Making Sense on Today’s Software Price
To understand the new economy we need to come back to the old laws of economics. In a free market, once companies have recovered the up-front investment necessary to create a product, the product’s price slides toward the cost of manufacturing an additional copy and because this is usually very low, the product’s price will tend to be low as well. When the product is delivered over the Internet, the variable costs almost disappear because the product has no additional cost for packaging, nor shipping.
Having placed ourselves in a business and economic framework, we can say that now, we can’t use cost-based pricing. Nor can you set prices according to the competition—that’s a sure road to ruin. The only viable strategy is to set prices according to the value a customer places on the sofware.
In the way the software industry has evolved, the question today is not how much is the right price for my product, it’s when can I charge for my product:
- Free products have basic functionality as the competition.
- “Enhanced” products have more valuable features than the competition.
- “Deluxe” versions have a bonus price.
We can charge when we get to the “enhanced” version: products that are more compelling than the competition.
This concept leads us to realize the amount of the investment we need to make on a software product to be viable in the market. The amount of money we need is at least as much as to produce a product as advanced as the competition. We actually know that we are not going to recover this money with the basic product. Hint: Be careful when we make projections on sales based on these basic products.
Therefore, the explanation for the 92% margin of Windows and the difficulties for other companies to compete comes from understanding that Microsoft already sunk their investments (fixed cost) and a newcomer can be caught in devastating price wars. If competition forces a company to reduce its prices to a level near its marginal production costs that company will never be able to recoup its big up-front investments. This is why we need to make our financial projections based on the revenue from the “enhanced” products.
When Adobe gave away a simple version of its Acrobat software it was because they were the first to produce this as a standard. Adobe anchored of Acrobat reader was then able to sell full versions at $600.
Of course, if all we do is to give software away for free, we are betting to win the lottery (Skype, Google) or going-out-of-business soon. We should offer free versions only when:
- Building Awareness (make sure you have a marketing budget).
- Building a customer base (make sure you have in your financial model this as promotion) to sell extensions, upgrades, and services.
- In exchange of advertisements.
- Protecting our main products like Explorer, in order to prevent Netscape from gaining control over computer desktops.
The trick is to identify the best ways to distinguish the different versions of your product. We need to create the right number of versions and set the right prices for them. The goal is to get each customer to pay the highest possible price for the product, thus maximizing the overall return. Since the customers themselves are selecting the price they’ll pay, based on their own calculation of the information’s value, they will be far less likely to take offense at paying different prices than they would if the manufacturer were imposing the prices on them.
on 31 Aug 2007 at 8:43 am # Carlos
Mario Could you be more clear on when we can charge. Carlos
on 31 Aug 2007 at 8:43 am # bill stunt
It seems to me that everything is free or opensource.
Bill
on 31 Aug 2007 at 8:44 am # Mike Dean
How is opensource related to freeware?
Mike
on 31 Aug 2007 at 5:01 pm # Mauricio
It seems to me that software is getting to the open-free spectrum very fast. Services around software are the business for surviving. You mention google, they make their money from charging top companies to appear in top places in their searchs, that is a service, as well as publicity, and others.
Good one. Thanks
on 31 Aug 2007 at 5:17 pm # mario ruiz
Carlos: We can charge when we have a better product than the rest of the market. We have to be aware that this window could be short too.
Bill: Free and open source are not the same concepts. They usually go hand-by-hand. We have to realize that sooner rather than later we make money or everyhing shuts down.
Mike: There are plenty of explanations on the Internet to read.
Mauri: Services can only be around products although the 49ers model repeats itself in every incipient market. Most people went for the gold. Very few found it. People serving the gold miners found the true gold; for example Wrangler jeans.
Mario