Product Pricing Primer

Eric Sink writes about product pricing for a small software ISV.

Every small ISV wrestles with the question of how to set pricing for its software products. I've been asked many times to write an article on this topic, and I have finally decided to do so. Before we begin, I would like to offer a disclaimer:

Product pricing is hard. There is no magic formula that will determine the best price for your product. I can't provide any easy answers, but I can give you some things to think about as you make your pricing decisions. In the end, you will just have to make a decision using your own judgment. There will be times you will wonder if you made the right decision. You may never know for sure.

Stating the Problem

Let us first say that our goal is to find the price at which profit is maximized. If we say that a price is "too high" or "too low," we are saying that our profit could have been greater if we had set the price either lower or higher.

Obviously, revenue is the simple multiplication of quantity by price:

Revenue = Quantity * Price

It All Starts with Positioning

Pricing and positioning are inseparable. Don't bother trying to figure out your price point until you first figure out what position your product will have in the market.

Ask yourself these four questions:

1. Who are your competitors? If you honestly think you don't have any, then your product is going to be either a huge success or a huge failure.
2. How is your product different from your competitors? You should have a very short answer to this question, and you should be able to deliver it quickly. One important caveat: If you think your primary differentiator is price, think again. Differentiation is absolutely critical, but using low prices as your primary differentiator is a well-worn path to failure. More on this later.
3. How do you want to be known in your market? You need to be able to describe what position you want to have in terms of the way you want your target market to perceive you.
4. What are the prices of your competitors' products? Your prospective customers will compare your price against those of your competitors, so you might as well start doing it now.

Keeping all these things in mind, you should be able to figure out an approximate price range to use as a starting point. In rough terms, what price range is consistent with the perception you want people to have of your product?