Constellation Software and Transdigm have many similarities from the outside looking in: decentralised org structure, fragmented end markets, a core M&A roll up strategy, great capital allocators at the helm, etc. After spending some time researching both companies, one key strategy that both follow religiously is value-based pricing.
Value-based pricing is as it sounds: price products based on the value you provide, not the cost of the product. The first insight from our interview with a Former Managing Director at TSS was how VMS founders perpetually underprice their products:
A lot of software companies, in their contract, in small print, say okay, we can change the price at the indexation rate. Indexation is maybe 1% or 2%. But they are building newer software, with more added value and that added value is actually worth money to the customer. If you do not charge them for that added value, for the new functionality into the ERP system, then you are actually giving them a present. I truly believe that most of the VMS companies are underpriced.
If a VMS company is adding new features annually that adds value to customers, the subscription price shouldn’t be increasing at inflation-like 2-3% per year. If it's truly adding value to customers, the price should be increasing 10%+ per year. The low marginal cost of adding new software features can psychologically make it difficult to increase the price relative to the value being added. This is one reason why the likes of Constellation and Topicus see such growth in EBITDA post-acquisition.
The same happens in the aftermarket for aerospace parts. This is a quote from our interview with a Transdigm VP last year: