MTAT.03.244Software Economics

Workshops 10 and 11Economics of Software Products

Marlon Dumas

marlon.dumas ät ut . ee

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Where are we in the course?

1. Software measurement and estimation

• FPA, cost estimation methods

2. Business case analysis of software projects

• Benefit and cost analysis

• NPV, IRR, payback period

3. Economics of software products

4. Digital product management & entrepreneurship

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Outline

1. Economic Drivers of Software Production

2. Economic Factors of Software Pricing

Warning: These will be discussion-oriented classes, if you don’t discuss, there’ll be no class…

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Free Lunch?

Nobody offers free lunch, right?

But in IT, there are quite many “free” tools

• Examples?

• Do they have something in common?

Do other industries that offer products for free?

Why are IT companies so “generous”?

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Network Effects

Demand for a good depends on how many people acquire it

• Examples?

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System Effects

• Some products are quite useless unless they are combined with other products to form a system• Examples?

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Creating Network/System Effects

1. Simply free

• Creating market share

• Competing in a “winner takes it all” market

2. Freemium (incl. crippleware), limited in

• Time (trial period)

• Features

• Capacity

• Computing resources

• Support

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Your turn

• Think of a software product offered for free

• Why it’s free? System Effects? Network Effects?

• How much it’s free?

• Let’s avoid open-source examples, that is a separate matter…

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Case: BizAgi

• Founded in 1989 with the mission to support business process improvement

• Over the 90s, developed a platform for modeling and automation of business processes

• Ca. 2003 Bizagi had a relatively small number of customers, mainly in the Americas

• Lots of competition, incl. mounting competition from large vendors (IBM, Oracle, MS)

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Case: BizAgi

• In the early 2000s, BizAgi splits its platform into:

• Business Process Modeling tool

• Business Process Automation suite

• Business Process Modeler offered for free

• Meantime, other companies were selling process modeling tools

• Some time later, also an “Xpress” version of automation suite offered free for dev purposes

• Why?

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Costless, Fast Reproduction

Software goods have an unusual cost structure:

• High fixed costs of production

• Low or zero variable costs of production

• In the Internet era: low or zero distribution costs

Example: Windows

• This cost structure characterizes a class of technology products termed information goods.

• It includes software, but also other goods:

• Which ones?

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Software versus Information Goods

In addition to being an Information Good, software has additional characteristics:

• Sometimes needs to be developed uniquely for a customer or customized

• Can be useless without other elements such as training, support, configuration, or business process change (services create a system effect)

• Sometimes highly tied to data (e.g. mapping software)

• Software is often stacked on top of software…• System effects, system effects, more system effects

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Software Products vs ServicesCusumano (2004), pages 31-34

• Product companies: Economies of scale

• Service companies: Economies of scope

• Product companies: Higher sales productivity

• Service companies: Stable, predictable revenues

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Drivers of Service Sustainability

1. Knowledge or product reuse

• Economies of scope

2. Talent development and retention

3. Brand, image, reputation

4. Continuous marketing and sales activity

• Customer portfolio management

5. Economic context & market evolution

• Demand, competition

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Drivers of Product Sustainability

1. Continuous update (e.g. anti-virus sw.)

2. Continuous upgrade

3. Technological leadership

• IP Protection: patenting

4. Brand and/or community leadership

• Committed user community, user forums

5. Lock-in effects and switching costs

• Interoperability

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Case: SDL Trados

1. Translation memory software

• Typically used with or on top of Word

2. Several upgrades in the 90s and early 2000s

3. Active user community (translator’s forums)

4. Bought by SDL in 2005

5. Several product releases since acquisition

6. Many users still using the 2005-2007 versions due to interoperability with Word

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Main points to retain

• Effects of costless reproduction

• Importance of network and systems effect

• Tradeoff products versus services

• Product sustainability: continuous leadership, innovation, community building, lock-in

• Service sustainability: knowledge building and retention, productivity, ability to reuse

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Economic Factors of Software Pricing

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Pricing Strategies1. Cost-plus pricing (e.g. consultancy, reseller)

2. Value-based pricing

• Maximize revenue (to build market share)

• Maximize profit (rational strategy – more later)

3. Target return pricing

• Achieve revenue or quantity target

• Achieve profit target

4. Psychological pricing

• “Quality” leadership pricing

• “Discount” pricing

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Pricing Models• Pricing strategy is meant for our internal

decision-making

• In addition to a pricing strategy, we need a pricing model:

• Perpetual vs. periodic

• Fixed-fee vs. price discrimination

• Componentized vs monolithic (bundling)

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Perpetual vs. periodic

• Perpetual licensing

• Periodic licensing (a.k.a. subscription-based)

• When to choose which?

• What advantages/drawbacks for producer?

• What advantages/drawbacks for consumers?

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Perpetual Software Licensing• Microsoft Office:

• If you own a previous version, you may purchase an upgrade for less than the cost of buying the software for the first time. 

• You are not required to purchase an upgrade, but you may want to. 

• If the people you work with all upgrade, you may want to upgrade too – network effect.

• Intuit, makers of Quickbooks (business accounting software), is a little pushier.  • They release a new version of the software every year.  • You can continue to use your old version.  • Unless, however, you use one of the services that they also

sell, then you have to upgrade

Periodic Software Licensing

• Anti-virus software generally

• E.g. annual payment, otherwise software de-activated or no virus database upgrade

• Software-as-a-service (SaaS)

• Pushed to the extreme it becomes pay-per-use

Case: Zeroturnaround

• In 2010, Zeroturnaround switches from perpetual pricing to subscriptions

• What could have been the drivers or enablers for this change and its acceptance?

• From Zeroturnaround’s perspective

• From their customers’ perspective

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Fixed-Fee Pricing

• What price should we charge?

• Depends on the cost?• Fixed cost (once incurred, it becomes a “sunk cost”)

• Variable cost (e.g. support services)

• Maintenance cost!

But also on the demand curve, see: http://www.joelonsoftware.com/articles/CamelsandRubberDuckies.html

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Fixed-Fee Pricing (cont.)

• Limitations of fixed-price

• Does not take into account customization / assumes all customers are the same

• Does not capture consumer surplus (good and bad)

• Leads to price discrimination…

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Price Discrimination

• First-degree price discrimination

• Price depends on the customer

• Mass customization / personalization

• Does it apply to software?

• Second-degree price discrimination

• Price depends on “product variant”• E.g. Adobe Acrobat

• Price differentiation based on quality or usage volume• E.g. volume licensing, usage licensing, site licensing

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Price Discrimination (cont.)

• Third-degree price discrimination

• Different prices for different groups of users

• Examples: private users versus commercial users, student/academic licenses, geographical regions…

• Old versus new customers

• Upgrading versus new customers

• Can you think of others?

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Bundling

• Selling multiple goods for a single price

• Example: what software am I using now?

• Sometimes, software and hardware are bundled…

• Sometimes (perhaps not often enough), software is sold with guarantees it will work…

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External Factors of Software Pricing

• Competition effects (incl. open-source)

• Network effects

• System effects

• Lock-in effects (switching costs)

• Piracy

• Especially: consumer (B2C) software

• For B2B software:

• Procurement limits (e.g. $500 corporate credit card)

• Enterprise-wide vs. departmental/project-based need

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Case: Plumbr.eu

• Web app server add-on for memory leak detection

• Check pricing at: https://portal.plumbr.eu/pricing

• What are the drivers for Plumbr’s pricing

• From Plumbr’s side

• From customers’ side

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Case: Signavio

• Former pricing structure.

• Professional Edition: Per modeling user with annual redeemability: $99.95

• Corporate Edition: Per modeling user with annual redeemability: $174.95,

• Ultimate Edition: Per modeling user with annual redeemability: $269.95

• What are the pricing drivers?

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Case: Fotor.com

• Currently not monetized beyond online ads and referrals

• Analyze their possible monetization and pricing possibilities:

• What is the competition? What sets apart fotor.com?

• What are the drivers for not monetizing now?

• How could the product be monetized in future? What would be the factors to consider for pricing?

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Further Readings (Optional)

• Joel Spolsky’s blog: Camels and Rubber Duckies:

• http://www.joelonsoftware.com/articles/CamelsandRubberDuckies.html

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