How much is that software worth, anyhow?

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by: John Caddell

Pricing business software licenses is one of the gnarliest pricing jobs around. My pricing bible is "The Strategy and Tactics of Pricing" by Tom Nagle. I took a class with him at Boston University around 1990 while I was studying for my MBA, and this book has been on my bookshelf every since.

Nagle says that you should take into account incremental & avoidable costs, economic value of the product, and competition when pricing a product. A good price balances each of these factors to maximize profit.

Enterprise software poses some challenges on this front. First, incremental and avoidable costs are very small (how much does a CD cost? a download?), which creates a dimensioning problem (should we price it per processor? per seat? per transaction?). Economic value is difficult to calculate (especially with complex software programs that span many departments), and prospective customers are often reluctant to let you really see the value they'd receive, for fear that they'd compromise their negotiating position. And good pricing information on competitors is rare, since deals are often priced on a one-off basis–never mind understanding their strengths and weaknesses enough to create the proper premium or discount.

Some of these problems, I think, have helped the Software as a Service (SAAS) industry. Since SAAS bundles in application support and hosting, it has a much clearer incremental cost picture, which helps justify a certain price level. Also, SAAS applications have been smaller in scope, yielding an easier economic value assessment for both suppliers and customers. And competitive pricing information is available, given the internet-based selling models of the SAAS providers.

There are certainly lots of reasons for the recent rise of SAAS, but I think pricing transparency is one of them.

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