Author: Neil Davidson
ISBN: 978-0-9571791-2-7
You want to know how to price your software product? To make things even better, the author gave this book away for free. You can download it here. And in case you didn't know, this is the software pricing bible, used by the biggest tech companies!
EXCERPTS
Once you’ve determined what your product is, you need to consider its value to your customers. In the case of the Time Tracker 3000, let’s say that it will save a particular customer, Willhelm, three hours of work and that Willhelm prices his time at $50 an hour. That means that Willhelm should buy the Time Tracker 3000 at any price under $150, assuming he has nothing better to spend his money on.
Of course, this assumes that Willhelm is the rational, decision-making machine that economists love. In fact, Willhelm is a flesh-and-blood, irrational human being who doesn’t price his time and calculate costs and benefits. He has a perceived value of the Time Tracker 3000, which may or may not be linked to its objective value. The perceived value of a product may be higher than its objective value.
A product’s perceived value may be lower than its objective value too. A few years ago, I stumbled on somebody who insisted on using Excel as a word processor. According to this user, the additional expense of buying Microsoft Word wasn’t worth the benefits he’d gain.
If you want to change how much Willhelm will pay for your product, then changing the product is one option, but only if you can also change his perception too. In fact, it turns out that you can change Willhelm’s perception of your product’s worth without touching the product at all. That’s one of the things marketing is for.
People base their perceived values on reference points. If you’re selling a to-do list application, then people will look around and find another to-do list application. If they search the internet and discover that your competitors sell to-do list applications at $100 then this will set their perception of the right price for all to-do list applications.
This doesn’t mean you need to copy the reference point. If your product genuinely is better than your competitors’, and you can demonstrate the value of this difference, or create a perception of that value, then you can charge more.
Here are some more ways of increasing the perceived value of your product: Increase its objective value. Perceived and objective values aren’t identical, but they’re still correlated.
Give your product a personality. 37signals may not sell the best project management software in the world, but it has personality. The 37signals team stands for something: uncompromising simplicity. Want an extra feature? Tough. If you want features, buy something else.
Link your product to yourself , and then define, and promote, yourself as an expert.
Make people love your product.
Provide a better service. When somebody buys software, they want reassurance that it’s going to work and that you’ll be around if it doesn’t. If you’re a small company with big competitors, this is something you can do better than they can. Capitalize on it.
Create a tribe. Products can be symbols of belonging. If you can turn your product into a badge that people wear to make a statement about who they are, which groups they belong to, and which they don’t, then that’s valuable.
Remind people of how much work you’ve put into your product. People are more likely to pay for years of your time than for an easilycopied software product.
Appeal to people’s sense of fairness.
Sell more than just the physical product.
At BMW, we don’t just make cars. We make joy.” How much is joy worth? Certainly more than just the price of a car.
Ultimately, it comes down to differentiating your product. It almost doesn’t matter on what – features, benefits, the way that you sell, the service that you provide, the country you’re based in – more or less anything will do.
If you want to sell a to-do list at $200, when the market price is $100, then you need to add a couple of features so your customers cannot make a direct comparison, and then promote comparisons to other companies’ $300 productivity suites, not their to-do lists. At the same time, avoid all comparisons to open source alternatives.
If your customers can’t find a reference point for your product, then they look for proxies, or signposts.
Say you sell two products: the Time Tracker 3000 and the Task List 400, a to-do list application. When somebody thinks of something they need to do, they store it in the Task List 400. Later on, they can prioritize their tasks, split them up into sub tasks, track their progress and smugly mark off the tasks as done. Let’s say the Time Tracker 3000 has no competitors, but the Task List 400 has plenty. Your customers will judge your Time Tracker 3000 price on how you’ve priced the Task List 400. Charge a reasonable $25 for your to-do list application and customers will take your word that $300 is a good price for the Time Tracker 3000. Charge $1000 for the first app, and they’ll assume you’re fleecing them on the new one too.
If your product is unique, and customers can find no reference points or signposts, then you have a chance to set your customers expectations, and define their perceptions. If you tell your customers that the Time Tracker 3000 is worth $300, then the odds are they’ll believe you.
If you have competitors in your market, then your customers will be more conscious of cost, but if your product creates a new category, then early adopters are less likely to be price sensitive.
If you can create a teleporter, a brand new category of product, that will beam you, unharmed, from New York to Paris then not only can you define your price, but you can also raise your price from $20,000 to $25,000 and people will still buy it. But if you create a car, a new product within a category that already exists, and increase your price from $20,000 to $25,000 then your sales will suffer.
When you set your product’s price you need to think about how your competitors will react. If you undercut them, will they start a price war?
If you are going to compete on price, then you should minimize the possibility of a counter-reaction from your competitors.
Focus on their marginal customers and hope that by the time they notice you it will be too late.
On the other hand, if you set your product price too high, will other competitors emerge? Price the Time Tracker 3000 at $10,000 and you could create the market, only for a competitor to produce the Tyme Trakka 3000, undercut you, and steal your business.
Microsoft is famed for this. They wait for competitors (and often partners) to prove markets with low volume, high price products – whether it’s CRM, testing tools or business intelligence – and then jump in with a low-cost, high-volume model.
If you’re trying to persuade people to switch to your product from a competitor’s then you’ll need to position the price to overcome the switching costs your customers face. Say you’re trying to persuade a customer to switch from his garbage $500 word processor to your superior $100 one. First of all, you’ll need to price to overcome the economic switching costs. It’ll take him time, and therefore money, to convert his files to a new format and to learn the new menu layouts.
Secondly, you’ll need to overcome the psychological switching costs.
Another powerful psychological factor people struggle to overcome is the emotional attachment to money they’ve already spent. Rationally, it’s gone. It’s a sunk cost. Your customer shouldn’t care that he’s already spent $500 on his garbage word processor. But he does.
If you’re planning on not charging the majority of your users, then think very carefully about the cost of each additional user. If you think it is zero then you are almost certainly wrong. If you’re running a web site, then each additional user will cost you storage space, CPU cycles and bandwidth. This might be a very low cost – fractions of a penny, even – but if you need huge numbers of users to make money then small costs multiplied by vast numbers can equal big outlays.
If the price your customers are willing to pay is lower than what it costs you to sell your software, then you haven’t got a business and your product will flop. You need to cut your cost of sales, or change your 33 pricing mechanism so customers end up paying more over the lifetime of the product.
So far I’ve talked about marginal costs – how much it costs to produce, or sell, each additional unit of your software. Your up-front cost is different. You might have spent one hundred dollars developing your product, or a million, but that money is all spent. Gone. It’s a sunk cost. What matters now is not how much you’ve spent, but what people are prepared to pay.
If there had been some way to sell the product to each customer at the maximum price that they could afford to pay, you would have been able to sell $1150 of software. That’s what’s versioning is about. It’s a mechanism of segmenting your users according to their willingness to pay. You figure out if you can group your customers in different ways, and then see if those groups are willing to pay different prices for your product.
By industry. Perhaps architects, or software developers or aircraft designers have specific needs, and perhaps your software can be customized to suit them. The Time Tracker 3000 could come in a special edition, aimed at law firms, that not only tracks application usage, but also bans certain applications.
Of course, you need to be aware of the dangers of versioning too. You need to make sure that the features you choose for each version appeal to the segment you’re targeting. For example, if you introduce a ‘Lite’ version of your product, you need to be sure that professional users won’t downgrade to it.
When people are presented with a bunch of confusing options they cannot compare, going for an extreme isn’t their only option. They also have a tendency to defer: to simply not buy, or go for a competitor’s product. [Read: The Paradox Of Choice]
Once you cross a threshold, you can often move up to the next one relatively easily. It’s easier to persuade somebody to spend $10 instead of $1 than it is to get them to open their wallet in the first place.
Information, the theory goes, has zero marginal cost. It costs nothing to ship the next set of bytes to your next customer. Therefore, the price that consumers will pay for your information, and the cost you must sell it for, will eventually approach zero. The success of open source operating systems such as Linux, the Apache web server and the Open Office suite seem to illustrate this point. This argument has a number of holes in it. For a start, as already discussed, you are not just selling bits and bytes. You’re selling a whole bunch of stuff around it, including support, documentation and handholding. Your customers are buying man-years, decades even, of your past, present and future blood, sweat and tears. Is that worth $100? Or $1,000? Heck, yes, and you should tell that to your customers.
Free trials only work for software that people use again and again, and where the free trial doesn’t fix the problem by itself.
The freemium model involves providing a free version of your software for some people, and a paid-for version for others. Typically, the ‘standard’ product will be free, and the ‘pro’ version will be paid for.
At the very least, you need to be careful, and make sure the free version is good enough to be useful, but not so useful that it cannibalizes paid-for sales. It can also require extremely high volumes to make it work. Flickr only manages to upsell around 5% of its standard users to its professional account. And storing, searching and serving the 3.5 billion images Flickr’s free customers store certainly isn’t free.
Free becomes even more important when your networked product has competitors. In this situation, it turns out there are two stable situations: no customers, or plenty of customers, and that there is a critical point beyond which user numbers accelerate quickly. Get past the tipping point and your user base will accelerate rapidly. If you don’t quite reach the tipping point then your user base will shrink back to zero.
It becomes, therefore, extremely important to reach the tipping point as quickly as possible, and the ‘free’ price point is a good way of doing that. Of course, once you’re past the tipping point you’ll need to make money from your product, without losing users.
Your business model and your strategy have to support your pricing model. If you have expensive sales people driving expensive cars, taking your customers’ CEOs out to golf, and end users who expect plenty of hand-holding and customization of the software you sell them, then you can’t sustain a low price point. Similarly, if you’re selling shrinkwrapped, mass-market software over the web then a high price point will be counter-productive.
Product pricing is as much art and craft as it is science. Sure, it helps to understand the economics and psychology of pricing, but theory can only tell you so much. At some point, you need to make a decision and do it. Use the information in this handbook to make an informed stab at what a good price would look like, and how your customers will react, and try it out. The exact price almost doesn’t matter – get it broadly right, don’t screw up totally – and you can tweak it later.
You might be worried about how your customers will react when you change your prices. Don’t be. For most of us, our customers have better things to worry about. If we shift our prices from $100 to $150 then most people won’t notice, and of those who do notice very few will care.
It’s not what your customers say that’s important, it’s how they behave. Whenever you make a price change, pay close attention to what your customers do. If they stop buying, rethink.
What’s your strategy? Are you going to price low and sell lots, or price high and sell a few? How does this fit into your brand, the product you have and the image you want to project? What’s your product? Don’t forget that it’s not just the software that you’re selling. It’s the entire package around it.
How will your customers judge the fairness of your pricing? What reference points will they use? How will they determine what seems right? Will they baulk at the price you choose, or will they accept it?
Who are your customers? How does their business work, and how do they expect to be charged? How much money do they have? Do they prefer a one-off fee, or a monthly subscription? Get under their skin.
Who are your competitors? How will they react to your pricing? How much more, or less, valuable is your product than theirs? What is their business model? What are their prices? If you undercut them, will you trigger a price war? If you do, are your pockets deep enough for you to win it? Do you want to co-exist with your competitors, or destroy them?
