Pricing for $oftware By Daniel Shefer

Pricing has far-reaching effects beyond Product the cost of the product. Pricing is just as much a statement as a definition of the cost to buy. Price defines the entry threshold: who your buyers are and their sensitivities, which Managers competitors you will encounter, who you will be negotiating with and what the customers’ expectations are. Good pricing will remove the price issue from Pricing software products • Estimating the potential being an obstacle to a sale. Pricing market for a product is is also used as a weapon to fight the When it comes to pricing possible, but estimating competition as well as gray markets. demand is problematic. software, Economics 101 Pricing is also unique from other Most customers tend to be decisions for several reasons: does not apply enthusiastic when seeing a • Price is the only marketing element When pricing software, the new product, but their input is not that produces revenue; all other “Economics 101” you learned a good indicator for real demand. in college is irrelevant. There marketing decisions produce costs. • For enterprise software, are many reasons for this: • Pricing is the most flexible marketing numbers are too small for a decision. • Supply and demand curves statistically significant study. are based on the assumption By the time a company has sold • Pricing reflects a product’s strengths that the marginal cost for enough licenses, it has advanced and weaknesses; it implies as manufacturing additional to a newer version or the market well as positioning. products is non zero and that has changed, or both. it decreases with quantity. • Pricing has the most immediate impact • For most products, there are In the software industry, the on the bottom line. In the high tech competing products, and their marginal cost for an additional industry, a 1% increase in prices can influence on the demand curve copy of software is zero. lead to a 10% (or more) increase in is hard to estimate. profit. This is twice the effect that the • Estimating price elasticity for • Product life cycles are short, making same change in volume and fixed or a specific product is practically comparisons more difficult. variable costs have on profits. impossible. Hence, pricing decisions cannot be based on • Purchasing decisions are complex supply and demand curves. and are influenced by many constantly changing factors.

24 • productmarketing.com • November/December 2005 Tips for Setting Prices The company’s perspective • Before making pricing decisions, you must thoroughly understand your ’s decision-making and buying processes. • Properly-priced software will not guarantee the company’s profitability. • When deciding which product competes with your own, the market’s perspective is what counts. • Internal company parameters such as costs come into play only when looking at the potential profitability of the product. I.e., can the company make money selling the product at a given price point? • The price of the software must be higher than the cost of selling it, and the margins must be higher than the cost of creating, marketing, selling and supporting it or else the product will lose money. • When new to a market, being a small, unknown company minimizes value. Lower, “penetration” pricing may be required. • If customer segments value the product significantly differently, this may justify segmenting the product for each of these markets. • When attempting to price commodity products, it is basically the competition that sets the price of the product. Setting a higher price in a commodity market is limited to the company’s ability to differentiate the product from its competition. On the flip side, offering a lower price in such a market is sustainable only if the company has a lower cost structure. • Just like other aspects of the product, pricing needs to follow the technology adoption lifecycle of the product. Early market buyers may be interested in your product but tend not to be willing to pay its full price. It may make sense to price the product at its target price for larger markets and offer early adopters the product at a discount.

The customer’s perspective • The price has to consider what the customers feel is reasonable. For example, market leaders are expected to charge more. Hence their higher prices can be perceived as “legitimate,” up to a certain level. • Using the pricing model as a differentiator is always worth considering as long as the model is easy to explain and it makes sense to the customer. • The costs of training, implementing and supporting the product are perceived as additional costs by the customer. • When setting the price within a range of competing products, it is important to understand how reference prices affect your customer’s price evaluation. This is imperative when customers have limited product or price knowledge.

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Guidelines for setting the price - The difference in brand value that Guidelines for setting the price of software in existing markets customers attribute to the products. of software in new markets When setting the price for a software - The difference in cost for If there are no reference products, the product, classical economic theory implementing the respective approach is slightly different. The first comes up short. Here is an empirical, products. step in setting a price is identifying iterative method to arrive at a price. - Any other item that customers how customers will position it in their minds. If the product is perceived by The purpose of these guidelines is to attach value to such as localization customers as a utility or productivity arrive at the “right” price. This is the of the application, geographic tool, price it in these ranges—that is, price that lets the company accomplish proximity (for services), etc. until the product can be positioned its goals for revenue, profit, market If the product excels in a certain aspect, (in the buyers’ minds!) as belonging share, renewals, etc. The method then simply add that value to the price, to a higher place in the food chain. detailed below will help you identify if it lags, simply subtract the value. This See below for examples of products the highest price a market with existing step must be iterated for each competing and typical price ranges. competitor presence will bear: product. The price of the software must If the product does not fall into the • The price of the software must be less be similar or less than that of the main previous category, start by defining the than the ROI it provides. The smaller competing product in each segment price ceiling. This is the highest price the ratio of the ROI to the cost of the minus the difference in price that is based on a product’s benefits. A high software, the easier the sale. justified by the functional and other aspects previously identified. price will work if early adopters are • Create a chart willing to pay a for a new based on feature sets. Identify all • The price must be below the product. However, this price level may competing products and place them purchasing authority of the targeted prove to be unrealistic as there may on this chart. Identify and group the decision maker signing off on the not be a sufficient number of buyers value elements in the product that purchase. for a new product at that price level. address the needs of each segment. • The price should be outside the Then, choose a “penetration” price. For each segment, identify the features “Dead Zone” of $5,000 to $20,000. Penetration pricing is used when a for which customers are willing to product is first launched in order to pay extra and that differentiate your • The price must fit how the market gain market share. A low penetration product from the competitor’s. Attach a perceives the product category. For price is used to discourage competitors price tag to the value of each attribute example, desktop utilities can be from entering the market and to gain that is not identical such as: priced up to $50, productivity tools up market share. Its drawbacks are lower to $500, etc. If the product is priced margins, difficulty in raising prices in - The feature and functional too high, the price will become an the future because pricing expectations differences. issue. If it is priced too low, customers are now set and the risk of customers will perceive it as not worthy. perceiving the low price as a low quality indicator.

Typical software price ranges • Utilities: $50 to $70. Purchases of utilities are many times spur-of-the moment decisions. Customers need to feel that the potential financial risk of buying the wrong product is minimal. • Productivity tools: $100 to $500. These are purchases that are within the budget of a low-level manager. • Professional tools: $1,000 to $5,000. Applications that are required by professionals to do their job, such as computer-aided design tools and many others. • Enterprise applications: $20,000 and up. Applications that impact many functions and departments in the customer’s organization and that require an evaluation process, and sometimes, a purchasing committee. Selling into such a 26 • productmarketing.com • November/December 2005 customer is many times a costly and labor-intensive process. The penetration price has to be sustainable and higher than the company’s variable costs. If possible, the price should be low enough to remove the price of the product from the buying decision. These two markers set the price range for a new product. Follow the relevant perspective, it lets them buy into the guidelines in the previous section to product while minimizing their initial finalize the price point. investment and exposure. From the independent software vendor’s (ISV) The software price “Dead Zone” perspective, it keeps them focused on The Pricing Dead Zone is a price range making the customer successful with between $5,000 and $20,000. Some the product rather than the “fire and When offering a subscription model, would even say that the range extends forget” approach to selling software. the vendor is betting its future on its up to the $40,000 - $50,000 range. Moving from a perpetual license to ability to keep customers. For hosted Software products in the Dead Zone a subscription model increases the apps, setting up a hosting environment are the exception. This is because vendor’s risk as it becomes easier can be very costly. The vendor is software priced in this range is hard for customers to walk out on them. basically giving customers a loan that to sell profitably. It may also have a negative effect on will be paid back over the length of the short-term stock price due to Wall the contract. This creates additional Products that cost less than $5,000 risks that vendors may want to avoid. can be sold over the web or through Street’s focus on quarterly revenue vs. channels. A purchase of this size is cash flow as the vendor is mortgaging So now, the bottom line. How much within the decision authority of middle their present for their future. This do you charge for a subscription managers, and there is no need for is because, over time, the income model? There are no axioms here, on-site visits to close a sale. More statement reflects the growth from but many companies charge one-third expensive products require higher- prior years’ bookings, as the deferred of the cost of a perpetual license for level signing authority or purchasing subscription revenue is transferred to an annual term. When offering a committees. A committee’s decision the income statement. Over the long subscription model, maintenance can cause the sales cycle to drag on term, the subscription model allows is usually mandatory. for months and get entangled in for significantly better revenue visibility internal politics. These products and consistency. This is beneficial, as Pricing maintenance and support require sales reps’ on-site visits but Wall Street loves companies that make have to produce enough profit to their numbers. For example, when For enterprise applications, 18 to support this type of sales effort. signing a three-year license for 20% of the list price is the “standard” $20,000 is at the bottom of the price $100,000, one-twelfth of it can be cost of support. This usually includes range that can support a complex sales recognized each quarter with high support over the phone for a single process. The exact boundaries of the certainty. In such a case, cash flow contact from the customer during Dead Zone depend on the specifics becomes the much more representative regular business hours as well as of how the product is sold. indicator of income. This works as product updates (both point and major long as the renewal rate is high. releases). More advanced packages that include 24/7 support are priced Perpetual vs. By offering a subscription-pricing model, higher, in the 20 to 25% range, subscription licensing customers face smaller payments. From and require a minimum of $30,000 the sales reps’ perspective, a lower Subscription software is an application to $100,000. Minimums of $200,000 to initial price lets them aim their pitch that is “rented” on a temporary basis. $300,000 are the norm for packages that lower in the customer’s organization. Licensing is usually on an annual basis, include assigned support engineers. Another advantage for the sales process but monthly terms also are available. Onsite support should always be is that calculating an ROI on a shorter Subscription licensing works when priced as an extra. time scale makes it more tangible, customers see an ongoing benefit from hence helping the sale along. the software. From the customers’

productmarketing.com • November/December 2005 • 27 Discounting and Calculating volume discounts non-linear pricing The way most companies calculate their Discounts come in two variations, discount schedules is surprisingly off scheduled and negotiated. Scheduled the cuff. They simply decide how much discounts are those that are pre-approved money they would like to get from by the company, based on pre-defined a large target customer per user and criteria such as the volume of the then draw a curve between the price purchase. Negotiated discounts are an of one unit and the price of a unit at ad-hoc result of the sales process that the high-volume level. They then Most companies have a no-discount differ from or go beyond the pre-set stand back, look at the curve and policy on support. That is, even when scheduled discounts. This article will play with it until “it looks good.” the software is discounted, the support only discuss scheduled discounts. pricing stays at a percentage of the list Another, more rigorous method for price. Very large deals may justify a calculating volume discounts is to Volume discounts discount, such as if all support calls select a consistent discount rate for are routed from a single person at the There are multiple reasons why ISVs every growth in units. For example, customer. One approach is to give away offer volume discounts: a 10% discount on the 10 - 20 units, a few months of support during the a 10% discount from the previous • Many times, the utility to the customer first year. Psychologically, it is better price on the next 10 units (which of additional licenses decreases as to give away “months” than to lower equals a 19% discount from the volume increases. To guarantee that the price of the yearly contract. original price) and so on. the value to the customer is more than For non-corporate users, there are two the price of the software, the price VAR discounts basic models for providing support: must decrease as the volume goes up. Value Added Resellers (VARs) get • The per-incident model: The most • In many sales situations, the cost of the software they resell at a discount. common model for personal support sale per unit decreases. This savings Discounts are typically between 40 and is “per incident”—that is, a flat rate can then be passed on to the customer. 60%, depending on the marketing and for resolving each support question, • A volume purchase increases the sales efforts required by the VAR to regardless of call length. The median customer’s investment in your product promote the software. Many companies per-incident price for surveyed and reduces his or her chance of design incentives for VARs by creating companies that offer this option buying the competitor’s product. volume thresholds that increase their is now $100, with 50% of these discount level. Tier discounts require companies charging per-incident prices • Large customers are convinced that it VARS to commit to sales volume. between $35 and $185. Support for is their inherent right to pay less per For example, they may give a 15% developer tools and more technically unit than smaller customers. discount for no commitment and advanced issues run into the hundreds • Buying more units now rather 35% for very serious ones. VARs of dollars per incident. For example, receive training and licenses for an a call into Microsoft’s tech support for than in the future has a discounted current value. additional cost. In comparison, reference developers costs $245. These models partners whose activities are limited to typically include a refund if the Once a discount is offered, buyers referring customers to the vendor get problem is determined to be a defect will assume that this discount—or 5 to 10% of the deal. in the vendor’s product. a better one—will be offered for all future purchases. When setting a pricing schedule for • The per-minute model: A less-popular VARs, take into consideration that the model is a “per minute” rate. Here, Before offering discounts, you have VAR has to make a profit and may be there is less variation in pricing: The to understand the impact on revenue. feeding its own distribution channels. median per-minute price is $2.71 and When offering a 10% discount at This approach is relevant to original the 50% range is $2 to $2.95. Note a contribution margin of 70%, you equipment manufacturer (OEM) that the $3 per-minute rate is one will have to increase sales—above pricing as well. of the few service prices where there baseline—by 17% to make a positive is significant customer sensitivity contribution to profit. and pushback.

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OEM pricing Pricing discrimination One of the difficulties of pricing OEM Price discrimination is a technique for maximizing profits by offering the deals is that there are no industry same or similar product at different prices to different customers. The idea standards or accepted price ranges. behind this is to set prices so that purchasers who are able and willing to pay higher prices do so. Pricing discrimination allows vendors to capture When signing an OEM agreement, additional market share by addressing segments that attribute a lower some companies require an up-front perceived value to the product. fee for Non Refundable Engineering (NRE), which are efforts needed to Price discrimination can be explicit or implicit. Explicit price discrimination tailor the product to the OEM’s is when a special price is limited to customers who meet certain criteria. specific needs. NRE fees include For example, academic pricing is a form of explicit price discrimination charges for developers, QA and because only students and faculty can buy at that price. Implicit price project management. These fees can discrimination is when all customers are technically eligible for the easily run into the six digits. Some special price, but the vendor inserts a condition that makes it unattractive OEM deals will tier their pricing based to some. For example, rebate programs are a form of implicit price on the up-front fees and volume discrimination. commitment. As a rule of thumb, the higher the commitment and up-front To make pricing discrimination work: fee, the lower the royalties. • Each segment needs to have a version unique to that segment

Site licenses • One market segment cannot buy the product created for another segment Site licenses give customers unlimited • The difference in pricing must be justifiable and must not create use of a product across their enterprise a feeling with customers that they are being treated unfairly while paying a flat fee. A buyer’s Another common form of pricing discrimination is introductory pricing. request for a site license is mostly a The idea behind this technique is to release a new product at a purchasing ploy. The reasoning is that premium price and to lower the price in time. This is a common with a site license, the buyer does not technique in the computer chip industry where power-hungry buyers are have to worry about counting seats. willing to pay extra for the latest and greatest. The reverse can also be However, it’s only another way to ask: true: introduce a product at a significant discount for a limited period to “what is your best price?” One problem stimulate early sales and then return to the higher list price once the initial with this model is that as a vendor, you surge of excitement has passed. lose your ability to track the number of installations at the customer site, and if your product is successful, you will be Illegal pricing discrimination leaving money on the table. Another The Robinson-Patman Act made it illegal for sellers to directly or drawback of site licensing is that indirectly discriminate in the price of similar commodities, if the effect when you sell a site license, you have hurts competition. This is especially important when selling to distributors effectively lost that customer for any and VARs. For example, if a vendor has two distributors that compete repeat sales. If you are concerned against each other, they have to be offered the same basic terms. If one about getting the product in front of distributor is allowed to buy software from you at a lower price than as many users as possible, just offer another, competition is adversely effected because the second distributor, steeper discounts to encourage buying at the higher price, will have a greater difficulty in reselling proliferation and use. the software. Site licenses must provide adequate It is important to note that there are situations where pricing discrimination safeguards so keep usage within the is explicitly legal. These include situations where the vendor’s boundary of the site. Customers may manufacturing, delivery or financing costs are different for different not want to count “seats” but they customers as well as situations where a competitor dropped its prices. need to have a means for controlling Meeting the lower price is not illegal even if this price is not offered the use of the product. to other customers. Note that the law applies only to products and not to services.

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Bundling Bundling is when a group of products (or services) is offered as a single Legal issues when package. By offering bundles, ISVs can increase their sales to segments bundling that would buy only one product. There are two types of bundling: All mixed bundling strategies are legal. • Product bundling. Product bundling is when two products are This is because the customer’s ability integrated into a single package. The purpose of product bundling is to choose the product they want is not to create a combined product that has more value to customers than hindered. On the other hand, pure pricing the separate parts. An example of product bundling is the Oracle bundling is illegal if the vendor has “market ERP® package where the database and application layer are bundled power.” Market power means that the vendor into a single package. can force a consumer to do something that he would not do in a competitive market • Price bundling. This is when an ISV provides a discount to customers or when “a substantial amount of commerce who buy two or more products at the same time. is at stake.” There are basic differences between price and product bundling. If a vendor possesses market power, Whereas price bundling is a pricing and promotional tool, product pure product bundling is legal only if bundling is more strategic in that it creates added value. Price bundling the benefits to consumers offset potential products does not create added value in itself. Therefore, a discount damage to competition. For example, in the on their combined prices has to be offered to motivate consumers Microsoft® vs. DOJ case, Microsoft’s claim to buy the bundle. of consumer benefit was enough to justify the integration of Internet Explorer with Bundling can be “pure” or “mixed.” Pure bundling is when a vendor does Windows®. Note that merely combining not offer any other option but the bundled products. Pure price bundling products together in a single installation is basically forcing a customer to buy at least one product that they are not does not constitute integration and will interested in and can be illegal. Mixed bundling is when a vendor offers be difficult to defend as providing benefit both the bundle and the products separately. to consumers.

Price bundling is used to: Compensating for bundling’s effects on profits • Increase sales to segments that have Unbundling different perceived values for the vendor’s An issue that must be addressed when Unbundling is a process where a products. offering products as a bundle is the potential product offering is split into modules loss of revenue. The higher the variable costs • Expose a new product to a large with some becoming optional. By for the products in a price bundle, the larger customer base. taking a complex product and splitting the increase in sales needed to overcome the it into modules, the product can become • Provide product visibility and a discount involved. For example, consider two attractive to additional segments. low-cost opportunity for customers offerings: a refrigerator and stove costing Furthermore, each segment tends to to test a new product. $2,000 and $1,000 with variable costs of become less price-sensitive regarding $1,600 and $800 respectively.The second the modules they need. For unbundling • By offering bundles, vendors make it offering is a bundle of a spreadsheet and to make business sense, sales to difficult for consumers to price-shop. a package of financial macros costing $300 additional customers have to make up and $100 with variable costs of $20 and $10 Product bundling is used to create added for the optional modules that customers respectively.When sold separately, the packages value for customers. By using integrated passed over. Another drawback of will provide $600 and $370 of profit. By products, customers can increase unbundling is the added complexity offering a discount of 10% on the bundles, productivity, performance, lower costs of to the product. After unbundling the the profit will be reduced to $300 and $330 ownership and reduce purchasing costs. product, there are multiple options respectively.Therefore, the appliances company for customer installations, managing In both types of bundling, vendors can has to sell 100% more units to make up for the product and supporting it increase increase customers’ switchover costs by the discount vs. the software company that in complexity. One risk of unbundling selling them more products than they has to increase sales only by 9% to make up is that if the product becomes too intended to buy. for the discount. granular, vendors run the risk of giving the customer a feeling that they are “nickel and dimed.” 30 • productmarketing.com • November/December 2005 Pricing for Software Product Managers

International pricing Other pricing issues Price wars The international prices of identical A price war occurs when two products vary widely compared Pricing NRE projects companies drop their prices regularly to U.S. pricing. The “uplift” as it is to close sales. Pricing wars start once Non-Recurring Engineering (NRE) is called, varies anywhere from zero the differentiation between products a one-time engineering effort by a to a premium of 50%. This uplift is has eroded. Proper product planning vendor that is paid for by a customer. justified by increased costs due to the and positioning can help prevent a NRE is driven by a feature or capability need for localization of the product price war by allowing the leading that a product lacks for which a as well as marketing and sales vendor to charge a premium. However, customer is willing to pay. expenditures the vendor faces in if two competing products have similar foreign markets. The cost of localizing In theory, costing an NRE project is offerings, as the market matures, price the software has to be considered, but easy. Estimate the engineering hours becomes a bigger factor in the buying in many cases is not the bulk of the and overhead costs, add a “fudge” decision. Unless the vendors can investment in foreign sales. Higher factor for uncertainties and risks and extract themselves from the price war support costs are due to the additional multiply it by your grossed cost rate. with better positioning, the vendor that languages needed, the more expensive The result should then be multiplied is able to offer lower prices over time labor (at least in Western Europe) and by a factor of 5 or so. This is assuming will win the war. of course increased business risk. On that your company spends 20% of its Reducing prices don’t necessarily the flip side, in some geographies such revenue on R&D. cause a pricing war. It also depends on as in Asia, services are less expensive where the product is positioned. If it is than in the U.S. It is critical to understand the reason for this “5” factor, especially when the the highest-priced product, dropping Note that differential pricing in NRE takes up a significant portion of the price to be more competitive will international markets runs the risk engineering’s resources. If engineering probably not result in a price war. If of creating a “gray” market for costs amount to approximately 20% you are the lowest-priced competitor, the product. of revenue, an NRE project costing X you may serve a different customer would have a 5x negative impact on segment and your competitors may Another issue that makes international sales. This is because the resources not respond. pricing difficult to manage is fluctuation used for the NRE were diverted from in exchange rates. There are two Some factors that increase the producing sale-generating products. approaches to adjusting prices when likelihood of a price war in a given This indirect cost must be taken into the exchange rates change: market are: consideration and not doing so runs • Adjust the local price to reflect the the risk of embarking on revenue • A perception by managers that price in U.S. dollars. This approach generating but money-losing projects. pricing is an easy to implement may cause difficulties in countries and reversible tactic A company that is in good financial where the currency’s buying power condition can follow this procedure for • Commoditized products that decreases compared to that of costing NRE projects but a company on customers cannot differentiate the dollar. the brink will probably not be able to between them • Adjust the local price to partially achieve these premiums. • Multiple competitors with compensate for the change in the Support and maintenance costs need to manufacturing over-capacity exchange rate. be priced as well. If the results of the • Low switching costs between Both should be done with an eye on NRE efforts are not incorporated into products optimizing sales, taking into consideration the product and are available only to how revenue is affected as well as the the customer who paid for it, support • High price sensitivity effect the change has on gray market is extra. These costs should be more pressures. than the going rate to compensate for One of the ironies of price wars is that the added difficulty of supporting code while price wars are usually started as which is basically a one off. This is an attempt to increase market share, when because each maintenance release the dust settles, the respective market becomes an NRE project in itself. shares of the players tend to remain constant but at lower prices and margins.

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Gray markets Price capping How pricing affects A gray market is created when a At times, customers may ask for a sales methods product that costs less in one market cap to future price increases. Pricing As a rule, the lower the price of the is sold to another market where prices caps are a negotiation issue. As in product, the less effort vendors can are higher through unofficial channels. all negotiations, never give away spend selling it. Enterprise applications There are multiple pressures that can something for nothing. Agree to the are costly to sell. Marketing programs foster the creation of gray markets. price cap in return for something that for generating leads can cost anywhere These include price differentials or an is important to you. This could be a from $20 to thousands of dollars per authorized retailer that can’t sell all its press release, closing the deal by the lead at targeted tradeshows. Then inventory and may move the leftovers end of quarter, etc. One trick is to there is the time spent by the sales rep to unauthorized dealers. agree to a maintenance cap only if qualifying the prospect and traveling to the customer will commit to a number meet him. An onsite sales call typically A classic example is the current sale of years or whatever term for which costs them $2,000 to $5,000. It costs of pharmaceuticals from Canada to the the customer wants price protection. roughly $2,000 per day to send a B2B U.S. Canada places limits on the prices sales rep into the field. If the sales rep of pharmaceuticals and so they are Just remember that like any forward- takes a sales engineer with her, this significantly cheaper than they are in looking commitments, potential buyers will entail an additional $2,000. Then the U.S. This creates a strong motivation of your company would not appreciate there is the rep’s compensation to factor for U.S. customers to import drugs long-term price commitments that cap in. The bottom line is that fully-ramped from Canada. Another example is your revenue. sales reps can cost a company $200,000 Amazon.com®. Books sell for different One way to reduce the impact of a price to $250,000 a year and prices on the local Amazon websites. cap is to price new features separately. more. Therefore, a direct What prevents a German customer Instead of adding a great new feature sales force selling $2,000 from buying a book on the American into the base product, consider making software is simply not a Amazon website and having it shipped it an extra option. Offering the feature tenable situation. to her home in Germany if she can separately gives you price negotiation save money? When it comes to Companies selling mid-ranged flexibility and makes you seem like a consumer software, where delivery products usually have inside larger company with more products. costs are zero, the problem is more sales reps that prospect You can always turn back around pronounced. and take orders over the and offer a discounted “bundle” that phone. When enterprise- Gray markets can damage channel includes both the base product and wide deals come up, a relationships but the aspect that is the extra option. specialized sales rep is sent relevant to this article is the undermining onsite. For smaller software of the segmented pricing schemes. Two additional issues packages that vendors want An important aspect of international to sell directly, the only pricing is the ability to price at the • By offering price caps, you may solution is to offer the software level that each market can bear. When get into legal problems with other online and through indirect a gray market forms, it can limit the customers (see the Robinson- sales channels such as company’s ability to charge a premium Patman Act). Amazon.com and CompUSA®. in a given market. • If you cap increases to customers, Gray markets aren’t always bad. As make sure to factor in any up-stream, long as they do not directly clash third-party fees that you owe your with the existing channels, there can suppliers. For example, if you can be beneficial sides to them such as only increase your price by 5% per incremental sales and the ability to year and your suppliers do not have reach into untapped markets. caps on their price increases, your margins could shrink. One way to avoid this is to exclude third-party fees from the price cap.

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By reducing the price of a product, ISVs reduce the risk Retail pricing to consumers trying an unfamiliar product. Assuming that the consumer has a good experience with the product, Natural price points they will be more likely to purchase it the next time, Natural price points are prices at which there are even without a discount. This is especially true if by using discontinuities in the price/demand curve. Customers the product, there are significant switching costs for the expect to see commodity software products priced customer. From a competitive perspective, rebates and at natural price points that are traditionally, $19.95, other forms of temporary discounts are used to lower $29.95, $49.95, $99, $199, $495, etc. The effect of prices while attempting to avoid a price war. increased demand for a $19.95 mouse vs. one that costs When executing a promotion, vendors have to beware that: $20 may stem from an underestimation mechanism. One explanation is consumers’ tendency to round • By reducing the price of their product, even temporarily, prices down and to compare prices from left to right. vendors risk implying that their product has inferior value. • If a temporary price promotion goes on for too long, Temporary discounts customers may begin to expect the lower price. The Temporary discounts are used to stimulate short-term “reference” price is then perceived as expensive and increases in sales and for enticing price-sensitive buyers customers are reluctant to pay it. that would otherwise be reluctant to buy at the regular • The promotion must be targeted to new buyers and price. A temporary discount can increase customer not to repeat buyers. demand for a product. However, this peak in demand is usually temporary and will many times decrease One way to meet these criteria is by creating a trial offer. future short-term demand. Price promotions may This is basically a type of temporary discount. Usually, a entice new, price-conscientious buyers, but they can condition is attached to emphasize the trial offer’s “special actually hurt future sales to the existing customer nature.” This can be done by setting an expiration date to base. Promotions are tactical, not strategic, and they the offer, requiring an additional purchase (a form of need to be managed that way. bundling) or an exchange of something of value. For example, the customer’s agreement to present at a tradeshow on the vendor’s behalf.

Rebates and coupons Rebates and coupons are discount mechanisms. There are several ways rebates and coupons work: • A discount at the register. This has a 100% redemption rate and is therefore not used very frequently. • Coupons at the shelf presented at check-out. • Mail-in rebates. Another type of rebate is given to the retailer. These are given after the consumer’s purchase and are a form of a discount to the retailer. These rebates are used primarily for adjusting prices to fit the closest natural price point. Another factor to consider is the cost of administrating mail-in coupons. The cost averages between $1.50 and $3, depending on the processing services offered with the rebate program.

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Charging for beta software Pricing post mortem Testing the validity Most companies do not charge for the After setting a pricing model, it is always of the pricing model Beta versions of their software. Another useful to go back and look at a deal’s The pricing model should always be approach is to charge the customer closing price. In many cases, you will tested against sales scenarios. The best for the Beta version and then offer see two things: the average price that fit should be within the target market. a substantial discount for the final deals close at is lower than the list price Most models will not be optimized for release. The company gets to use the and a distribution curve of prices. Low some segments. In some cases, it may beta version of the product, pays for closing prices indicate a lack of discipline cause money to be left on the table or it and is used as a reference account. in the sales force or a price that is set deals to be lost due to too high of a When the official version is released, unrealistically high. price. One way to test the fit is to list the customer will then “buy” it. How various sales scenarios and compare When the deal prices fit a wide curve, long the reduced price is offered once the effect on revenue caused by changes this is a negative indicator and can be the product has been released is a of the pricing model and the price caused by: matter of negotiation. points that feed into it. This exercise • Lack of sales process discipline. Sales should be repeated at least twice a Revenue recognition reps are closing deals as they see fit, year. The assumptions used in the squeezing as much (or as little) as comparison should be validated and If a contract calls for onsite training and they can from customers. the model should be tested on the service to a customer as part of the deal, previous quarters’ sales. the revenue cannot be booked until the • Customers varying in the value they service is delivered. A simple email perceive and therefore the price they Another test for the fit of the pricing from a sales rep stating that they will are willing to pay. model and price point within a market send someone onsite to help with the segment is that a comparison with the implementation can cause problems • Fragmented buying power. The competitors pricing must be made. Take since it would be considered as an product is being sold into market into account the pricing differential element of the transaction and the segments that significantly differ in based upon positioning and functional revenue would have to be deferred until their ability to pay for a solution. differences. If the differences between the company delivered the service. your price and that of your competitors’ cannot be justified, you will either have Make sure the product roadmap doesn’t to change the model or the pricing end up in the contract. If the contract factors in it. mentions future product features or that it will support a new operating The last test is the market. Make sure system, the revenue cannot be booked that your prospects and customers “get until those capabilities are available in it.” The pricing model should be simple the product. to explain. If you need more than a couple of sentences to explain the pricing model, it is too complex.

Summary Daniel Shefer is Director of Business Development at SanDisk. Daniel has a decade of experience in the software industry, mostly Understanding pricing is critical in and Product Marketing. Prior to joining to Product Managers. Pricing goes SanDisk, he was instrumental in product design with Interwise, beyond setting a numerical value establishing and managing the product management and the for the product. It sets customers product marketing operations. Additionally, he has also managed technical sales expectations, positions the product and drove technology partnerships with third-party vendors. Daniel’s Software and impacts the way it is sold. Product Management & Product Marketing website is www.shefer.net. You can Successful pricing is an ongoing email him at: DS_PM/delete-this/@spamex.com effort and should be reexamined continuously as the product goes More on this article is available online at though its life cycle to ensure http://www.shefer.net/Articles/Pricing_for_Software_Product_Managers.pdf congruency among all elements.

34 • productmarketing.com • November/December 2005