03033 Setting Prices: Dark Art or Evil Science?

Setting prices for a software product is definitely one of the more daunting tasks for a Product Manager. While it’s a little easier to set the price for shrink-wrapped, mass-marketed software for consumers, finding your way to a satisfactory and satisfying price for enterprise software is like finding your way through a labyrinth.

It’s hard to tell whether coming up with a pricing scheme is a dark art, bordering on witchcraft, or an evil science, combining a methodical, experimental approach with cynicism about human nature.

In the end it’s the gut that decides it. Maybe that’s why the whole exercise seems so mysterious.

Read on for tips on setting software pricing, advice based not on how things ought to be, but how they really are.

There’s Good Advice Out There

There’s a great deal of sturdy, comprehensive advice that you can peruse when you sit yourself down to set pricing. You can start with Software Product Management Essentials, by Alyssa Dver, who was interviewed in a past issue (see 03015 An Interview with Alyssa Dver). In addition to getting a solid foundation from books like these, here’s some advice like the kind journalists get when somebody from the administration decides to speak off the record.

People Use Logic to Justify Emotional Decisions

You’re in for a hard time if you want to craft an objective solution that points you to the “right” price. Setting the price may very well be just like choosing which software to buy, meaning that people use all sorts of logic (60-page RFPs with weighted scores) to justify an emotional decision to go with the vendor they like the most.

Just like a successful sale, it’s okay if the outcome is pretty emotional and irrational. But it helps, for those more logical ones among us, to be able to justify the price with a logical explanation (1.5% of your department’s budget, $400.00 per user, etc.).

Begin With the End In Mind

I doubt Steven Covey, who defines “Begin with the end in mind” as one of his Seven Habits of Highly Effective People, meant it this way, but …

In order to get to a price that you like, you’re probably going to need to start with the price you want, then figure out the logical justification for that price.

It may be that you choose your price by figuring your company’s annual revenue goal, then dividing that by the number of sales you expect to make given the sales force and marketing plan. Not exactly idealistic, but definitely realistic.

Models People Love to Hate

When it comes to pricing models, stick to the tried and true. A whole lot of novel ideas were floated during the dotcom days, but they rarely stuck. Take gainshare pricing, for example, where you share in cost saved or revenue added due to the product. It’s just too hard to ensure gain with software, especially if you don’t have a say in the business processes. It’s a nice idea, but it doesn’t hold up in the cold light of day.

Also, models based on how big a company is in terms of sales are viewed with great suspicion, especially by CFOs. “Why should I have to pay you more than XYZ company down the street for the same system just because we have more revenues?” they ask, and rightly so. Unless you’re in a situation where there’s a consistent correlation between total revenues and number of users, transactions, or processing power, stay away from this one.

Don’t Get Caught In Your Own Web

When you come up with a pricing model (one that’s simple enough for anybody to explain and understand), test it out by applying it to existing customers and serious prospects, to check that the results make sense. Be wary of a scheme that winds up shortchanging you or producing skewed results in typical customer scenarios you will encounter.

Pricing the Ends of the Spectrum

Your pricing model may hold up pretty well for the bulk of your market, but you’re likely to find it skews at the low and high ends of the spectrum. That’s okay, it doesn’t have to be right for everybody.
Identify rock bottom pricing that serves as a minimum. Also identify discounted pricing for the high end of the spectrum. Companies expect to benefit from economies of scale as the product scales up.

It’s a Gut Thing

Unless you’re selling a commodity, there aren’t many guideposts out there about what the market will bear. Even when it’s a commodity, the power of the brand can mean that customers gladly pay double or triple the price of a competitor.

In the end, you’ll know if the price is right by listening to your gut, just as your customers listen to theirs.

— Jacques Murphy, Product Management Challenges


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