MTAT Software Economics. Session 10: Software Pricing

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

2 Readings of previous weeks Week 9: Hal R. Varian. Economics of Information Technology. Draft paper, Week 10: Neil Davidson. Don't just roll the dice. Online book,

Draft paper, 2003. Week 10: Neil Davidson.

3 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 3

4 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, 4

its OS. Once a first copy of the OS has been developed, it can be replicated almost costlessly.

5 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 5

useless without other elements such as training, support, configuration, or business process

6 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 6

7 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 7

strategy, we need a pricing model so that we can

8 Fixed-fee Pricing Flat perpetual fee Flat periodic fee 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: 8

Depends on the cost, Fixed cost (once incurred, it becomes a sunk cost ) Variable cost

9 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

10 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 10

Second-degree price discrimination Price depends on product variant E.g. Adobe Acrobat Price differentiation based on quality or usage/volume E.

11 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 11

Examples: private users versus commercial users, student/academic licenses,

12 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 12

Sometimes, software and hardware are bundled Sometimes

13 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 13

14 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? 14

non-mission-critical Pricing model based on cost + margin (costplus) Should

15 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? 15

What additional information would be helpful in making a decision?

16 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 16

17 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 Informal discussion board on The Business of Software : 17

In Proceedings of the European Conference on Information Systems (ECIS),

Because of inherent tradeoffs between marketing mix elements, pricing will depend on other product, distribution, and promotion decisions.

Because of inherent tradeoffs between marketing mix elements, pricing will depend on other product, distribution, and promotion decisions. 10. Pricing Strategy One of the four major elements of the marketing mix is price. Pricing is an important strategic issue because it is related to product positioning. Furthermore, pricing affects other