Part 2 of 3: Constructing the Optimal Industrial IoT Proof of Concept Pricing

John Tough, Partner
February 26, 2018

Our goal with this series is to help the sales and business development teams of software companies structure proof of concepts that lead to higher likelihoods of success with industrial and energy companies. In second installment of our 3-part series we will cover the optimal proof of concept budget. You can find the first part (Aligning for PoC Success) on our Medium page.

Why Is the Proof of Concept so Important?
Heavy asset firms are notorious for moving at glacial speeds to sign new contracts. And, with large capital expenditures, these firms make decisions that have 20 to 50 year consequences. While it may be frustrating for sales, this methodical pace is a feature in the process, not a bug. A more deliberate proof of concept process eliminates vaporware and rewards companies with true differentiation, patience and understanding of the underlying problem.

Designing a proof of concept with terms that are in-line with market comparables and alignment with the specific internal metrics of heavy asset firms can materially accelerate a PoC relationship and create a higher likelihood for long-term success. That success, compounded with digital innovation tailwinds will create a business that advances innovation and is accordingly economically rewarded.

Use Market Data to Right-Size your Proof of Concept Budget. Between integration costs, longer timelines and complicated internal systems, the first customer project will take longer and cost more money than expected. Allured by a big logo (or promises for more strategic engagement), many software companies make the mistake of materially under-pricing PoC work. While early forms of project engagement can be treated as a form of customer acquisition cost, your software company needs to charge at or near full time rates for a proof of concept.

Why do we insist on establishing a higher revenue threshold?

It’s all about the asset-heavy business model! Big asset firms like utilities, manufacturers, and commercial real estate generally seek a “return on assets”, meaning they tend to make more money when more assets are deployed. Depending on the industry and risk associated, the company expects an approximate 3% to 8% annual return on assets. While those are not huge percentage returns, the absolute dollar free cash flow can be material when the asset base scales into the tens of billions. Your pricing should capture your software’s upside impact throughout the large asset base.

To demonstrate the leverage of software in the heavy-asset industry, consider the example of a large energy utility that has over $120BN of assets and generates almost $3BN in net income annually. While this $3BN is only a 2.5% return on assets, what the large asset base implies is that if your software can increase the productivity of the assets by even 1% (to 2.525%), then your software has delivered $30M in incremental profit. Software companies can build meaningful businesses driving even small impacts across asset-heavy industries. But, what is the right amount to charge? We dug through tens of established contracts in our network to get to a consensus recommendation, and have highlighted those examples below:

Software companies targeting the energy and industrial verticals need to structure their PoC in an analogous manner to existing in-market contracts as the PoC price and structure will anchor the discussion for the subsequent contracts. With that, there are three key trends to highlight:

  1. Big energy and industrial companies expect an upfront, implementation fee. General Managers expect bespoke configuration and that those costs need to be passed through. However, in a proof of concept pushing these upfront costs to a success-based or benchmark-based fee to help win the trial may be needed.
  2. Software products that provide a solution for the underlying asset base can achieve a “take rate” associated with the AUM. These percentages tend to lower as a percentage as the larger the corporate account scales its total AUM on the platform. As a reference, we have generally seen annual recurring revenue equate to ~0.01% of the targeted asset base. This equates to around $100,000 for a $1 billion asset, that is expected to generate around $50 million a year in profit. (It is worth noting that each asset will have many contracts. We will discuss the average number of contracts per asset in another post).
  3. Contracts that rely on savings can vary wildly in how the economics are shared. The lack of market clearing prices here generally points to the difficulty in identifying value, projecting savings, and who should capture the savings. Uncertainty kills sales deals, so it is best to try to tie the project to the asset base versus ambiguous savings projections.

As we mentioned in Part 1, the goal of your IoT Proof of Concept should be to demonstrate that your product works and that it will be valuable to your consumer, in a technical sense and in a business sense. To ensure that your relationship with the customer is set up to succeed — from the PoC to full deployment — value and pricing must be aligned to profitably fuel your business. Remember that your customers’ purchasing decisions are not based on the price they will pay but rather on the value they expect to gain in exchange. Focus on delivering a real solution to a big problem, and make sure you are fairly capturing some of the value created.