In this age every company uses computer systems in one form or another for just about every function in their business. These systems need constant upgrading over the years as new technology and software features are developed. In my years working in Pricing and Revenue Management I have been on both sides of the equation as both the purchaser of system software and the seller of system software. When purchasing software there were certain factors that we had to consider internally to determine if the price was acceptable. When selling software I now use that knowledge to help determine what customers are looking for in order to find the right price to design an offer for customers.
For this article I am writing from the viewpoint of the seller of software and how to develop pricing, however purchasers of software can also learn from this article on how to evaluate the price of software being offered. Keep in mind that these are not PC-based software packages for $39 that I am referring to. These are software systems such as booking systems, network optimization software, pricing systems, etc. These systems can cost hundreds of thousands of dollars or even millions of dollars when purchased. However, in the past years there has been a new method of buying software based in the cloud. This is known as Software as a Service (SaaS) where companies can buy a subscription for the software and pay on a monthly basis rather than purchasing the software outright.
There are many different possible variations of SaaS such as long-term agreements or short-term agreements, where the software is hosted and on what type of platform. All of this needs to be factored into the pricing model but I want to outline some of the higher-level pricing considerations rather than getting into the complexity of the various technical possibilities with SaaS.
There are three different areas of cost for customers:
- Implementation fees (usually a one-time cost)
- Hardware fees (whether customer hosted or supplier cloud hosted)
- Software license fees (SaaS)
- Annual maintenance fees, or that may be covered by the SaaS
- Number of licenses
- Product differentiation
- all the above factor into the value the customer perceives
Item 1 is straightforward if you ensure that there are proper deliverable clauses in the contracts to ensure that both parties will devote resources to have a timely and successful implementation.
Item 2 can be discussed who will host the software and the technical pros and cons. The variables that a customer will consider are the cost of hosting the software themselves in their cloud or using the seller’s cloud. Seller’s usually prefer that their cloud be used so they can easily monitor the systems, check error reports, load patches, install upgrades, etc. While there is a financial element to this decision my experience is this is more of an IT discussion between the two companies rather than a pricing issue.
Item 3. This is the main topic that I want to focus on. Software license(s) pricing for new customers (later I will speak about maintaining existing customers). There are three areas that customers will consider.
New Customer Acquisition
A: The Cost/Benefit Analysis This is how much revenue (or cost savings) the customer will gain compared to the cost of the software fees. The software fees may also include the number of licenses a customer may purchase as well as the product features that make the software better than the competition. This is all about the value the customer perceives.
B: Alternative Solutions Companies will always look for ways to save costs. A company will look at the cost of alternative solutions such as developing software internally or seeking another software provider that has something similar or can develop it at a much lower cost.
C: The third element is Time While customers may consider alternative solutions it will likely take some time to develop (1-3 years) while your software is available now. However, you may have a short-term win if you price high knowing this, but this approach may lose a long-term customer over time to the competition. Alternatively, I know other software companies that go in with a lower price in the beginning to win the business and then have a price escalation clause over the next 2-3 years based on a certain price index published by the government.
See the below Software Pricing Model diagram for your reference:
Now, realistically will your Pricing Area look like a perfect sphere? No, this is just an illustration. Most likely the Pricing Area will look like a strange shape, and that shape will be different for every customer since each customer places a different value on the different variables.
Maintaining Existing Customers
Next, I want to talk about how to maintain your existing customers and the associate pricing strategy that may be deployed. The chart below is quite similar to the chart above but the labels on each axis are a bit different.
A: First, as the solution becomes successful over time the incremental benefit each year reduces. This is known as diminishing returns as the company becomes more efficient. In my experience the Finance department in various companies will challenge why they should keep paying for the software when the annual incremental benefits are less than the annual software costs. While that may be true what needs to be explained is that without the software the company will not be able to maintain its realized benefits. If the company stops paying for the software, then the incremental benefits will fall back to previous levels, or even lower since the staff are no longer trained to perform the manually methods previously deployed prior to software installation.
It is very important that your contacts in the company are armed with these facts to ward off the sceptics in the company. And in my experience, there are many skeptics in each company.
B: If a current customer wants to consider changing to a competitor then there are significant switching costs that will be incurred. These switching costs can possibly include new hardware, new training of the staff, and new integration efforts both incurring costs from the competitor and the customer’s internal costs of resources. Switching costs can be quite expensive for a company and often the customer may not realize these costs before they embark on a new venture. It is important to subtly inform the customer of these costs and try to determine what you can do to make sure you can offer something that is more affordable than switching.
C: Over time your competition may develop alternate products or even some software with better features. This relates back to the Cost/Benefit Analysis and Switching Costs. In fact, all three dimensions are interrelated when understanding the value that your customers are willing to pay and to maintain their service contract.
In closing, keep in mind that although the example above is for pricing software, many of the variables outlined can be used for understanding how to price other goods or services as well.
Three Tree Solutions 