Instigator Blog

Deciding on pricing for a software product is never easy. There are a lot of variables and unknowns. There are certainly no guarantees. But there are some fundamental things to look at when deciding on how to price your software product.

1. Frequency. One of the first major decisions you have to make is on frequency. How often are you going to charge customers? What is the model? These days, most software is sold on a subscription basis - Software-as-a-Service - either monthly or yearly. But there’s still plenty of software that’s sold on a one-time basis, with the possibility of charging for future upgrades.

   If you decide to go with a subscription model, you then need to decide whether or not to offer yearly pricing. It’s great for cash flow, but often less appealing to customers. A lot of software companies offer monthly and yearly packages, with incentives to secure long-term relationships. There’s no right answer. Each has its pros and cons. The most important thing is to keep the pricing simple. Don’t overwhelm with options.

2. Secondary Revenue Sources. Charging for the software is obvious, but there are other ways to make money from a software company. Think: training, support and upgrades. Some software companies choose to give their software away (for free or very cheaply) and make their money off training, support and upgrades. It’s not an unreasonable model, although when it comes to charging for training and support, more and more customers expect those things to be thrown in, and they expect the software to be so easy that they won’t be burdened with training and support needs. Telling a customer they’ll need a 5-day intensive training session to use your software will make it a harder sell. Nevertheless, think about these things and how they impact pricing, because there are advantages to spreading out the pricing across multiple items so customers don’t get hit with “one lump sum.”
3. Packages. Software companies often have more than one version of their product. Alternatively (and this seems to be growing in popularity), they create usage barriers and charge increasing amounts for increased usage. This is called price discrimination, but it’s not really as bad as it sounds. The idea is that people who use your software more, pay more.

   I don’t disagree with this, although I find the usage limitations can be quite arbitrary. And that can prove frustrating to customers. But it can also help a software startup understand how much usage its product is getting and what the sweet spot for pricing might be.

   At Standout Jobs we decided against price discrimination. We created two product offerings, targeting different markets, but didn’t go with increased pricing for increased usage. There are two reasons for that: First, we didn’t want to set arbitrary limits without learning more about customers’ usage patterns; and, second, there were no good values to assign limits to. For example, we might have discriminated based on the number of job postings; but our value proposition is more than just job postings. We could have discriminated on the number of candidates a company received, but it seemed like you would be punishing employers for their success. We chose to keep things open and accessible, without setting limits, but it’s a model that a lot of software companies use.

   And don’t forget fremium where you maintain one version for free, but charge for upgraded versions or added features. It’s a model that many people believe strongly in, and continues to gain traction.

   We decided against a fremium model for Standout Jobs. It wasn’t a decision made lightly. We looked at all of the factors listed here and took them into consideration. We were driven by a few key factors: our channel partner strategy, market conditions, buying habits, and the product itself. We didn’t want to break the product up into pieces and offer a lesser product for free, and we didn’t want to assign usage barriers on free versus paying versions.

   No matter what: keep it simple. Don’t launch with 10 different plans. Don’t make it confusing to understand how a customer moves from one level to the next.

4. Competition. This is an obvious place to look for pricing data. What are your competitors charging? At minimum, you should know, because your customers do. It might be easy to say to yourself, “Let’s price ourselves cheaper than everyone else,” but I would argue against that strategy. At that point, you might as well be free. Price is important, but it’s not the only factor in a purchasing decision. Oftentimes when people are looking at price quotes from vendors they throw out the cheapest and the most expensive … it’s like scoring in figure skating.

   You need to know and understand your competitors’ pricing. Why are they charging what they’re charging?

5. The Wrong Competition. The “wrong competition” includes those companies you’ll be compared to even if you don’t actually compete with them. This might be similar vendors in different verticals, or companies you’re “thrown in with” because they needed to “put in a box.” Truth be told if this happens a lot, you have other problems, but you should understand who these companies are and what their pricing looks like. You might find some valuable information as well, which you can use to your advantage.
6. Customers. Existing customers are a great source of information on pricing. But be careful — if you’ve been giving something to customers for free and then you ask them to pay, the response may not be extremely positive. They’ve been pre-conditioned to accept your product for free; the change may shock them. Nevertheless, you should canvas your customers early and regularly on what they would pay for your product … and what they would pay for future versions, if it had X or Y or Z.

   You can also find out from customers what they’re paying for similar products and services. Be a bit careful about this, and approach it delicately, but for those customers where you have a really good relationship, it doesn’t hurt to ask.

7. The Market. You need to have a general sense of the market and what it will bear. You need to understand how software is purchased in your market, by whom, and when. Know Your Market. This is a catch-all category for pricing, but the more you know about your market, its buying habits, etc. the better off you’ll be. Do you know how much a divisional manager can put on her credit card without seeking approval? Do you know if software purchases over $5,000 have to be put to an RFP?
8. Internal Numbers. You need to have a strong handle on internal cost numbers and revenue projections. These numbers shouldn’t dictate how you price your software product, but they certainly have an impact. For example, what happens if you charge $120 more per year per customer? Does that have a significant impact? How many fewer customers do you need to break even if you charge $10 more / month?

   For a lot of software startups - targeting the small and medium size markets - a slight increase or decrease in pricing can have a significant impact. You need to have strong economic models in place that you can experiment with to understand these price differences.

   If you’re running a subscription-based business you should look at monthly and yearly renewal rates; because these are critical to your success and they can impact where you set pricing.

   You should also consider the likelihood and opportunity of increasing your pricing in the future. No one said your pricing had to remain the same forever.

Pricing Strategies to Consider

So what else needs to be considered when pricing software?

1. Don’t make it a moving target. Pick your pricing and stick with it. Not forever, and not if you’re horribly wrong (but you won’t be!), but try and stick to your guns. There are ways of testing various pricing options without publicly changing it on a regular basis.
2. Target specific markets differently. Different markets have different appetites for different pricing and different buying habits. Startups rarely pay for anything (for example), but you might still want to leverage startups for buzz, initial traction, etc. So segment your market, consider even verticalizing your product slightly, and sell at different price points. But don’t do it all in one confusing mess from your main corporate site. Think about implementing micro-sites and other marketing strategies.
3. Limited time offers. There’s no reason you can’t offer lower pricing for a limited time offer. Or a special introductory offer. But don’t rush to lower your pricing at the first sign that things aren’t going well. It’s an obvious, knee-jerk reaction but it doesn’t guarantee success and can be perceived quite negatively.
4. Don’t sell yourself short. It’s easy to worry about your pricing. It’s easy to worry about a lot of things…But don’t sell yourself short and cut away at the value you’ve built. In some markets, they’ll equate price with value, so coming in too cheap will send the wrong signal. It’s easy to convince yourself to sell too inexpensively (or give things away for free), but don’t do it without really understanding all the data and collecting as much information as possible.

Pricing isn’t Easy

Pricing a software application isn’t easy. Even if you check off all the items above, you won’t know for sure if you’ve picked the right pricing. And I suppose you could second guess yourself forever, even if you’re gaining traction. But there is enough information out there to make a good decision. And once you do gain traction - that’s the perfect time to experiment further, segmenting your market, looking for new verticals, tweaking pricing with different options, etc.

If you run a software company or startup, how did you decide on your pricing (even if it’s a free or fremium model)?