Software Pricing

MTAT.03.244
Software Economics
Session 10: Software Pricing
Marlon Dumas
marlon.dumas ät ut . ee

Readings of previous weeks
• Week 9: Hal R. Varian.
Economics of Information Technology. Draft
paper, 2003.
• Week 10: Neil Davidson. Don't just roll the dice.
Online book, 2009.
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Outline
• Economic Factors of Software Pricing
• Case Study: Nuway Software
Warning: This is a discussion-oriented class, if
you don’t discuss, there’s no class…
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Information Goods
• Software products have an unusual cost structure:
– High fixed costs of production
– Low or zero variable costs of production
• Example: a well-known software company spends
100s of millions of dollars developing each version
of its OS. Once a first copy of the OS has been
developed, it can be replicated almost costlessly.
• This cost structure characterizes a class of
technology products termed information goods.
• It includes software, but also video, music, books,
…
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Software versus Information Goods
• In addition to being an Information Good,
software has additional characteristics:
– Sometimes needs to be developed uniquely for a
customer
– Can be useless without other elements such as
training, support, configuration, or business process
change
– Sometimes highly tied to data (e.g. mapping software)
– Software is often stacked on top of software…
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Pricing Strategies
• Cost-plus pricing (e.g. consultancy, reseller)
• Value-based pricing
– Maximize revenue (to build market share)
– Maximize profit (rational strategy – more later)
• Target return pricing
– Achieve revenue or quantity target
– Achieve profit target
• Psychological pricing
– “Quality” leadership pricing
– “Discount” pricing
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Pricing Models
• Pricing strategy is meant for our internal
decision-making
• In addition to a pricing strategy, we need a
pricing model so that we can explain our pricing:
– Fixed-fee pricing
– Price discrimination
– Bundling
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• Flat perpetual fee
• Flat periodic fee
Fixed-fee Pricing
• When to choose which?
• What price should we charge?
– Depends on the cost,
• Fixed cost (once incurred, it becomes a “sunk cost”)
• Variable cost (e.g. support services)
• Maintenance cost!
– But also on the demand curve, see example at:
http://www.joelonsoftware.com/articles/CamelsandRubberDuckies.html
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Fixed-fee Pricing (cont.)
• Limitations of fixed-price
– Does not take into account customization / assumes
all customers are the same
– Does not capture consumer surplus (good and bad)
• Leads to price discrimination…
9

Price Discrimination
• First-degree price discrimination
– Price depends on the customer
– Mass customization / personalization
– Does it apply to software?
• Second-degree price discrimination
– Price depends on “product variant”
• E.g. Adobe Acrobat
– Price differentiation based on quality or usage/volume
• E.g. volume licensing, usage licensing, site licensing
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Price Discrimination (cont.)
• Third-degree price discrimination
– Different prices for different groups of users
– Examples: private users versus commercial users,
student/academic licenses, geographical regions…
– Can you think of others?
• Price discrimination based on purchase history
– Old versus new customers
– Upgrades versus new licenses…
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Bundling
• Selling multiple goods for a single price
• Example: what software am I using now?
• Sometimes, software and hardware are
bundled…
• Sometimes (perhaps not often enough),
software is sold with guarantees it will work…
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External Factors of Software Pricing
• Competition of course, including open-source
• Lock-in, switching costs, standards
• Piracy
• Network effects:
– Demand for a good depends on how many people
acquire it, e.g. 3G mobile phone, Skype, …
• System effects:
– Some products are useless unless they are combined
with other products to form a system, e.g. products
without support and training may be useless
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Case Study: “Nuway Software”
• Nuway is a 4-year-old company selling highly
customized software, but based on common
toolkit
• Products sold are non-mission-critical
• Pricing model based on cost + margin (costplus)
• Should Nuway start selling its Nulogic toolkit as
a software package and with what pricing
strategy?
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Class Discussion (in groups)
• Enumerate arguments for and against productbased
marketing of Nulogic? Do you favour or
oppose this move? What additional information
would be helpful in making a decision?
• If Nulogic was marketed as a software package,
what pricing model would you adopt?
• If Nulogic was not marketed, what other
opportunities exist to capitalize on the existing
Nulogic investment?
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Homework
Pricing/Business Model Analysis
• See “Assignments” page on course’s Web site
• To be completed in teams of 2-4 members
• Worth 5 points
• Report due 29 November at 10:15am
• To be submitted via e-mail
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Further Reading
• Paper by Rajala, Rossi & Tuunainen:
A Framework for Analyzing Software Business
Models. In Proceedings of the European
Conference on Information Systems (ECIS),
June 2003.
• Informal discussion board on “The Business of
Software”:
– http://discuss.joelonsoftware.com/default.asp?W1341
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