The enterprise software market is almost always a paid one. So how do you price a brand new enterprise innovation?
Software is one of those “magical” goods in microeconomic terms: it has virtually no Marginal Cost. So how do you get a customer to pay you thousands—or even millions—of dollars to buy something you can reproduce for free?
If you’re looking for a “magic formula” to calculate the price of your software, you can hit the ‘back’ button. You won’t find that here. Instead, if you are looking for a strategy to establish a tangible, defensible price for an intangible innovation, read on…
STEP 1: Price by the value you create
There are many, many software pricing models. However, at the end of the day, you’re going to have to defend your quoted price. This is easiest to do, if you price based on what your customers value. Figure out what units your customers use to measure value, and then pick a price model based on those units. Now you have Value-based Unit Pricing.
STEP 2: Use ROI to establish your “list price”
Enterprise software purchases are investments in “promised value.” However, it will take a lot of work for your customer to “unlock” that value: they have to get budget approval, initiate a program, execute it without over-runs, integrate it into their business operations, etc. To make it worthwhile, your software will have to provide a large return on this upfront cost—at least 40-50%. If your software cannot do this, it will never clear the triple wicket of business sponsor, IT manager and procurement manager.
Look at the market—and more importantly—what it costs your customers to do the very thing you are trying to automate or improve. Calculate the cost per year and subtract enough for a 40% ROI. Now you have your List Price. (Note: if there is already software you want to displace, price your product to make replacement of it something that yields a 40% ROI. Why should anyone take the risk to buy your product if it is not good enough to do this?)
STEP 3: Use co-development to establish your “maximum discount”
When you go to a new customer with a new product and quote a price, they will immediately ask for a discount (especially if you are new to the market). How do you insulate yourself against this? Establish a fixed lower bound for your software that you can legitimately never price below (at least until 1-2 generations pass and everything changes).
The best way to do this is by using co-development partnerships. Co-development partners not only buy and use your product; they provide added time, people, teamwork and insight to make it better. (This is not only good for them, it is also a path you can use to establish market leadership). Co-development should be rewarded with your Maximum Discount.
Once you have done this, whenever a follow-on customer pushes for a larger discount, you can point out that your co-development partner only received your maximum discount because of the work and time they contributed.
STEP 4: Build your price rate cards
You now have all the tools you need: value-based unit pricing, list price and maximum discount for co-development. You are now ready to give your sales and contracts team all those wonderful spreadsheets to calculate the price of your new enterprise software—at least until the next generation of innovation arrives…
A Few Closing Remarks: Two things to NEVER do when pricing your software
Give it away for free to get the deal*. You will inevitably get enticed to give your software away for free to get a major customer. Don’t fall into this trap. Once you have done this you have established your software truly has zero Marginal Value (not just zero Marginal Cost). It is really hard to negotiate UP from zero. Give away add-ons, charge implementation at cost—do anything—but don’t give away enterprise software for free (*unless you are using a Freemium model, of course).
Demand premium pricing. You may be so proud of your latest and greatest software that you will want charge more than “legacy providers” for your innovation. Unfortunately, unless you can demonstrate—at a visceral level—that your software provides value that no one else can, you have destroyed the ROI value proposition of your product.
Article first published as How to price new enterprise software at Oulixeus