How To Correctly Price Software
With the Power of Minimal Marginal Cost Comes Responsibility of Good Pricing
Welcome Launchers. As you all know I have a high affinity for software due to its low marginal costs. My posts have been more spotty lately. I am in the process of spinning up a couple of new SaaS product so the topic of pricing is fresh on my mind.
Software offers unparalleled flexibility in the way you can package a product/service. That also leaves an incredible amount of burden on making good decisions. Pricing can often be the difference between success and failure.
Today we will be covering the all important topic of pricing in software recapping themes from one of my all time favorite practical guides. I use this book as a bible when I’m launching a new product.
New Must Read Book Just Dropped
This post is heavily influenced and based on the book Don’t Just Roll the Dice. Short and to the point it can legitimately be read in an afternoon and drastically improve your company’s profitability. I will summarize some of the key points and give a couple personal anecdotes.
#1 Focus on Total Profit Not # Users
Unless your software has substantial network effects then you should be focused on profitability over users. What you’ll find is there’s often a sweet spot between # of users and price you can charge.
Take a look at the below example. We have 4 bars:
At $0 Price - An invisible, infinitely thin line. This line has 1000 users x $0/user = $0 in profit (area = 0).
At $100 Price - 500 users x $100/user = $50k revenue
At $300 Price - 200 users x $300/user = $60k revenue
At $500 Price - 50 users x $500/user = $25k revenue
As we can see the sweet spot is somewhere in the $100-$300 range after which point we either come in too low and fail to capitalize or come in way too high and lose users.
Consider Hidden Costs:
Missed opportunities for network effects - does your product offer substantially more value the more people use it? In that case, you may want to err on the side of more users and slightly lower price.
Missed Referrals - likewise if you are new, you may miss out on marginal customers who would buy and potentially refer other customers to you.
Cost Per User - this one is a win for higher pricing. Consider that your costs may go up significantly if you need more users to hit the revenue target. You may wind up paying substantially more in each of these areas:
Cost Per User Acquisition
Customer Service for Each User
User Churn
Picking an optimal price is an art and not a science. Each of these factors should be considered but ultimately you should do some research and even tests (A/B tests anyone??) and build confidence for yourself where your software should be priced.
#2 Utilize Package Options to Anchor & Drive Profitability
Did you know that there used to be only small and large popcorn sizes?
Why add medium?
The oddities of human psychology of course. When customers make a decision often subconsciously they are thinking “what does this decision say about me?”. In the case of small versus large the customer has to choose between feeling like a cheapskate or feeling like a fatso/sucker who pays too much.
Enter medium. Now there’s a safe choice!
I’m not too cheap! I’m not a sucker! I choose medium!
Now what happens if we add in jumbo? That’s right. More sales of large.
Use this effect to your advantage.
Note this tactic only works when packages are easily comparable. If not, you need to bring out the big guns in #3.
#3 Be Cautious When Adding Packages: Clarity Is Essential
You’ve probably seen some variety of the below graphic before:
Why do companies use this chart?
Because in the face of too many options with lack of clarity, the user will just quit and take their business somewhere else. It is imperative that you clearly explain what each package offers and does not offer. Get the user over the hump of deciding as fast as possible with as little effort as possible.
If you do not have versions that are easily comparable you need this chart badly.
The package pricing table is a beautiful and simple way to illustrate your package offerings or to even compare your offering to that of a competitor.
#4 Biggest Pitfall: Failure to Consider Competitor Switching Costs
I see it a lot that entrepreneurs come in and say “yea there’s an entrenched competitor but. We’re just going to beat them by being better (or cheaper)”.
I’ll believe it when I see it! It’s possible but you need to thoroughly consider your positioning first. If you’d like to woo the competition’s customers. Consider the following three components of switching cost:
Economic Cost: if it costs them significant time or money to switch to your solution, you better be able to justify it economically.
Psychological Cost: humans are lazy by default. Making them switch requires them to learn a whole new system, admit they’re wrong, and say good bye to an old friend. Irrational? Yes. Is it critical that you overcome it? Hell yes.
Beating the Switching Costs:
Engineer Interoperability - are users mostly using a competitor? Fine. Go ahead and make it easy for them to import all of their data/settings from said competitor. That drastically improves your odds of winning the deal.
Tactical Free Trials - if you hear the concern over switching costs a lot, it may be time to consider a free trial. Companies offer a free trial to minimize the economic costs and the psychological impact of switching (see it’s not so scary). Plus now you’re getting bias to work in the other direction: they feel like your product is theirs now.
Some BTL Original Thoughts on Pricing
These are not included in the book but they’re my own views relevant to the topic.
#5 Try to Capture 10% of The Value You Create
I am a big fan of B2B. The reason is it is much easier to bound how much a worse product/process costs the user. And. Figure out how much you can and should charge.
As a rule, I try to create around 3 to 10x the value that I’m giving clients which keeps them happy and that sweet sweet MRR high. If you can go to a VP with a deal like this and can’t get it done you need to look in the mirror.
What Not to Do
I was just on a call with a mentee when they told me “BowTiedLaunch, we’re going to revolutionize a $100B industry and drive down costs 99%. All for $50/month. We just need millions in investment and a couple years.”
There’s two big problems with this:
Price is Way Too Low: if you’re keeping costs that low and saving people that much money something doesn’t add up. Someone would have done what you’re doing before. Even if you are a genius and figure out how to accomplish the above, by charging only $50/month you make your product look crappy so even smart consumers will be wary of you.
Time to Spin Up + Costs Out of Whack: how about instead of trying to save 99% of costs, start with 10% of costs and do it in 6 months? If the market is truly that big, there will be clients that will line up around the block. With that momentum you can refine the product, start profitably and iterate until you hit that 99% goal.
Closing Thoughts
Pricing is an art that can make a big difference in your software’s profitability. If you haven’t yet I highly recommend you read Don’t Just Roll the Dice and strengthen this area of your game.
More Recommended Reading
#1 - Rework by Jason Fried & DHH- Two Tech Startup GOATs & They’ll Teach You Their Minimalist, Practical Methods
#2 - Atomic Habits by James Clear - Learning the Ins and Outs of Human Behavior Formation Is an Incredibly Lucrative Talent
#3 - High Output Management by Andy Grove - Former Intel CEO Shows You How to Use Engineering Principles to Build a Strong Business
#4 - Extreme Ownership by Jocko Willink - Former Navy Seal Officer Teaches You How to Build a Team of Doers with Initiative
#5 - Deep Work by Cal Newport - Georgetown Professor Shows You How Connectivity is Massively Overrated, Focus is Underrated and How You’re Currently Fucking Up Your Productivity
#6 - Actionable Gamification by Yu-Kai Chou - Game Development Expert Teaches You How You Can Play 4D Chess with Incentives & Accelerate Growth on a Massive Scale
Good thoughts to consider in here.