Sustainable Supply Chain

Setting The Right Pricing Strategy - A Chat With Chris Mele

June 24, 2022 Tom Raftery / Chris Mele Season 1 Episode 236
Sustainable Supply Chain
Setting The Right Pricing Strategy - A Chat With Chris Mele
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Show Notes Transcript

Setting the correct price on your products sounds like it should be easy, right?

Well, it is not that straightforward at all as I discovered in this episode of the Digital Supply Chain podcast where I talked to Chris Mele, Managing Partner at Software Pricing Partners.

We had a great conversation spanning how to create your pricing strategy, how the shift to SaaS is impacting pricing strategies, and the roles that things like licensing, packaging, and support also play. 

I learned loads, I hope you do too...

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Thanks for listening.

Chris Mele:

before you embark on any of this, reflecting a bit on your philosophy of pricing is probably one of the most crucial alignment decisions that a software company can make and I'm talking about the idea of how you want to treat your customers when it comes to that landed price point

Tom Raftery:

Good morning, good afternoon, or good evening, wherever you are in the world. This is the digital supply chain podcast. The number one podcast, focusing on the digitization of supply chain. And I'm your host global vice-president at SAP Tom Raftery. Hi, everyone. Welcome to the digital supply chain podcast. My name is Tom Raftery with SAP and with me on the show today, I have my special guest, Chris. Chris, welcome to the podcast. Would you like to introduce yourself?

Chris Mele:

It's Chris Mele with, Software Pricing Partners. And I'm the managing partner and funny side note, I was one of the first certified SAP, R2 consultants when I was at Ernst and Young, when I got outta college.

Tom Raftery:

R2 you're giving away your age there. Chris that's not today or yesterday. So, Software Pricing Partners, what's that?

Chris Mele:

It's a, tech enabled consultancy. Let's put it that way. So we have some pretty sophisticated software for modeling different outcomes of pricing recommendations, and then the strategy and mechanics Everything from launching a new product and how you would price, package and license that which we'll get into today and all of the things you need to, uh, over a pretty rapid 10 to 12 week cycle, kind of get out into the marketplace and start transacting.

Tom Raftery:

So, the need for this, Chris? I mean, isn't pricing very straightforward. If I'm producing a software product, don't I just have a scan around the competitive horizon and see what anyone else in that space is charging. And then just go 1 cent lower than them?

Chris Mele:

That is what, people do. And we are very wired around the competitive set. And so I, I used to own a software company for about 13 years. And it's what I did too. It's the way that we're all onboarded in the software industry. And if you look at how pricing and packaging and the strategies emerge, the first one into the market is a founder, Tom, you and I could be co-founders and we're gonna sit in a room and we're gonna make it up. And if we are successful enough, the next competitor is gonna say, well, Tom and Chris must be doing something right. And so they're gonna copy what we do. And if you fast forward five years, everybody's doing it. And nobody really knows why. And it turns out that, the way in which product is developed, most software companies don't think about the complexities of pricing, which we'll get into until kind of after the product is built. It it's really not what it's supposed to be, which is an element of the design of the product and a way to order and prioritize the roadmap based on its monetization potential. But in fact, we just build product and we're concentrating on a great customer experience. And nine times outta 10, near the end of the year, the call comes into us that says, Hey, I, you know, we're launching our product in two weeks. And we just realized we, we were kind of getting into some complex conversations on how we should price this. And we wanted to get some help. We thought we'd hire a consultant that could come in, uh, for a day workshop and answer all these questions for us. And it it's just too complicated. It doesn't really work that way. There's there, there are so many variables and things to consider.

Tom Raftery:

Such as, if I'm a little skeptical or confused, I mean, isn't it just projected sales, minus costs, minus profit margin.

Chris Mele:

Well, if we get high enough level, then it's just revenue. And that sounds really simple. So I, I might argue that your walkthrough is a little bit more complicated than that, but the question is let's get into the first element. Well, isn't it just a projection? Well, if it's, for example, I sell you a license and I don't care what you do and it's 50,000, that's a pretty easy problem to solve. But what if it's more of a consumption strategy that says you know, I I'm gonna charge you based on the ins and outs of flows of appointments into your healthcare facility. Well, that's a very different kind of forecast that carries with it movement of the quantity that you're selling to that customer, maybe on a monthly, quarterly or yearly basis. And it carries with it all kinds of complexities on being able to understand your growth dynamics and what ultimately that forecast would even look like. And some of those problems are quite intractable because you don't know what a prospect's pattern of usage might necessarily be. And by intractable, I mean, you just can't solve that problem. And so forecasting in SaaS is very complicated, but if you wanna keep your strategy really simple, then I would tell you. Sell a license for a flat fee. It's the easiest thing that you can sell charge 50 grand for it. Your forecasting will be super easy. Your valuation will be garbage and you'll never see an upgrade or an upsell because you've already given them everything.

Tom Raftery:

Okay. so, talk to me a little bit more about the consumption based model. It would seem to me that in a SaaS environment, it's the consumption based models that would make most sense because you want to be charging people based on what resources of yours they're using, whether you're charging per transaction or per compute cycle or per storage or a combination. Isn't that the best strategy for a SaaS company to charge on a consumption basis?

Chris Mele:

Not necessarily. So, so the question first is what is consumption, and consumption is more of a gradient. You know, in the earlier example, the unit was always one, right, pay me 50 grand, and you can do whatever you want. The quantity in the contract is one. In the other example, you can get really excited and say, you know, everybo every time, somebody does something in the software. I'm gonna charge for it. And then, you know, you'll get really excited about a really complicated forecast that maybe you'll, figure out and you'll end up with this enormous amount of profit and a, and a martini maybe down in the Caribbean somewhere. The problem though, is that when somebody goes and tries to sell that. The buyer might say, well, that sounds great, Tom, but I don't know how many transactions or how many CPU cycles or how much compute I'm gonna use. And by the way, I'm a fortune, 100 company and a global operation. Like how on earth am I gonna know that number? And if I don't know that number as a buyer, I'm gonna perceive a lot of financial risk and that comes in the term of a misestimate and I'm not gonna buy. And the first thing, if even I can get over that hurdle. And sort of emotionally grasp the amorphousness of it all. I'm just gonna reduce this down to a pilot and depending on how you choose to charge for your software, you know, don't be surprised if the users change their behavior. You know, if I'm gonna charge you every time that there's a workflow on your visual design of your workflow engine, don't be surprised if I stuff everything under one workflow as a user, cuz I don't want to pay and I know how the monetization strategy works, but don't worry, I'm gonna call the support lines and I'm gonna complain that your software is really crappy because I can't debug and figure out what's wrong with my 7,000 step one workflow when really the best practice was to lay that out across a hundred workflows, but you've decided that this consumption strategy is so exciting. And maybe you got the cart before the horse, and now a year later, you realize everybody's using your software very differently and we have this sort of backwash that comes into customer success and support with those kinds of oddball scenarios that I'm talking about. And this is what I mean about complexity. You know, as you work through each one of these topics, it's a little bit of a ball of yarn that you start to pull on and it starts to unravel and it has large ripple impacts and through customer success and through finance and revenue recognition and through sales and through marketing and through sales ops, I mean, it's just... the monetization strategy, the packaging strategy, the licensing strategy, the pricing strategy, how you put all this together, sits at the hub and the heart of this product and its user experience. And if you think about what we just talked about, then the natural evolution and conclusion that you would make, which is a correct one is that monetization is really more of a product design element. It's not really appropriate to build the product and then decide how to do all of this because it will fundamentally change the product based on some of the decisions that you make preferably earlier on rather than later, uh, right before launch.

Tom Raftery:

So, pricing itself is even more complicated because, to your point about monetization it's, not just the upfront sticker price, but it's also, you're charging very often licensing you're charging, support, other things like that as well. So how do you go about if you are a software company, what's, the strategy apart from starting early, what's the strategy around pricing?

Chris Mele:

Well, the first question that you really wanna understand is, how dynamic do you want the model to be, and what is gonna be in that quantity field? And this doesn't necessarily have to come very first, but it, it is a very fundamental decision to make. So, so what I mean by that is that let's say that you, have a relatively, new and inexperienced sales team selling on a consumption strategy and the complications that come with getting buyers comfortable with these misestimates and other things is, is a, is a much more advanced sales dialogue. And, and maybe better match to a more seasoned, sales team. And so if you had that kind of a configuration, you might decide, you know what, I don't really wanna be into these, numbers that vary so much. And so let's take an example and take it a step further. Like, let's say that you were restaurant software and you just charged by locations. And that worked for a while. And you're like, well, you know what, gee whiz, this is really slow growth. I mean, I have to wait for this business owner who's not really super sophisticated to build another location. They have to go get a bank loan. And this is like a capital expenditure and this is like a year build out. So now I'm two years before I see any accretion in my revenues with this customer. And so that's just super slow growth, but in a way, probably easier to sell. You might say. Ooh. What if we charged based on, you know, the number of, uh, consumers that came in and, you know, made reservations and ate in our restaurant. And that way, if you think about it, we're thinking about locations very differently, right? Some restaurants have big, big locations. Some restaurants have, uh, smaller locations, but now we have that problem. We talked about earlier with getting the buyer comfortable that if I have a busy year, I might pay a little bit more. And this is the trap of consumption or of really the range of quantities being too large, which is why I don't really like the term consumption, cuz it's just too amorphous when the ranges of quantities are really large. Like, so for example, with locations, maybe restaurants have between one and four, but maybe for, buyers and diners, you know, the numbers anywhere from one to 10,000. Well, that, that range means that you're gonna get really excited on that forecast martini and the Caribbean, but like, look at what happened in COVID. If you were that company that made that change and got really excited about that quote consumption strategy, you're probably not in business anymore. And so how close you want to get to the wire and how by the wire I mean, how, how much variation do you wanna withstand is always a double edged sword. And it's always been interesting to me, Tom, that nobody really talks about this part. You know, there's another example of, uh, software. Handles kids camps. And you can go category by category, by category of what really got hurt during COVID and, mitigating risk is a big strategic decision. It's a huge decision and deciding how you want to gear the model for what it ultimately is that you're gonna make your stake in the ground is in part your tolerance for risk because there's good years and there's bad years. And you don't know about the, you know, you've got a Ukraine war, we've got inflation, we've got COVID, we've got, you know, climate. I mean, there's a lot of variables out there that can throw curve balls. And so part of the decision is as a business owner and there's a lot of processing that we do on our projects to understand that what you pick, be aware of the, of the other side of the sword. Right. And be okay with that. And there's a lot of ways to mitigate that, but that, that decision is not one that you would, you know, at SAP, blow down into a, maybe a pricing manager. I mean, this is an executive level decision, right. Because we're talking about business risk

Tom Raftery:

Mm. Yeah.

Chris Mele:

and that, that again makes it a little bit more complicated, right? Because imagine a big organization like SAP and how, how would you get the right people in the room to understand that as well as the other dimensions, across making a decision on how you even want to gear the model. Otherwise we're just trapped in mechanics and forecasts and other things and getting excited about we might be missing the big picture. So it starts with elements like that, that those are maybe more strategic elements. And then we get into more mechanical elements. Around packaging, which is strategic and tactical. And then of course pricing. And the funny thing about pricing is it's really a support function. The big decisions are in licensing and packaging. Now pricing is crucial. Pricing is a heavy modeling, and mathematical exercise. And if you don't do your homework, right, you can get really hurt, but its job is to attach a price to the offer inside the package and its job is to scale the offer by the unit of measure the quantity field, the, the number of diners or the number of locations in the earlier example. And it plays a very important, crucial role, but often it dominates the discussion because by the way, it tends to present itself as well, I closed a deal and we didn't, we're not making the money that we want. And so your first road in is I think we have a pricing problem, but it may not be that at all. So now you can kind of get a sense for how we have organized around the problem because of the way the symptom has presented itself.

Tom Raftery:

And I mean, you talked about licensing, packaging and pricing just for the uninitiated. Could you define what those are?

Chris Mele:

Absolutely. So licensing is ultimately what is in the quantity field of the contract. It is what you're gonna count. It is the thing that you multiply by the list price to come up with a total deal. So if, for example, you've ever been in a transaction, that's very large. And you've multiplied the quantity times the list price. And you ended up with a number like 17 million, and you're walking into the RFP discussion and telling yourself, well, I'm just gonna right side this down to 2 million. So I don't get laughed out of the building. You probably have a licensing problem, right? Likewise, if the quantity is always one and it's an all you can eat, you're probably not getting paid fairly and you probably have a licensing problem. So licensing is basically mechanically the quantity field in the contract for the array of products

Tom Raftery:

the number of seats that you're selling.

Chris Mele:

Sure it could be users. It could be anything. In fact, one of the beauties of intellectual property, and by the way, we are talking about monetizing intellectual property. So it just turns out that that can come in a lot of different forms. It, we, we wanna focus on the form that it takes in our software, but it can come in in a wonderful form called a service

Tom Raftery:

Yeah.

Chris Mele:

that's actually some really rich IP that sits in there, especially if you're designing workflows or behavior changes or business process reengineering or other aspects to more complicated software. So licensing in the case of that, would be unique by product or product line. You know, it's possible to have some products with different things that you count, but it is best practice to not have too many of those. Otherwise, if I buy three different products, I have to walk you through a sales dialogue. Say, Tom, well, Hey, it's number of seats on product number one, but I know, you know what product number two, that's based on CPU cycles. Oh, you wanted product number three. That has to be number of transactions. And now I spend all my time trying to explain to you how the pricing works instead of what the value is. And that's a bad spot to be in, on a sale

Tom Raftery:

Okay.

Chris Mele:

now that, that, so that's licensing. Right? So, so packaging, remember it's intellectual property. So. There's a gazillion things we could potentially do. And if you package to everybody, you package to nobody, that's called Al LA carte. And some of our customers software in the security space and other industries, healthcare are, are just so complicated it would be a mind blowing, impossible sales process if you made it Al LA carte. So you can just think of packaging as preconfiguring products and services capabilities in, in summary, into offers that resonate with a targeted group of customers. And this is where some of the nuances will start to expose themselves. This is not marketing stack, buying persona kind of stuff. This is groups of users that take down value similarly and, uh, early it's very possible that groups of users that take down value similarly don't align to, Betty in purchasing. I don't know why Betty's always in purchasing by the way. And Kevin's always in the warehouse. Right. But, but they, they that's, you know, some of those folks will never use the software if they happen to be, um, buying on behalf of other users. So your strategy wants to get something that makes rational, reasonable sense to the buyer, but it really needs to extract the value that's being delivered and returned back to the customer's organization. And, and that's what you're really monetizing. And so that structure of customers that use and derive and return value back similarly is what you're hunting for. And that actually turns out to be a pretty complicated problem with a very simple output. You know, most of our clients will have one or two maybe of those groups that underpin their packaging. And if you were to use a marketing stack like, Phenomenon you'd end up with really overly complicated packages and all these features that are hyper geared. You know, you can have two of these and six of these and 10 of those at the enterprise level. And if you do, and that's, uh, that's a really complicated sale as well. And so packaging really just is designed to keep things easy and it is designed to intersect with product management so that new capabilities on the roadmap can flow through that process. And you're always asking yourself, the question is this new capability, you know, really going to fundamentally change these groups? Or am I really talking about kind of the same type of group of customer and, customers are a lot more uniform and similar than you think when you look at it through monetization and value. And of course they're a lot more different than, than. And we would argue that they're incredibly different if we're using, buying personas and marketing things, cuz they like different content, different things, speak to them, Betty in purchasing and Kevin in the warehouse, you know, will consume different content, but that that's all stuff designed to get leads into the funnel and, attract, users, inbound, marketing, et cetera. But that's not, that's not monetization. So, so packaging is how do we keep this whole thing so simple that I can buy a lot of product and I have a couple of choices. And I'm not gonna be in a situation where I say, Tom, I'm happy to buy today. But the thing is, I'm not gonna use 25% of this offer you're giving me. And so let's just say it's a really large deal at a million dollars. Like I have it already approved Tom, 750 grand for the SAP stuff. Like I'll sign today. I just don't want to pay for what I'm not using. I'm not gonna use the advanced reporting module. I'm not gonna use the API layer. I'm not, I'm not. And you'd be amazed how many times that that deal hits the deal desk and gets approved. It may not even hit the deal desk. It might just get approved because you're not dealing with a buyer who is trying to game the system as much as they just want to pay fairly for what they used. And then it just so happens that accidentally a year later, they used the 25% that they said that they wouldn't use, but that's a different problem, right? Um, that may not also be malicious as much as it is just the gearing of the software, but you, you get the idea of packaging designed to solve the similar problems that customers are trying to achieve. And, finally then you get into pricing, which is all of the math and science of, well, what is a fair price? How, how do we develop a library of and, an understanding of what things are valued and how do we activate our perspective on that? You know, probably the biggest misunderstood piece to the whole puzzle is pricing is not a democratic process. Never has been, it requires good judgment. If you wanna run it as a democratic process and survey and all that, of course you can, but it turns out customers really, they don't really care if you make money. In fact, if I could buy SAP and know that you lost a little bit of money, but you would still answer the support lines and, and keep my investment sound. I'm okay with that. I'm totally okay with that. My procurement team is totally okay with that. Of course I'm being facetious, but, but they are actually okay with that. And so. You know, you, you have to have a position on your value and a defense of that value. And a lot of times people think that defending value is being tough on price and it's not defending value is having a good package and an offer so that I can't come back to you with that earlier example and say, but I'm, I'm only, I'm a partial use guy over here. I'm only gonna use 25% of it. So I'll close today at, you know, 75% of list.

Tom Raftery:

Cool. And we're shifting at the moment very much away from on-prem to, software as a service. So for companies that are in the software as a service space, what kind of advice would you give them for them to improve their monetization?

Chris Mele:

Well, we did touch on being very clear about their buying process and from their perspective, you know, how do they think about the value and what are they extracting? And when you use, we use terms like consumption and other, we don't use consumption. We don't like that term cuz it's too amorphous. But if you use terms like that, what you're really saying is that it is probably master of the obvious that the way in which people are getting value is probably from some aspect of use of the software. That's why we built it. And so charging somewhere in that sea of possibility of the use of the software is probably gonna align you much better with your value than something arbitrary. Like the number of locations that you have, or some of the other examples we used earlier. And so I think. The, the first advice I would give is trying to, understand how that value is being extracted and how it's being returned back to the organization. And it turns out that that return back is, uh, really crucial because customers wrap all sorts of workflows around your software. And the return back of that value can get quite creative. They'll close gaps in your software that, that maybe you don't do. And the more that you understand how the software is being used, and then that value is being created within your customer site and return back. That gives you a great amount of knowledge to understand how you might make those decisions on, on how to gear. The model in the form of, you know, licensing and then eventually packaging and pricing. And understanding how, they want to use more of that over time. And what that looks like is really important. And then understanding the, alternative set. And notice I didn't say competitive set, alternatives. Two of the most common are I'm gonna just kind of keep doing what I was doing. It sounds awesome, Tom, but gee whiz at that price, I think we're okay with turns out we don't quite have the problem that I thought we had. That's a huge competitor, sort of the, do nothing status quo or huge alternative. The other big alternative would be here in Charlotte. We call it the Lowe's Effect, Lowe's likes to build everything on their own. So if you do business with Lowe's, you just have to know there's a lot of organizations like Lowe's, it's not just Lowe's, but you know, they like to build things on their own. And so they're gonna think about your package and its overall total cost of ownership against the comparable of, well, what, what is it gonna cost me to build this on my own? And if you know that you can construct offers and price points with that in mind, and it's not always a name to competitor is my point. So understanding how they think about the category. How they evaluate the category is really important. In banking, for example, I remember we had a project where the buyer was a, a tech buyer and they're comparable. This was a security company. They were buying security software, their comparable, was, the purchase of Microsoft office for all of their, employees and, and that just was in the buyer's mind. You just had to know that. And by the way, that that is not the same as security software, right. One might argue that at least early on the, the, the office suite was devoid of security. Right. Uh, so they're just not fair comparables. And we could argue with them all day long, but they are comparables. And that's what I mean by understanding how people think about the category and those things by the way, are best uncovered in live dialogue. Or those, those things are really hard to uncover in some sort of formal Q and a, or a, a web survey or something like that. So I would just get curious with customers by asking them those sorts of questions and the thing that I would also pay attention to is kind of what we were talking about earlier, Tom, you know, in the, if you weren't web first and you are familiar with the on-prem world, It, it's an interesting history to study. I built our software company, my software company on, um, it was a co-founder of, of mine and, and myself. I was our CEO and, we built it on prem as well. And, we used to, complain about the multiple versions of the software. And of course there was a deployment value add of being in the cloud, but the, the money flow was really interesting, right. I pay, I pay upfront, I pay 20% annual maintenance and usually that's the reference that you're hearing then everybody stops. But actually there was another component which was at the end of the year, we published version two and we charged you and went through an upgrade with services and implementation to give you version two and then version three and then version four, et cetera. And that was part of the revenue stream. Now, when you move to SaaS, somehow that got like glammed over and some companies, you know, they forget that there's hosting. And so they don't include that in their model. That's a pretty obvious one, but this one is a little bit more thorny because it brings up the question of where monetization fits. Remember earlier, we said, it's in the product design, not sort of after we build the product. And secondly, it has to do with this idea of... what do we give customers in exchange for this in perpetuity revenue stream? And it turns out that we give them way too much. And how that typically rolls out is if you imagine the old world of on-prem, I'd give you a V1 software and some maintenance, and that was kind of the money flow and then V2 had new capabilities, but that V one, it was expected that you would maintain and do some improvement, bug fixing and other things, and probably some moderate capabilities, but like the bigger capabilities were in V2 that you would pay for. Well, when you move over to SaaS, all that just gets glammed together in the subscription stream. So now in the subscription stream, you have maintenance, code, and, bug fixing minor improvements. You have major improvements and sometimes you have the seeds of new product and all of that stuff if you're not careful, just gets given away to the customer base. And so monetization as a design element, you can think of it as a bit of a dam or a wedge that you put in that stream of value that kind of says, Hey, wait a minute, before this just flows down stream, I'm gonna swim around this little Eddie or part of the pool here. And just ask myself the question, like, is that heading down stream or is that really the seat of a new product? And is that really better positioned as a different part of the offer? Is that really an optional component? That, and is that something that should be a percentage of charge cuz it really enhances everything or is that better as like an integration flat fee and here's why, and having a perspective on all of this is of course the big picture of monetization.

Tom Raftery:

Chris we're coming towards the end of the podcast now, is there any question I have not asked that you wish I had, or any aspect of this we've not touched on that you think it's important for people to be aware of?

Chris Mele:

I think the, the one I would bring up is just before you embark on any of this, reflecting a bit on your philosophy of pricing is probably one of the most crucial alignment decisions that a software company can make and I'm talking about the idea of how you want to treat your customers when it comes to that landed price point. In universe number one, we're okay that, Tom, you and I bought the same thing and paid two radically different prices. That carries with it a whole host of symptoms on the sales floor of protracted negotiations, slow growth and other inefficiencies. On the other side, philosophically, we say, you know, We're saying we're treating our customers fairly. So we're gonna get serious about that. And if two people come in and they buy the same thing from us, they're gonna pay the same price. And we call that market fairness pricing. And that requires much more sophisticated packaging. Like what we've been talking about today, much more sophisticated monetization skill sets. But it carries with it. So many pragmatic benefits, accelerated deal cycles, and, more revenues, better upsells, better cross sales, transparency, and all these things that buyers want, um, much smoother procurement processes and, and a brand trust and, putting sort of trust back into the system. And it's hard, it's harder work. And so philosophically, I think aligning on one of those two forks in the road is a really crucial part of the journey before you get into the mechanics. Otherwise, when you get into all of this, if some team members have different philosophies, boy, are you in for messy conversations and you're not gonna get very far.

Tom Raftery:

Good. Chris, if people want to know more about yourself or about your organization or any of the topics we discussed on the podcast today, where would you have me direct them?

Chris Mele:

Software pricing.com.

Tom Raftery:

keep it simple. I love it. Okay.

Chris Mele:

It's pretty easy. Isn't it?

Tom Raftery:

exactly great. Chris. That's been really interesting. Thanks a million for coming on the podcast today.

Chris Mele:

Thanks for having me.

Tom Raftery:

Okay, we've come to the end of the show. Thanks everyone for listening. If you'd like to know more about digital supply chains, head on over to sap.com/digital supply chain, or, or simply drop me an email to Tom dot Raftery @sap.com. If you like the show, please, don't forget to subscribe to it in your podcast application at choice to get new episodes, as soon as they are published. Also, please don't forget to rate and review the podcast. It really does help new people to find the show. Thanks, catch you all next time.

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