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Here's the model I am thinking of right now:

Total cost to buyer = (number of seats) X (partial 3rd party license cost + app development cost + 1 year support & updates).

Number of Seats

My first question is how do I explain to the customer, the rationale for per-seat license fee? Meaning that 5 person using my software will be 5 times more expensive than a single person using my software? Right now, I don't know how to explain this other than that more people using the software will produce more support requests, but this seems disputable.

Partial 3rd party license cost

On another note, I am using 3rd party commercial licenses in my software. I have spent about 2 grand in total. Should this cost be passed on to the end user? I am leaning towards passing it because the 3rd party license itself has an ongoing annual license cost that I need to pay for continued support from that company. In addition, the 3rd party library I do not have access to it's source code so it's technically not my code so I need to spend extra time working with it (ie. fixing library related workarounds).

Another rationale for not passing the incurred development expense to the user would be that if I somehow miraculously have lot of volume, I could cover that expense.

Application Development Cost

So this should include some human capital expended in putting together the complete product. What if it took you 1 year? 2 years (that's me)? Should you price it differently. Basically, how much premium should you add?

1 Year Support & Software Updates

So this is an ongoing bug patches, feature updates and etc. What percentage of the total development + license cost is suitable to add?

OR

Just match your competitors? But what if your product is a different approach to the same problems? Should it still be similar to your competitors license fees? How would you go about finding out there license fees if they don't disclose it on their website?

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2 Answers

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Let's think of the customer in mind: try and keep the pricing model simple.

The "per seat" or "per user" pricing model is fairly well understood in most (if not all) industries you need not explain it. Until you have a series of questions or objections about it there is no need to justify your model or your price.

Also the customer does not need to know about the 3rd party license. That's an overhead (fixed cost) you have to building your product, not variable. In any event unless this cost is significant then just price your per-user license accordingly. Just make sure your price is high enough to pay your fixed and variable costs, otherwise you'll go out of business rather quickly!

If you are looking for a formula to determine pricing: there isn't one. You need to charge according to what value your product brings to the market. If your product is substantially better than the competition, you can charge more and get away with it. If you offer less, you are likely to have to charge less.

Support costs vary, but more often than not I see it quoted at 20% of the initial purchase price. If you had a high-support product you might go higher, if you had a low-support offering and do not intend releasing bug fixes or new features you might go lower to 10%.

I would not recommend matching your competitors pricing - it just encourages a price war or a feature shootout. You can promote your product as being superior to theirs and charge more than them. Or you might not offer as much and can get away with a lower price.

For more information on pricing software check out this Joel on Software article.

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very good answer. +1 – Kim Jong Woo Nov 22 '11 at 5:28
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Recently we changed our pricing to match that of Atlassian's. Earlier we followed what our competitors charged. But our product is little different in the deployment and technology. Here is the reasoning behind the change http://www.mockuptiger.com/starter-licenses-pricing-that-makes-sense

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+1, really awesome article. – Kim Jong Woo Nov 24 '11 at 18:03

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