Price selection can be the most difficult and elusive part of marketing. How do you know if your selection is right? What happens if it is too low? What happens if it is too high? What if you need to change it? Is it possible to market to all types of customers—those who want cheap, those who will pay more, or those who won't buy if the price is too low? Sometimes pricing feels like a shot in the dark, but it really doesn't have to be that way. This post will explore different ways of pricing software applications, how to modify them if needed, and approaches for setting pricing tiers to ideally attract as many customers as possible.
Price, another “P” in the 4 P's of Marketing
The traditional 4P's of marketing are Product, Promotion, Price, and Distribution (Place). I covered some distribution options in the first part of this marketing series, the ESD Equation.
Economists will tell you that pricing is based on supply and demand. If the supply is limited, and the demand is high, you can ask a higher price. People will pay more if they can get their hands on a product over others. Think of it like an auction. Demand can be increased by lowering your price, but you could also decrease overall revenue. In some cases, the price can be too low and demand will actually decrease. This case can happen if the low price gives a perception low quality. An example is a business product priced well below of the pricing window of the competition. Consumers may not take the product seriously. The trick to pricing is to find the perfect mix. You want to take the equation Price x Volume = Revenue and make it maximize your revenue. Unfortunately, economics is not an exact science, so this simple formula is not always simple in practice.
Methods for determining a price
Two common methods exist for setting a price—Cost Plus and Market Pricing. Different markets will influence which method is most effective. However, a mix of the two is the most common approach. I come from a background in Program Management in the Automotive Industry. As an automotive supplier we were lucky to use a Cost Plus method, but found as more suppliers entered the market, we were forced to address Market Pricing. As in making automotive components and other manufacturing of physical products, a cost per unit is associated with each incremental unit of a product, therefore it is essential to account for that cost—the price cannot dip below that cost for very long, if at all. On the other hand, with software, especially downloaded software where no physical components exist, you will usually find Market Pricing in place.
Cost plus pricing is setting a price based on its unit cost. Cost Plus pricing is actually quite simple: Cost of materials for one unit + Cost of Labor to assemble one unit = Cost of One Unit. Add on a profit margin to determine a price. This profit margin is called your “Gross Margin” per unit. Multiply this price by your (projected) volume. Subtract your “overhead costs”—sales, general, administration (SG&A), which includes design and engineering—and you get your Net Margin or net profit. A company will start with a standard profit and work backwards to get the optimum price to cover all projected costs and budgets, but the bottom line is that the price cannot dip below the Cost of One Unit. So, with Cost Plus, you establish your price upfront and you select the profit you want to make. This pricing method works best when demand is stable and well established and price does not greatly affect demand.
Market Pricing is setting a price based on consumer demand and perception. If the demand is high, you can set a higher price. If your price decreases demand, you can lower your price to increase your volume (demand). Software tends to fall into the Market Pricing category because the Cost of One Unit is usually low, or zero if you sell mainly via downloads. The costs associated with your project are ALL SG&A (including the developers' salaries), so the Gross Margin is essentially equal to the price.
So where do you come up with a starting point for this type of pricing? How high can you go, how low should you go? Of course everyone wants to charge the highest price possible, but it can cause a marketing nightmare of a backlash of poor reviews and community non-acceptance leading to poor sales performance. You must, however, be also cognizant of a too low price. If the market is small and your price is low, you will eventually reach a limit for your maximum profit and you still have to cover the SG&A. If that maximum is close to or below your SG&A costs, you will quickly find yourself out of business. However, as low priced products drop out, the market pricing will increase, which can help all companies' profits. Market Pricing is most common in a consumer market, where demand fluctuates, and competition can easily enter the market.
Choosing a Starting Price
Luckily, market pricing is the easiest to research. Even if the market is new, similar markets can be used to determine the best price. Of course, sometimes mistakes are made, but prices can be adjusted accordingly. To determine a fair market price, look at the competition's pricing. Compare and contrast your features and quality against the competition or other similar apps in the market. Based on these considerations, a good price point for your product can be found.
As a rule of thumb, it's better to price your product a little high to start—as it is easier to come down in price (or discount) with less consumer objections, than with a price increase. An introductory price is one method for starting out with a lower price to generate early higher demand. When an increase does occur, consumers will assume the introductory pricing has ended and will better accept an increase.
Competitive analysis is especially useful if you can also determine the volumes your competition is seeing. You will get a window into what volumes are associated with a certain price point, level of quality, and feature set. If you find your product is comparable, you can sell at a slightly lower price and possibly generate more demand for your product. Alternately, you might find that the differences in prices do not affect demand or net revenue, so you can elect to keep yours at a higher price.
A New Market, Real World Example
Sometimes a market will be new and price selection will feel like it is being done in a vacuum. No good information seems to exist. Nonetheless, methods do exist to help you pick the right price. Take picking a price for the newly released Apple AppStore for iPhone as an example. One place to start the analysis is the existing mobile app market for smartphones. Check out the competition on the Electronic Software Distributors, such as Mobihand and Handango. (Pricing within mobile software ESD's is generally fixed between ESD's, by contract (developers must charge the same price everywhere or invalidate agreements), so analysis at one distributor should be enough.) List the competition, note features, rankings, even downloads, and price. Take into account the age of the product (does it have a modern UI?), the ratings (new and old). Be sure to compare pricing of similar products within the mobile market—look at how similar Blackberry, Windows Mobile, Palm, and Symbian apps compare. The more data you have, the better you can determine your price point. If you also sell in this current market, you can also use your sales numbers as a guide. You cannot stop here, however. A developer must be careful because it is also easy to make inaccurate assumptions for the new market. If you assume the AppStore market will be the same as the existing mobile app smartphone market, you may set a price too high or too low. Just look at the actual resulting AppStore pricing, where prices are much lower than the existing smartphone app market. It's easy to pick out the developers who only based their prices on the current market—their prices tend to be too high.
Next, consider what other consumer markets Apple has targeted for its iPhone. Apple is also targeting the general population of cell phone users. These apps are priced very low, but also sometimes have lower capabilities and feature sets. Apple is also targeting its fanbase of iPod and Mac users. iPod apps are likewise priced rather low, but Mac apps can sometimes command a premium over their other desktop counterparts. A quick look at the desktop vs mobile app markets will also give you further information. Mobile apps, although some as powerful as their desktop counterparts, sell for considerably less.
The AppStore market has a couple of unique qualities. The consumers come from a combination of markets: smartphone/PDA, cell phone, iPod, and Mac (and maybe iTunes song/video). Secondly, the developers will also be coming from these various markets. A smartphone app developer may be reluctant to price his application low, but an cell phone app developer could be used to cheap pricing, and have no problem setting a 99 cent price.
All these factors will affect the ultimate price, but if the volume (demand) does not provide for a good net margin for covering costs, the pricing will eventually creep upwards as low-priced app developers can't survive and either exit the market or raise prices. If the demand and volume is huge, pricing may come down even further, but competition will increase as everyone wants a piece of the pie. As the individual developer, you will have to gauge what you can afford to price your app vs what the market will bear. Your success will hinge on understanding the marketplace.
Attracting a Range of Price Sensitive Customers
Once you have priced your product there are many ways to increase your profits and your demand. The market is not made of only one type of consumer. Some will love your price. Some will think your price is too high. These latter consumers can be gained by offering discounts, such as coupons or flat rate discounts. Coupons are great because if someone really wants a lower price, they will go through the extra effort, but someone who was satisfied with your price will just buy it at full price and not bother with the coupons. Whereas, a straight discount will give a lower price to both consumers and might be a lesser choice for maximizing revenue. Another way to attract these price sensitive customers is to provide a “Lite”version where features are limited, but the price is lower and within their expectations.
Some consumers will actually think your price is too low. If the price is below the competition, your product could be perceived as lower in quality or that your company isn't serious—not knowing how to price a product right. You may find that increasing the price will actually increase demand, surprisingly. One way to gain this consumer is to offer a “Pro” version, which could also change the perception of your product and satisfy those who are looking for feature-rich applications rather than cheap apps.
Another way to add to your market volume is to bundle products. A customer may only want one of your products, but does not plan to buy others. If you offer a discount for buying both, you will sell more products, and only at a slightly lower price. A common example is the “Buy 3 tires, get one free” sales pitch. Most consumers are apt to replace one, maybe two tires at a time. But if they see what a deal they can get by just buying one more tire, the tire store will sell four tires per customer instead of one or two. Consumers always consider buying more than planned when a deal is presented to them.
What if I Have to Increase My Price?
After studying the initial revenue results, sometimes prices will need to increase. By starting out with an introductory rate, you lay the groundwork for a better accepted price increase. You can also justify increases by adding new features, or releasing a Pro version. Some companies charge an upgrade fee as a way to roll in a price increase. Some techniques for gaining current customers' acceptance of price increases are offering to them the old price for a limited time, providing a discount for a future product, or justifying the increase by other factors that have been established publicly (such as an increase in commissions from the distributor that has gotten a lot of press). Prices can be increased with the right approach.
All in all, setting your price is a difficult decision. However, in many cases you can get a good idea of where to start by studying the competition and the market before jumping in. If you price it incorrectly, increasing the price can be accomplished by varying techniques. Plus, with online software, you can change prices in real time—no need to change or scrap any physical packaging. Setting price tiers can also increase your overall volume by attracting a varying range of consumers. Of course, lowering your price is usually well received by consumers. Remember to take into account your costs so that you don't set a price that will eventually drive you out of business. Conversely, do not set a price so high that you see little, if any, volume which also affects your revenue. With a little investigative work and some trial and error, a developer can easily find a sustainable pricing strategy.