Standing in the Field
Notes from SJS Application Server Field Engineering
Standing in the Field
Notes from SJS Application Server Field Engineering
Well it's almost a month later, and I still haven't finished my article on software economics. I've been busy, as always, but I've also had some recent changes in my job that have been distracting me. More on those job changes tomorrow.
But since I don't think I'll be able to finish my article in the foreseeable future I wanted to post a summary of what I had been thinking.
As a reminder, this article was to be a response and follow up to Bryan Catrill's recent post.
As Bryan Catrill pointed out one of the interesting aspects of software economics is the fact that the gross margin of software is effectively 100%. (Although I'll debate this somewhat in part two.) This has all kinds of interesting consequences, many of which Bryan points out in his original article.
One of Bryan's points is that an existing software customer is relatively price inelastic. In other words, once they are locked into a vendor, they will generally continue to buy regardless of changes in software price. The exception being if the software cost exceeds a the cost of migration: what Bryan terms the FYO point.
In contrast, however, customers that are not locked into a vendor quite be quite elastic in response to price. There may be 100 companies willing to spend $10,000 a CPU for your software, 400 more willing to spend $2,000 for your software, 6000 willing to pay $100, and 100,000 more willing to use it if it were free. So software vendors have the choice of either charging everyone $10,000 per CPU (in which case you end up with a niche high end product and only one million in revenue), $2,000 a CPU (you end up with more customer, but the same about of revenue), $100 (less revenue, lots of customers.), or even offer the product for free and try to make revenue offering consulting and support to the large group of customers.
Further complicating this issue is that the cost of sales and customer expectations will also change as you change the price point. If you have a $10,000/CPU product, your customers will expect hands-on attention from a sales force, long evaluation periods, analyst coverage, and 7x24 support. If you charge $100/CPU, customers will expect a lot less: they will buy over the web. They will have lower expectations of support and services. Evaluation periods will be short. This is only natural: companies are are trying to avoid getting locked into the situation that Bryan describes. A $100 investment is a lot easier to abandon than a $10,000 investment. But the net result to vendors is that pricing not only affects the revenue you make from a product, but also how your product is perceived and purchased.
There was a discussion on the Joel on Software forums about this. Joel writes about the fact that customers will sometimes avoid less expensive products because they are perceived as "cheap". He also talks about certain price thresholds. Under $500 and your product can be bought by a low level manager on a corporate credit card for departmental use. He also says,
[A]s soon as your price gets up in the $3000 level, the amount of approval it needs is so absurd that you are not going to sell products without a salesperson making a few visits. Hiring the salesperson, sending them out to make presentations, hotels, airfare -- now it costs $50,000 to get the sale done just in sales closing costs. That's why you see a lot of software products at $100,000 and a lot under $3000, but anywhere in-between and it's impossible to make sales.
This really resonates with me because Sun Java Web Server has a list price of $1,495/CPU and Sun Java Application Server Standard Edition has a list price of $2,000 per CPU. Which makes a lot of deal sizes in that five figure range that Joel warns about, and I've seen the challenges that price range brings. It's hard for Sun to justify putting me on a plane to do a demo for a potential $10,000 deal. But on the other hand, volume wins. So Sun wants these midrange products to be successful. It's a difficult balancing act but, as always, Sun tends to err on the side of customer satisfaction.
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