Pricing to Value: The software entrepreneur’s challenge
Driving through the small Quebec town of Portage-Du-Fort this afternoon, I came across this real-estate jewel. The seller’s marketing approach is oddly contradictory! It’s for sale (implying value), yet it’s dangerous… go away!
This got me thinking about the dozens of chats I’d had with software startups about pricing models – or lack of. Developing a sound business model is tough work. Perhaps the web 2.0 “model” is a convenient excuse for ignoring monetization: “we’re gonna focus on traffic, then worry about making money – you know, like Google does it!” Well, even Google knows that nothing is really free. Somebody’s paying for it somewhere along the chain.
Selling software is very different than selling consumer goods. Many established pricing models don’t apply. For example, cost-plus pricing takes into account the cost of raw materials, manufacturing, packaging, shipping, warranty returns, margins for the distribution channel, and direct & co-marketing. Then profit.
In the software world – development and sales are the main cost-centers. Instead of cost-plus, look at pricing to value. If a customer using your product makes an extra $5,000 in profit (whether by enabling new services or cost reduction) surely your product is worth more than “free”. What’s it worth? $20? $99? $450? If your product is indeed as good as you say it is – then go for $450!
Marketing guru Seth Godin agrees,
Your sales force and your customers may scream that you need to lower your price.
It’s not true.
You need to increase your value. If people don’t want to pay, it’s because you’re not delivering enough value for the money you’re charging.
You’re not selling a commodity unless you want to.
If you’re still not convinced, read Ronald J. Bakker’s book Pricing on Purpose: Creating and Capturing Value.
There is one more important step before the cash starts to roll in. The most difficult part (for the non-salesman) is to stare into your customer’s eyes and demand they pay you the money you deserve, without flinching. That’s why great salespeople are hard to come by!
This is an important topic and you raise some key issues. Others to consider include:
- pricing relative to competition
- pricing relative to level of market development and your market position (mainstream leaders can charge more)
- pricing relative to early market buyer behavior
- pricing to skim (high margin/low volume) or penetrate the market (low margin/high volume)
- direct versus indirect pricing (monetize the the appln; or the eyeballs; services; or other)
- pricing and its impact on the sales cycle
- pricing model (perpetual or subscription; per user, per cpu core, etc.)
- is pricing fixed & unchangeable, or is it open to negotiation
- channel model (direct, indirect, OEM)
There are a great many interdependent strategy variables to consider. For example, you are right that sales is a major cost centre (typically 30-40% of revenue in a mature software company). This means that, right off the start, all other things being equal, the average price needs to 40-50% more than if that cost didn’t exist. Yet increasing the price lengthens the sales cycle and complicates the close ratio (more people involved in the decision).
Finally, once in the market with a given public pricing strategy it can be very painful to make changes. Lots of forethought is needed.
A great case study would be netscape-mozilla. Pricing strategy had everything to do with the rise and fall of netscape. Then they gave up and open sourced the code. The mozilla foundation give away a free product yet now has $100m+ revenue and an implied market cap of $1B+. How? They monetize every search made from their search form. Not bad, I’d say.
Steve
Steve,
Excellent points added to this conversation – thanks.
A very important point you highlight – “once in the market with a given public pricing strategy it can be very painful to make changes. Lots of forethought is needed.”