One can make a strong case that setting prices for software is a relatively more challenging task compared to setting price for other products and services. Since all software essentially comes down to lines of code, why is it that in the software industry, prices range from free to multi-million dollar enterprise licenses?
One reason why software pricing is challenging is because a conventional “cost-plus” pricing approach doesn’t readily fit. Compared with tangible products like medical devices or specialty chemicals, software has very low variable costs. Instead most of the cost is incurred during the upfront development phase. Accountants would say that such costs are “sunk” and therefore should not a consideration in decision making. So does this imply that software should always be priced low?
Now suppose you are a software company that builds applications for the call center industry and your latest product release offers tremendous productivity gains. Pricing on a variable cost plus basis may certainly make it easy to sell, yet this would be a very poor pricing decision. To illustrate this point, consider the following value model based on a real-world case from one of our consulting colleagues. The offering is a call center software application with voice recognition and other cutting edge features which provided much more functionality versus conventional applications.
As you can see in this value model, there is a large amount of economic value created by the specific benefits (green bars) provided in the software application. Compared to the existing software (blue bar) this is nearly a 7X improvement! Given that, a $1.50 price (custom price) can be justified. The lower right box show the split of the $2.75 worth of differentiation value: $1.65 for the customer and $1.10 for the software company (“Us” meaning the software company). The software company successfully used this analysis to capture higher margin and growth.
Note that all the values are expressed in a “per call” unit of measure. Choosing an appropriate unit of measure (also known as price metric) is extremely important when creating a value model such as this. The price metric needs to reflect the customer’s business reality. Since revenue and cost per call are key performance indicators in call center operations, it makes perfect sense to compare competing software offerings using this price metric.
Conclusion: Software companies especially need to differentiate themselves based on the economic value they create for customers. Better features and functionality are not sufficient in communicating value. Instead, demonstrating specific, quantified impacts to the customer’s business operation like shown in this call center example is a far better approach. For additional commentary about the software industry, see: A Tough Year for Software.
Note: this is another in a series of value models to illustrate current business topics using the LeveragePoint for Value Management solution.