The Science of Software Pricing
One of the hardest parts when releasing a software product is determining the ideal pricing point. Wouldn’t you like to know the magic number that doubles your profit?
Pricing is not an exact science, but it is not magic either – it is influenced by perception of your software, market conditions and its value. So what is the process of finding that sweet pricing spot?
The Sweet Spot In Numbers
When we are pricing products, our goal is (usually) to maximize profit – we want the equation of
sales x price to be equal the highest possible value.
Economic theory suggests that as we raise the price we lower the amount of sales. Each intersection of price and amount of sales can be plotted on a graph, creating what is called a demand curve.
The sweet point is where the intersection draws the largest rectangle. This rectangle represents the
sales x price calculation, and the largest rectangle represents the largest profit.
This makes sense until your consider that customers are people – and people do not make rational purchase decisions often. Quoting from the excellent eBook “Don’t just roll the dice” by Neil Davidson:
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.
Neil goes into much more detail than I could in this article, but to recap quickly – perceived value can be different than objective value, and that perceived value can affect sales in ways that the demand curve does not predict. For example, when buying a brand-name product you are paying a premium on purpose because the perceived value is higher even if the objective value is the same. Some brands purposely price higher to sell more since the perceived value increases.
Pricing higher with the same products
Going back to the fictional issue tracker from Neil’s book:
Back to Willhelm and the Time Tracker 3000. 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.
That’s right. You can request a higher price without changing your product, just by changing the perception a potential client has of it. One of our value propositions to sellers on Binpress is that we help with the marketing aspects. With their permission, we edit the description and summary when possible to represent better value, and by writing articles like this that increase awareness of how important marketing is for both sales and maximizing profits.
Soon we will also provide design and UI services to our sellers for improving the weakest link in marketing for most developers – design. A well known fruit software company has become a giant by out-designing their competition, and it’s no coincidence. Apple charges a premium for products because of the perceived value of their products.
One of the common ways to understand the perceived price is to check out the competition. Are you selling a wordpress plug-in for newsletter management? google for it and see what else is on the market. If you’re in luck, you provide the only solution in this space – but if not, you have to consider your clients can use google just as well as you and bring your competitor’s pricing into account.
What do you do when there’s a free product that does what your product does? you have three options then:
- Either demonstrate your product is clearly superior or has unique features the free product doesn’t.
- Create those differentiating factors.
- Win on marketing.
- Provide support.
Giving support is an important differentiation – one of the biggest deterrents for business from using lesser known open-source products is the concern about ongoing issues and future needs. A commercial product offering support can often win customers that want that security blanket. We will soon be adding an issue tracker feature for each component, with our sellers having the option to mark a package as accepting support tickets. This could be another way to differentiate packages or increase perceived value.
Giving support has an added benefit besides increasing the value of the product – it’s a chance to get real feedback on your product! using the feedback from support requests will allow you to improve your product and sell even better (or increase the price) in the future.
Determining pricing point
So far I’ve talked about perceived and objective value and maximizing the demand curve. But what about the actual price tag?
When we go about setting about pricing our product, we should run through the following exercises :
- Determine the objective value of the product. How much would it be worth if people were indeed a rational, decision making machines. When talking about selling source-code, the calculation can be as simple as :
value = (hourly rate x development time in hours) - price. This simplistic calculation determines the value to the customer, if he were making a completely logical decision (of course it varies depending on the hourly rate and the experience of the developer affecting development time, but those two numbers are usually related).
- Understand the perceived value of the product. What is your target audience? how does the product help them? (ie, saves them time, improves their business / product etc.)? who is the decision maker that can make the sale? (the actual developer, a project manager, a company credit-card holding dude from SF, etc.) For doing this you should research your market – what are the competing products? what is the demand? who would need this solution and how unique is it? how hard is it to develop it from scratch? This discussion on the programmers stackexchange gives a nice overview of those considerations. You can find answers to those questions relatively easily for everything but the most obscure needs by using Google and visiting sites such as the programmers stackexchange site and Quora, where people post questions such as “where can I find
ywith requirement and language).
- What is the value I want to convey though the price? there’s a big difference in the message you are sending to a potential customer when pricing at $1.99 and when pricing at $19.99 – the difference in conveyed value is incredible. Don’t just try to minimize the price at first in the hopes of generating more sales, since you are telling your customers that it is worth that much. We had a wave of components submitted for publishing recently with a price around $1.99 which seemed to be more related to publishers copying each others pricing in the hopes of succeeding better than anything related to the actual value of the product. We added a minimum pricing of $4.99 for this purpose specifically, and we believe that the vast majority of components should be priced much higher.
After determining the perceived value of the product, we can go a step further and try to optimize it to reach our best price by :
- Improving perceived value via marketing. The topic of marketing software products is broad and will be covered by future posts, but lets summarize it in a few key points – focusing on benefits, reducing possible fears and product design. Consider those elements when trying to increase perceived value. If we found out that the perceived value is below our objective value, then it’s almost certain that we can raise it at least to the objective value point, and probably with creative marketing we can go past it.
- Improving objective value. Quoting the excellent Joel Spolsky article on Simplicity:
With six years of experience running my own software company I can tell you that nothing we have ever done at Fog Creek has increased our revenue more than releasing a new version with more features. Nothing. The flow to our bottom line from new versions with new features is absolutely undeniable. It’s like gravity. When we tried Google ads, when we implemented various affiliate schemes, or when an article about FogBugz appears in the press, we could barely see the effect on the bottom line. When a new version comes out with new features, we see a sudden, undeniable, substantial, and permanent increase in revenue.
Going back to the point I made earlier – you can increase pricing by providing the differentiating factors by understanding what people are looking for and attacking the weaknesses in your competition. Everybody is using Magento because it is does provide a lot of value, but they keep complaining about its speed amongst other things. Suppose you built a similar eCommerce platform that is blazingly fast? bingo, you target the biggest pain your competitors clients have. Sometimes it is a good thing to have competition just to know what people really need.
- Testing. When all is said and done, it’s very hard to determine an ideal pricing point from the get go. You need to test several prices and try to build something like the demand curve and try to find that sweet spot. We are going to offer an automatic feature that does this for you soon – it will vary the price after a set amount of component views and compare the sales numbers for each price and then run several sub tests around the best prices to find the ideal price point. This can be done manually as well for now, but automatic tracking will do it much more accurately and efficiently.
- Creating tiered pricing. This is very important from a psychological point of view – when you offer just one pricing for your product, you don’t give any points of reference (except your competition). You can increase the apparent value of your regular pricing by adding a premium pricing package that is priced much higher. The point of the premium package is not to sell (though it will in fact make a few sales – you should always give people the option to pay more if they want to), but to make the regular pricing seem like a better deal. When pricing components on Binpress, we usually suggest sellers to add the “Sublicensable license” option for a much higher price – not only do some people will actually purchase it, but it will also make the regular pricing seem much more valuable.
Start with a good guess and test, test, test
At this point you should have the basic process of how to price your product. There’s no universal truth in pricing – it’s best to start from a good guess and then test as much as possible. In order to help you test (and of course, generate more sales), we are focusing on generating much more traffic to Binpress over the next couple of months. We are now starting to run PPC and SEO campaigns that will take to get the ball rolling, but your patience will be rewarded.
I expect to hear your thoughts in the comments. Lets see what you think about pricing your software products.
Author: Eran Galperin