How do software companies determine the price of their products, and when should they do it ? This article describes some of the ways companies price products but argues that value based pricing may be the superior approach.
So, how do you put a price your new software product.
Free & Fremium: This is where you give away the software for free and make money out of related services, such as maintenance, training, advertising and the like. This model works if you are good at holding your breath and probably excellent in marketing.
Pick a number: I suspect a lot of companies employ this model. I quite like the story of Hewlett Packards first product, an oscilloscope that they priced at $54.40. The price was chosen because it reminded them of an 1844 slogan used to establish the northern border of the United States – “54” 40’ or Fight!. Not necessarily a great strategy, but it did work for them.
Competitor based: What do the competition charge. Be careful here as buyers sometimes associate the cheapest solution as the one with the lowest value. If you do price against a competitor you should try and find out why they selected their price and what the links to value are. Again, this strategy probably needs a good marketing strategy to support it.
Cost Based Pricing: In this strategy you try and associate your costs of production with the cost of selling.To a certain extent all business will have to do this to keep running (i.e. you business plan needs an associated revenue stream). However, remember your internal costs have little direct relevance to the value to the customer.
Value Based Pricing
This article is really about value based pricing and why you should consider this approach before you start to develop you product.
Why do people buy products in the first place?
I like the article by Belle Beth Cooper Why people don’t buy products – they buy a better version of themselves. The article is based on consumers but I think the message works just as well in a B2B context. It’s a message we all know, people buy benefits and not features. However, most companies seem to drift into talking about features all the time. I think this happens very early on in the development process.
This results in a disconnect from the customer on day 1 and probably investment in the wrong features. So how can value based pricing help?
I believe that before product features are implemented or new products are invented we should all spend some time asking how this will make our customers lives better. One of the ways of doing that is to try and work out what ROI will be to them on your new product.
How do you do it ?
Simple ! You work out how much money your customer will save using your product before you build the product.
Ok, Ok, this is not easy but it is a great way to get your team to imagine how your product will benefit the customer on day one. Also, understand that whilst the eventual outcome is to get a great price, it is ‘the journey’ that will make you product more relevant just by trying.
We do this by borrowing some of the techniques that the sales industry uses in solution selling and insight selling. Simply put, these methods try to discover the real problems that a customer has now or latent ones that are soon to emerge in the future. They then try to quantify these and based on the price of the proposed solution will demonstrate why the ROI is compelling. The problems are often referred to as ‘Pains’ and if you can evaluate frequency and quantum these can be mapped.
Mapping out the Pain
Let us work through an example. (Note, that there is a free diagnostic tool in the downloads section , it’s completely free and incredibly useful).
To calculate the pain of a particular customer I think it is useful to have someone in mind, i.e. not just a segment. Once you have someone in mind and have identified a pain, you will be trying to work out the following:
- How often does this pain happen?
- What is the probability of it happening ?
- How much does it cost the company when it happens?
- How much do we envisage we can reduce it happening?
- What additional value can we add to the events?
- How important is this event to the customer (note that high value events are not necessarily the most important, i.e. it might be a pain associated with a mandatory regulation).
I would suggest that for a new product of feature you should try and identify between 1 and 10 pains that you product can have a positive effect on.
Once you have done this you will be in a position to calculate the approximate value of the pain and therefore align the price of your product to that . You can also map them out (as in the screenshot above, please download the diagnostic tool for more details). This will also give you some broad brush ROI statements that you can use in the sales process.
This exercise will be a combination of leaps of faith plus refinement. So don’t spend too long trying to be completely accurate with your estimations in the first instance. These can and should be refined. However, what it does do is force the development team closer to the customer. It will also serve as a document to remind you what you thought you were building in the first place. I think that one of the main areas where product companies go wrong is when the R&D team become disconnected from the customer. This technique will help reduce that happening.
What next ?
You can go with the number you have just calculated. You will already have benefited from the process of validating your thoughts against customer gains. However, you can go even further.
If you can get access to your target customer or a good proxy, you can try and validate your findings against them. This can be used as great relationship building tool as you will not be selling them anything at this point. Rather, you are in the position of asking them, as someone who has an opinion you value, to comment upon a new product your are trying to build. If they give you more accurate models to refine your data, it will become a winning situation.
At a later date you may be able to go back to your target and play them back their own savings and therefore generating a potential lead.