Pricing information products

June 08, 2010 01:14 pm | Updated 01:14 pm IST - Chennai:

Shrink-wrap tax software, video games, enterprise resource planning (ERP) platforms, software embedded in physical devices such as mobile phones and automotive engines, hosted applications of the type sold in the form of SaaS or software as a service… How do you price these products? You may find answers in ‘The Price Advantage,’ second edition by Walter L. Baker, Michael v. Marn, and Craig C. Zawada (www.wiley.com).

A chapter devoted to ‘software and information products’ introduces you to the five key characteristics of these products that make their pricing issues and opportunities distinctive. One, marginal production costs are at or near zero, with no meaningful capacity constraints. “Burning one more CD or DVD is cheap (ask any digital content pirate).”

As a result, gross product margins can be well over 90 per cent, but at the same time, companies may be prone to discount because the perceived margin ‘headroom’ is so large, the authors explain. They remind that the marginal cost to sell one more unit may not be negligible due to significant direct per unit selling costs in the form of sales commissions, packaging, documentation, account registration and so on.

The second feature of information products is that upfront costs to develop, market, sell, distribute, and support can be relatively high. As a consequence, companies come under extreme pressure to capture high volume and market share quickly, even at the cost of yielding to strong downward price pressure.

Product malleability

Greater malleability, the third feature, is about the ease with which companies can create different configurations. “For example, the ‘same’ digital audio song can be sold at different quality levels – MP3, CD, or Super Audio CD (SACD). It can take multiple forms: altering core product benefits (e.g. quality or features); or bundling/ unbundling elements of the offering (e.g. selling a software suite vs individual applications).”

Take for instance a product that has ten discrete functions or modules. The vendor can create a low-cost ‘base’ version with two of the functions, to drive penetration, then upsell the other eight functions as separate, optional modules, instructs the chapter.

Fourth, information products have the potential for high switching costs, the authors mention. They observe that users who have invested time and energy installing, configuring, and learning how to use a software may be unwilling to switch to an alternative or newer version of the product because they want to avoid further investment.

An interesting example cited in the book is of online information-sharing communities that allow dues-paying users to upload content and view other members’ content, as in the case of online dating services. Here, since switching costs arise from potentially having to re-create one’s profile and losing connectivity with other users in the community, convincing a potential customer to move to a new offering can be an uphill task.

Winner-take-all scenario

And finally, an intriguing characteristic of information products is the potential to culminate in ‘winner-take-all scenarios,’ in the wake of strong positive network effects derived from market standards. Baker et al. recount how Betamax lost to VHS in the format battle for videocassettes in the late 1970s, and HD DVD lost to the Blu-Ray format for high-definition optical discs in the early 2000s.

Another example, of a company that could create value in an indirect way, is Adobe which ‘established the .pdf portable document format standard by giving away the software application that enables people to read .pdf files (Reader) and selling the Acrobat software that allows people to author and modify .pdf files.’

Likewise, online newspapers too try the ‘creating value tomorrow’ strategy, by allowing users to view current stories and editorial content for free, and thus building a loyal reader base, but then charging readers for access to archived content.

Software licensing comes in many forms, ranging from named-user model to usage-based pricing. When choosing a licensing approach, align it with the drivers of customers’ perceived benefits while keeping it relatively simple to communicate and administer, the authors advise.

“For example, B2B software applications often price based on the number of users (e.g. one licence fee is incurred per user); this is appropriate for many applications where benefits scale, or ramp up, based on the number of people using the products (e.g. engineering design software).”

Hockey stick

The book addresses a complication faced by many software and technology companies: the end of quarter ‘hockey stick,’ with half or more of quarterly sales happening in the last few weeks! “Savvy buyers exploit the pressure on salespeople to make their quarterly quotas; they play hardball and close deals only at the 11th hour, and at substantially discounted prices,” reads a note of caution in this context.

Although such ‘hockey stick’ phenomenon may occur in many other types of business, the authors are of the view that software companies selling perpetual licences with a large upfront fee are especially vulnerable to this type of manipulation.

Their recommendation to companies facing this ‘sticky’ dilemma is a migration from perpetual licence model to subscription model, where the impact on the current quarter of closing a deal one or two weeks into the next quarter is significantly lessened. “This approach reduces internal perceived risk as well as the incentives to discount significantly.”

Suggested addition to the professional marketers’ shelf.

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