Part 1- Review of Hardware and Hardware+Software pricing options

Introduction

Business models in hardware have undergone a significant transformation over the last couple of decades. We’ve moved from a simpler world where hardware was primarily sold outright—akin to purchasing a music CD—to a realm where hardware and software are increasingly integrated and calling for integrated offers and pricing models (in our example, a CD purchase becomes a Spotify subscription). 

Concurrently, innovative revenue and pricing models for software have inspired the hardware sector. While some adaptations have introduced new and potentially better monetization schemes, others have tested the limits of their applicability, sometimes stretching them too far. In some other cases, common misconceptions and easy truths, such as “we’re sitting on a goldmine of data ” have made companies over-optimistic when it comes to the value they can generate out of data, and blind to the selection of the most appropriate pricing model for their products.

This Deep Dive is divided into 3 parts, where we will explore the landscape, outlining the various options available for selling hardware or combining hardware and software products. We provide real-life examples of several hardware and hardware/software/data pricing models. 

• Part 1 – Review of Hardware and Hardware+Software pricing options
• Part 2 – Risks and Customer value in Hardware+Software pricing models
• Part 3 – Opportunities and Complexities of Hardware+Software pricing models in the Energy industry.

We’ll also analyze some common pitfalls, offering insights into practical alternatives. Among these considerations is the ‘data monetization myth’—the overly optimistic belief that simply collecting data will unlock new revenue streams. This perspective often overlooks the complexities of data quality, privacy concerns, and the lack of real use cases for this data and the actual market value of the data collected.

Moreover, the rush towards models such as ‘rental’ and ‘Hardware-as-a-Service’ at all costs warrants a closer examination. While these models offer new revenue opportunities, they also come with their own set of challenges, including the alienation of customers with a preference for ownership. 

The Importance of a Solid Pricing Model for Hardware

Selling hardware inherently involves grappling with a Bill of Materials (BOM) and with the tangible cost of goods sold (COGS). For hardware products, these costs establish a “hard base” that cannot be overlooked by product managers, entrepreneurs, or pricing specialists.

But this is not enough; while a strong understanding of costs is essential, a focus on costs presents a significant risk of mispricing or underpricing, as we’ll explore in subsequent chapters. 

While this reliance on costs is often a trap for pricing novices, it also represents an opportunity for many products to significantly enhance gross margins through strategic pricing decisions. 

Indeed, pricing is your single most impactful lever to better margins. Consider an illustrative example: a product currently sells for $1,000 with a 20% gross margin ($200). By increasing its selling price to $1,200—a 20% hike—the gross margin doubles to $400. In other words, a 20% price increase can translate into a 100% increase in margin, highlighting the profound effect that adept pricing can have on a business or product’s profitability, especially when there’s a substantial marginal cost base, as is typical with hardware products.

A well-thought-out strategy, a clear pricing model, and a deep understanding of market dynamics are your best ally to unlocking a profitable business in the hardware domain. 

This aspect of pricing strategy not only influences profitability but can also significantly impact how a product is perceived by consumers, potentially setting it apart from competitors. In other words, pricing itself can serve as a key differentiator in the market. 

In the next sections, we will analyze different pricing models for hardware and hardware/software products. We’ll look into the different options with the eyes of the company, as well as with the eyes of potential customers.

Pure Hardware Business and Pricing Models

Even if your product is  ‘just a piece of hardware,’ the landscape of sales and monetization strategies is rich and varied, with opportunities to create value and secure sustainable revenue. From the simplicity of direct sales to the more complex, yet increasingly popular, recurring revenue streams of subscription models, each pricing model presents unique opportunities for profitability and customer engagement. 

Beyond mere transactions, these models reflect a strategic choice about how a company positions itself in the market, interacts with its customers, and ultimately, how it defines its value proposition. Whether opting for the upfront revenue of traditional sales or the long-term engagement of Hardware-as-a-Service (HaaS), understanding these models is crucial for tapping into the full economic potential of hardware products.

Pure Hardware Sales

The most straightforward model involves selling hardware as standalone products. Manufacturers of items like computers, bicycles, or vacuum cleaners sell these goods directly, transferring ownership to the customer upon purchase. This model is predicated on achieving high-volume sales and distinguishing products in the market, a necessity given the risks of commoditization and competitive pricing pressures. While companies ideally seek recurring customer purchases for a steady revenue flow, the frequency of repeat business varies by product type. For instance, disposable batteries may lead to regular purchases, whereas cars might not. Maintenance or support, when required, is often provided by third parties specializing in these services.

Although it shouldn’t necessarily be the case, pure hardware sales are often prone to cost-plus or competitive-driven pricing. While selling hardware alone still makes sense for various goods and products, it’s important to be aware of this risk. Adding software services and transitioning to a different pricing model, as explored in the following sections, may serve as a viable strategy to circumvent the pitfalls of cost-plus or competitive-driven pricing.

Example: Dyson’s premium vacuum cleaners exemplify the traditional model of selling hardware outright. High-quality design and technology differentiate their products in a competitive market, which is a must-do when the pricing model is not a differentiator per se and the market is crowded.

Hardware Sales with Additional Service Components

This model enhances value and revenue by incorporating maintenance services, extended warranties, and support contracts. It’s designed not just to maintain product functionality over time but also to build stronger customer relationships through continued support. Maintenance and support can become significant, or even primary, revenue streams, especially for corporate or industrial solutions that require ongoing services to function optimally. As such, these additional services can be in part included in the selling price, or just charged on top. 

Example: AppleCare extends the value of Apple hardware through maintenance services and extended warranties, illustrating how additional services can enhance customer relationships and provide a steady revenue stream beyond the initial hardware sale.

Rental

Here, ownership remains with the manufacturer or a third party, while the customer pays a recurring fee for the use of the hardware. This model suits customers with temporary needs or those wishing to test a product before making a full purchase. It’s particularly fitting for products whose value doesn’t diminish rapidly with age or use. Part of the added value to the customer is the ability to access equipment that undergoes regular maintenance and upgrades and pay only for the usage time needed. In this sense, customers are always in a “high value” part of their usage curve, and their willingness to pay is higher. However, this model is also “cash-heavy” on the manufacturer side, which has to allow for enough cash flow and cost of capital in their calculations. An interesting spin on the value proposition beyond the rental model is potentially with the environmental benefits coming out of a mutualized usage of hardware resources. In other words, the value delivered by such a solution can go beyond purely financial, and enable you to add “sustainability” to the list of your features.

Examples: Though not a tech example, Rent the Runway’s model of renting high-end fashion items illustrates the appeal of rentals for products where the value doesn’t diminish rapidly, aligning with the notion of providing customers access to premium experiences without the full cost of ownership.

Leasing

Leasing is akin to rental but intended for longer periods or when product wear and aging are significant concerns. Depreciation is hence more apparently and directly modeled in leasing than in rental contracts. Similarly to rental, leasing allows customers to use the equipment for predetermined periods without acquiring ownership. The lessee makes an optional downpayment and regular payments that reflect the equipment’s depreciation and the cost of use over the lease term, rather than borrowing capital. Many leases include an option to purchase the equipment at the end of the lease for its residual value, the estimated market value of the asset after the lease. This model is particularly suitable for businesses that require up-to-date equipment but want to avoid the full expense and maintenance responsibilities of ownership. It offers the flexibility to return the equipment, extend the lease, or buy the equipment at a fraction of its original cost. The Financed Amount is the difference between the initial cost of the asset and its residual value at the end of the lease term. This represents the amount of the asset’s value that will be used over the lease term; the Financial Amount is spread over the lease term and interests are added to it to calculate the lease payments.

Example: beyond the obvious example of car leasing, Dell Technologies IT Equipment Leasing: Dell offers flexible leasing options for its range of IT equipment, including servers, storage, and networking hardware, through Dell Financial Services. This allows businesses to keep their IT infrastructure modern and scalable without the upfront costs, and they can upgrade to newer technology at the end of the lease term.

Hardware-as-a-Service (HaaS)

Aligning with the shift from capital expenditures (CAPEX) to operational expenditures (OPEX), HaaS goes the “extra mile” compared to rental and leasing and offers hardware on a subscription basis. This model typically includes maintenance, support, and sometimes upgrades, providing customers with the latest technology without the responsibilities of ownership. HaaS can be viewed as a bundled rental of both the hardware and necessary services, offering a comprehensive solution for a regular fee. The model has gained popularity across various sectors, notably in IT infrastructure (servers, networking equipment), wherein the first decade of the century companies such as Amazon with AWS have started to offer the ability to “rent” full servers without the burden of managing the hardware, including its maintenance and lifecycle management. The model has since expanded, with companies like HP, Dell, and Lenovo introducing HaaS offerings, enabling businesses to equip their workforce with the latest hardware and support services for a predictable monthly fee. Besides the evident advantages in terms of complexity, HaaS goes a long way in facilitating true “value-based pricing”, as the provider must continuously deliver value to justify the ongoing subscription cost.

Examples: Amazon AWS, HP Ink Cartridges Subscription “Instant Ink”

Razor-and-Blades (Consumables model)

Famously utilized by printer and shaving companies, this approach sells the initial hardware at a low margin, banking on subsequent high-margin sales of consumables or accessories. The strategy depends on the initial sale to secure a continuous revenue stream from these additional purchases. Enforcement of these models requires a deep reflection, with the consequences of circumvention being taken into account. Patents (see Nespresso) or technical measures (eg. Lexmark) with legal instruments (DMCA and its equivalents) are ways to enforce the model, not without their limitations. 

Examples: Keurig’s coffee makers are sold at a low margin, with high-margin K-Cups driving ongoing revenue. The same was true (a bit less now) with Nespresso machines and their capsules, even though the model there is a bit different (almost a “reverse platform” model) and the expiration of Nespresso patents has changed the landscape. Finally, printers and ink cartridges also represent a classic example of the Razor-and-Blades model, with Lexmark being the champion of this model for years. 

Hardware+Software Products Pricing Models

The landscape of hardware products is increasingly characterized by the fusion of software. This integration is evident across a wide range of products, from the software that powers the sophisticated systems in modern vehicles to the applications controlling your smart coffee machine. Such convergence not only enhances product functionality and user experience but also introduces novel avenues for value creation and diversification of pricing models.

Integrating software with hardware significantly transforms the value proposition of physical products, aligning them more closely with the end-user’s needs and enabling these combined solutions to capture a greater portion of the value they generate. This fundamental shift requires a thorough reevaluation of pricing and sales strategies. Traditional models based on outright sales or leasing are increasingly being supplemented or even replaced by more dynamic approaches that better reflect the continuous value delivered through software enhancements and updates.

As products evolve to integrate both hardware and software, the basis for pricing also shifts. It moves away from traditional metrics based on the hardware components (e.g., a coffee machine) towards units of value that more accurately reflect the benefits to the user (e.g., the number of cups of coffee served). This shift in pricing units represents a more profound understanding of value from the customer’s perspective, focusing on the outcomes or experiences the product enables rather than the product itself.

Hardware Sales with Bundled Software: 

This model represents a harmonious integration of software with hardware, where the software is included in the purchase price as a value-added feature. It not only enhances the product’s functionality but also elevates its market appeal and differentiation. 

Example: A prime example of this is the iOS operating system that comes bundled with the purchase of an iPhone. As a customer, you don’t pay extra for the operating system, which, in turn, increases the value of the hardware (the phone) by enhancing and sublimating its functionality. Similarly, modern connected appliances, like a washing machine that ships with mobile apps, leverage this model to offer enhanced user experiences. While this model is extremely powerful in enabling differentiation of (commoditized hardware) thanks to software, specific risks of viability shall be considered, as we will see in the next chapter.

Hardware Sales with Additional Software-enabled Hardware features: 

In this model, hardware is sold at a nominal price and includes the technical availability for a vast range of options and features. At the same time, some of these options are only unlocked upon a specific payment from the user. This model allows the company to benefit from economies of scale (delivering the same hardware product to all the customers) while maximizing the value captured as a function of the individual willingness to pay (extreme segmentation).

Example: A notable example is the automotive industry, where manufacturers like BMW have explored charging separately for hardware features “activated by software”, even after the car’s sale. While this can open new revenue streams, it risks customer pushback against perceived nickel-and-diming for features traditionally included in the base price. While a full analysis of the perception of fairness is beyond the scope of this article, we urge anybody looking into this model to take it in the right consideration.

Hardware Sale with Independent Software License: 

In contrast to bundled software, this model involves selling hardware with the option for customers to purchase a separate software license. This is the traditional model where the hardware itself is usable and priced in a way that makes the hardware sale sustainable to the business on its own. Depending on the product, additional value is delivered to the customer through (paid) software updates or add-ons. Back to the example of cars, this is the case often with GPS Maps and updates, which are sold on top of the car hardware purchase, as a paid option. 

Example: BMW charges separately for navigation system updates; while the hardware (car and its electronics, sold upfront) is sustainable on its own, additional value is delivered through paid software enhancements, showcasing the potential and challenges of additional software-enabled hardware features.

Subscription Models (aka Embedded Hardware in a Software Service)

Here, the focus is on delivering a service where the hardware is part of the subscription. For example, security systems that include both physical cameras and sensors, along with the software service for monitoring and alerts, fall into this category. Another example many of us are familiar with is a “free router” bundled with our internet subscription. This model emphasizes ongoing value and convenience, ensuring customers always have access to the latest technology and support. A large advantage of this model is the shift of focus to the service (and value) provided, with the hardware representing a “necessary evil” to reach the customer’s end goal. At the same time, some complexity is shifted to the supplier, who has to anticipate hardware replacements in their business plan.

Example: Simplisafe and Verisure offer security systems where the hardware is part of the subscription, aligning with models where the focus shifts to the value provided by the service, with the hardware enabling the end goal of home security.

Platform Ecosystem: 

In both the subscription and the independent software models, the manufacturer delivers and monetizes services built atop their hardware. However, in a platform ecosystem monetization model, developing a hardware-software platform facilitates the creation of an ecosystem where third-party developers can build and offer applications or services. This model capitalizes on network effects to boost the platform’s value, and the platform itself turns into a revenue source through app sales, subscription services, and advertising. The manufacturer and/or platform provider typically monetizes their contributions through a commission on the sales of additional services offered on the platform, utilizing its hardware.

Examples: Apple’s iOS and Google’s Android ecosystems. They both take a cut on the sales performed on their hardware/Operating system.

Outcome-based pricing: 

This model represents an evolution from traditional subscription models, with pricing contingent upon, or at least dependent on, achieving an agreed-upon result. The hardware (and the service) required to reach the objective are simply means to an end. 

Recently, outcome-based pricing has become prevalent in the electricity production industry. Grid operators have taken on the burden and costs of installing photovoltaic equipment on the roofs of private buildings. In return, they share a portion of the energy production with the building owners in the form of reduced rates for power supply.

This model ensures direct alignment between customer and company goals, embodying an ideal setup for implementing true value-based pricing. However, the complete abstraction from the hardware and, generally, the costs incurred by the supplier requires thorough reflection regarding the business model’s viability and cash flow. Furthermore, although attractive in theory, a potential drawback of this approach for some products might be customer reluctance to “share a part of the pie” and the intangibility of the service offered.

Examples: Sunrun’s (US) and Younergy (Europe) offer Solar Contracting, a model of installing solar panels at no upfront cost, then charging for the power generated, directly linking costs to the results delivered (energy savings). A more complex example in the realm of Energy Contracting is Energy Performance Contracting (EPC), where the financial structure is directly linked to the energy savings achieved through the implemented measures. In this model, an energy service company (ESCO) evaluates, designs, and implements energy conservation projects, and the client pays based on the actual energy savings realized, often over a predefined period. This setup inherently aligns the interests of the ESCO and the client, as both parties benefit directly from the efficiency gains. The main challenges in Outcome-based pricing, is are two:

• Evaluating correctly (and upfront) the outcome that can be expected
• Managing the perception of “fairness”

Data Monetization

As hardware and software become increasingly capable of collecting and processing data, companies have the opportunity to monetize this information through analytics, insights, and direct data services. For example, data collected from mobile phone usage can be monetized directly by offering services to the user, such as navigation systems, and indirectly through means like providing location-based advertising. This strategy demands careful navigation of data privacy laws and the implementation of robust data management systems to ensure both ethical and legal compliance.

Example: Fitbit Fitbit’s use of data collected from their devices to offer personalized fitness insights and health tracking services to users (direct monetization). It also partners with health services for indirect monetization avenues (platform model) and with insurance for indirect monetization.

In the next Parts of this Deep Dive

In the next part of this Deep Dive, we will analyze the specific risks inherent to Hardware and Software pricing models, how to balance Customer Value vs Business Viability and we will propose a simple checklist for your hardware and software products pricing model.

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