What to Price for in Software

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For hardware products, we typically charge per unit.  When you make hamburgers, you charge for the number of hamburgers people want to buy.  (Of course it is more complex, but that’s for later.)  This is typical  because your costs of manufacturing are directly proportional to the number of units purchased and … buyers assume firms use cost plus pricing.  So it’s natural.

For software product though this is very different.  The marginal cost of the next unit of software is close to zero.  What does it cost Microsoft to download the latest version of Office to you?  Almost nothing.  That’s not to say there isn’t development cost, but the cost to manufacture the next unit is minimal.

In software, buyers can’t use cost plus buying.  Instead, they have to decide if the product is actually worth the price you are charging.  Therein lies the clue.  When pricing software, we want to charge for the items your customers get the most value from.  In pricing literature these are often called value drivers.

The goal is that the people and companies who receive the most value pay the highest prices.

Many enterprise level software companies charge by the number of users and the number of modules implemented.  For example, Saleforce.com does exactly that.  The more salespeople and support people using Salesforce, the more value these companies receive, the higher the price.  Similarly, the more options companies enable in Salesforce, the more value they receive, the more they pay.

The hard part is determining your value drivers.  For them to be effective they must differentiate customers with different willingness to pay, they must be actionable, and they need to seem fair to your customers.

Let’s keep exploring Salesforce.com as an example.  What else might they be able to charge for that differentiates willingness to pay?  How about companies that currently have horrible sales processes vs those that have great sales processes.  The horrible ones would surely get more value.  Yet, that isn’t very actionable.  It’s difficult for Saleforce to set a price based on the starting conditioning of their customers.  (Although not impossible by any means.)

Maybe Saleforce should charge based on the revenue of the companies they serve.  Companies with higher revenues surely get more value from closing deals through salesforce than those with low revenue.  However, as a general rule, companies don’t see this as fair.  Simply charging a portion of revenue is frowned upon.  It’s not a “feature” in their software they can charge for.

Another wonderful example is LinkedIn.  Recruiters get the most value by far from using LinkedIn.  So, LinkedIn created a set of features that are valuable to recruiters and they charge a lot for them.

If you are selling software, the key questions to answer: What drives value to your customers?  How do you charge for that value?

 

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