the next time that a service tech is in the area.  The cost to operate a service technician, parts and fuel is expensive and the ability to optimize trips based on better information has a very quick ROI.
Product Design Monitoring allows your customers to track a product’s operating characteristics and history and better understand how the product is used.  This has important implications to assist with:

·         Design of new products

·         Market segmentation (based on usage patterns)

Risk Reduction Risk is an important attribute that has a huge impact on cost, customer satisfaction, brand recognition and public perception. Many commercial IoT products enable real-time risk monitoring to measure things like driver safety, environmental safety, homes and commercial building safety, and preventive maintenance for products.
After sales service Based on monitoring data published by smart devices, you can ensure that you can dispatch the right technician, with the right parts, improving first time fix rate. With predictive analytics you have the ability to identify and resolve issues before they occur. Monitoring data can also reveal warranty compliance issues.
Follow up sales opportunities Product utilization data can be used to create additional sales opportunities.

For example: a check scanner product that needs to be cleaned after every 10,000 documents can inform sales team that a cleaning kit needs to be purchased. For example: a photo printer uses paper and ink as consumables, the printer can automatically subscribe to paper and ink subscription so that they never run out of consumables. (see HP ink subscription)

Audit Logging The machine data can provide an accurate and consistent record of the operating conditions of equipment eliminating the need to manually record data.

For example: Food safety regulations require that fridges and freezers are maintained at a set temperature and the temperature is recorded.  Across a large retail chain, training staff to record the temperature every hour introduces training and compliance costs. A more effective way is to have a connected-thermometer that automatically records fridge temperature.

Control Smart, connected products can be programmed with algorithms to automatically take actions, eliminating the need for supervision activities.

Note: All these values may not exist in the first version of your project.

Pricing models

This section describes some of the pricing models you should be thinking about for your new product concept.  There are many nuance implications on pricing and how its positioned.  Ultimately, customers need to clearly understand what they are paying for; this means there is a strong relationship between the value creation models above and the corresponding models described below.

One-time purchase IoT products can be sold as traditional product with  one time price.  For example, the Google Nest Thermostat is sold with a one-time upfront price with no recurring fees.
Upfront + recurring price IoT products can be sold with an upfront price (covers initial hardware costs) and recurring fees (covers ongoing infrastructure costs).  This is similar to a new cell phone plan.  For example, the Google Nest Cam has an upfront price for the camera, but has an on-going recurring fee to save data.
Subscription (recurring) IoT products can be sold with no upfront fees at all, and only rely on recurring revenue.  This approach is well suited for scenarios where the upfront hardware costs are relatively low and the buyer behavior prefers operational expenses over capital expenses.  For example, a warehouse RFID tracking system may charge per node per month with no initial upfront costs.
Consumables only IoT products can be sold based on the cost of consumables only.  This is similar to the razor-blade model where the upfront hardware is free, but every use has a cost.  For example, a medical laser for skin rejuvenation costs about $50,000 to $80,000 per year – a significant cost that deterred labs from purchasing many machines, and attracted copy-cat clones.  They created a version that had no upfront fees, but charged $25 laser cap required for each customer use for the life of the machine.  A clinic with 10 appointments a day, 5 days a week would generate about $65,000 annually.
Usage based pricing Usage based pricing is based on the runtime of the service.  For example: Rolls Royce airplane engines now charge per hour of use rather than an upfront capital purchase.  They also provide a service and maintenance plan; so that airlines simply have to pay for using the equipment and not for the maintenance or upkeep of the equipment.
Multiple product price points based on one hardware platform IoT products can have gold/silver/bronze versions of a product completely controlled with its software.  This streamlines product development, manufacturing and support work because they are supporting one set of hardware.  For example: John Deere manufacturers a single tractor engine, and offers three versions by differentiating key features like pulling power, horse power, top speed, torque. Each version is remotely upgraded via a software update.
With over the air updates, businesses can continuously improve their products, add new features and, introduce subscription models and charge for remote support and repair.
Connected Support Program Many heavy industrial products have a service and support contract that may require onsite service, diagnostics and repair.  These tend to be expensive contracts.

With remote management offered by IoT, it enables the maintenance model to move from corrective model to preventative maintenance to predictive maintenance to prescriptive maintenance.

For example, the price of an elevator and repair services doesn’t change; however, the elevator can be sold with an additional remote support program.  The remote support typically operates at a higher profit margin because most of the work is done using computer automation rather than manpower.

Field Service Program For long-lived products, the after-sale service represents a significant revenue. With IoT in Field service, the manufacturers can reduce the number of field technicians and truck rolls.

Many field service programs are based on responding to customers reporting issues into a help desk.  A connected product can significantly reduce the costs of field service based to identify problems before customers complain, fix issues remotely, diagnose issues and improve first time fix rates.  Many companies have found the ROI so significant, that they implement a connected remote support program at no charge because the internal benefits to support operations are huge.

Alerts and auto healing capabilities along with over the air updates, reduces overall warranty and service costs. It is a significant fundamental shift from reactive maintenance, to proactive service and support that can be sold as a separate product on an ongoing basis.

If you are creating a new IoT connected product, then several of these revenue models may apply to you.  The revenue structure may also be adapted by customer segment, enterprise accounts, small-medium accounts, consumers, resellers etc.

For a more in-depth discussion on how to create a revenue structure for your product concept, you can request a free consultation