2 Minute Method for Pricing Software

Regarding my 2-minute pricing method for new software, I'd like to briefly describe the technique (it may take more than 2 minutes to digest it).

The entire method, with a discuss of theory, basis, and data is provided in the paper: P. Betten, "Some Guidance on Software Pricing", Proceedings of the Technology Transfer Society, Proceeding of the 1997 Annual Meeting held July 21-23, 1997, Denver, Co., (pp. 217-222). The following is the "Cliff Notes" (or classic comics) abstracted version, and one should read the paper for a complete presentation.

The paper discusses how I price shrink-wrapped software for both single and multiple users. My basis for writing the paper was that I could find no logical method for pricing in the literature or from advice. Typical valuation methods (i.e. 25% rule, net present value, etc.) didn't work because the software is new, markets are unknown, and any market assessments are in the future or resource limited; yet there seems to be some company immediately calling and wanting a price quote. I've also come to the conclusion that pricing is important, besides knowing a royalty rate, because one can sell software directly, check the price if sold through a distributor, check business plans/equity positions via pricing, etc. This method is empirical and based upon 2 years of software pricing. The 3 steps are:

1) The 5% Solution: The first estimate of the software price is found by taking 5% of the Modified Replacement Cost (MRC). The MRC is the cost it would take the author(s) to recreate the software knowing what they now know after doing the R&D. (I usually ask for about both the time and MRC as a cross-check). Depending upon your knowledge of the software, immediately ask a few commercial assessment questions such as, "Can we sell this software as a shrink-wrap, now as is? Is a user's manual available? Can we transport this to a more common architecture or platform? Have you embedded other commercially available software in your package? ..." If any of these are answered, "No." then ask how much more time and money is required. 5% of the revised MRC is your first estimate of the commercial selling price.

Example: If the MRC is found to be $100,000, the selling price would then be $5,000.

NOTE: The total replacement cost is irrelevant as it includes R&D tangents and dead ends. Although it may be useful in court trials or buyouts where "cost" estimates tend to be on the "up side". The MRC is relevant because if the researcher was hired by an industrial firm, the researcher could re-create the same software faster and more efficiently than before.

2) The market rules: Determine if any commercial competitors exist. This is not a fully developed market survey, but I rely on the researcher as a first cut, as most researchers would not have developed the software if they were aware of commercial products.

2A) No competitors: Applicable to most universities and national labs. I have found that more than 50% of the time no competitors exist. The 5% solution is your price.

NOTE: Even if one or two software packages exist your may still be in the "no competitors" area because competition is not fully developed and the software sold is highly customized rather than shrink-wrapped.

2B) Highly competitively areas include software like work processing, spreadsheets, desktop publishing, linear programming, optimizers, etc. Rely on the researcher, as a first cut, and ask, "What competing software is close to yours in price and capabilities?" The intent here is to quickly, within a couple minutes, figure where your software fits in the market. More market research can occur later when you have more time and money.

Example: You priced the software at $5,000. Your researcher indicates that there are two somewhat similar products priced at $8,000 and $7,000. Your basic options are: 1) Go for market share and keep the price at $5,000 or 2) Increase the price to $7,000-$7,500 so that your pricing is within the commercially acceptable price window. NOTE: If the competors are lower at $3,000, a similar logic applies: 1) Go for the high end market and keep the price at $5,000 or $4,000 or 2) Drop your price to $3000 or so and fit within the commercially accpetable price window.

3) Multiple users. This is hard to explain without figures, but here it is anyway. My data indicates that there are two distinct regions (market share and highly discounted) essentially, but not always, distinguished by price. The "market share" software is highly competitive (spreadsheets, word processing, etc.) , usually costs below $2,000, and is not discounted much for multiple users. The "high-discounted" software packages tend to be unique, costing over $2,000, and very highl discounted. There actually appears to be a gray area on price, from maybe $1000 to $2,500, and the software may be placed in either regime based on other factors. Both follow an "L" shaped curve (single unit price versus number of units sold) with a curve breakpoint occurring at about 10 unit sales. Prices are normalized by the single unit price (normalized price = price per unit sold/single unit price). For ease, I've averaged out the data (error bounds are not provided) and these are shown below:.

Units sold Normalized price Normalized price Market share High discount

1 1 1 2-5 .85 .55 6-10 .75 .35 11-40 .7 .2 41-60 .65 .15

Example: What's the multiple user discount price for 20 copies If the software single unit price is selected to be $5,000. Based upon price, the single unit selling price is over $2,000 and therefore placed in the highly discounted software regime. Using the table above and calculation below, the 20 copy price is found to be almost the same as buying 7 copies at full price:

P-20 copies = $5000 (1 + 4 x .55 + 5 x.35 +10 x .2) = $5000 (1 + 2.2 + 1.75 + 2) = $5000 (6.95) = $34,750

Please note that this e-mail is not a definative thesis and that other pricing aspects were not addressed. This method is still under development and is being expanded to include more considerations. I'd appreciate any feedback from people that use it. Happy pricing!

c 1997 University of Chicago

The author: Paul Betten, Ph.D. Industrial Technology Development Center Argonne National Laboratory 9700 S. Cass Avenue Argonne, IL 60439 Tel: (630) 252-4962 fax: -5230 e-mail: betten@anl.gov

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