Issues related to pricing are very important regarding introduction of competition. Discuss some of the important pricing issues...

Issues related to pricing are very important regarding introduction of
competition. Discuss some of the important pricing issues with special reference
to the software industry.


Determination of prices is an important managerial function in all enterprises.
Price affects the profit, demand, revenue, cost. The quantity sold varies with variations
in the price. Thus pricing plays a vital role in profit planning. Banker is interested in
how to mobilize the resources. Fire fighters are interested in how to prevent the fire
rather than extinguish it. In the same manner every management attempts to maximize
the level of output, minimize the cost and thereby accrue maximum level of profit. This
could be best judged only by pricing. So setting up of an appropriate price is important
for every enterprise.
According to traditional economic theorists, the buyers and sellers alone determine the
price. But now-a-days the determination of prices and outputs of various products
depends upon the type of market structure in which they are produced, sold and
purchased.
Pricing theory under this hypothesis suggests that, given the demand and cost curves,
price and output are so determined that profit is maximized, i.e., at the level of output
where MR = MC. Some empiricists have however, produced the evidence, inadequate
through, that the firms follow a pricing rule other the one suggested by the marginality
rules. Besides, in a complex business world, business firms follow by them.
Competition
If a firm is not the market leader, competitive prices will influence the pricing of
products or services. Market leaders have often created a "pricing standard" against
which other product/service prices are compared. So if a firms product or service is
reasonably competitive with the market leader's offering then it can set a price that is
near the "standard". If the firm has the ability to price lower than the competition and
still be profitable, it may be able to capture a greater market share which can benefit it
over time.
The firm’s decision to compete with a lower price should not be made lightly. If the
competitor perceives that your low pricing has the potential of reducing their market
share or impacting their influence in the industry, they may respond with an even lower
price. Then, instead of increasing your market share, you could be faced with no
opportunity to profitably penetrate the market at all. It is always of value to know the
capabilities and tendencies of your competitors.
A different form of competition is the 'alternative solution'. The prospect's first
alternative is always, if the price is too high, a decision that they really don't need your
offering or any of your direct competitor's offerings. There may also be a variety of
ways for the prospect to solve their problem. For example, if you offer an airline
service, you are really in the business of transportation. So your prospect has the
option of your service versus trains, busses, rental vehicles, personal vehicles,
hitchhiking, bicycles, walking or (back to the first alternative) staying at home. The
availability of numerous alternative solutions will usually limit your pricing flexibility.
SOFTWARE PRICING
If you're a services company that's anxious to turn a reusable piece of code you
developed into a product, one of your greatest challenges will be determining an
appropriate price for your product. When you start thinking about how to determine the
price, you'll probably naturally move toward cost-based pricing (a formula that is related
to your development costs), or competition-based pricing (a formula related to what
your competitors charge). Before you settle on a price using either of those basic
pricing models, go back and reassess the opportunity for value-based pricing,
especially if your product has a strong vertical market affinity.
Value-based pricing requires that you be attuned to your potential customers and how
they'll really use your product. Your competitors may not have used a value-based
pricing model, so there may be an opportunity to define a new model that will mean
higher profits for your company. Using informal survey techniques at industry trade
shows, or even a focus group, you may find that your competitors' pricing models have
created substantial pockets of would-be users who cannot effectively relate to the
existing pricing model. For example, the product may be unaffordable for businesses
with a certain number of users, or a certain number of daily transactions. Perhaps the
up-front charges on the software are a barrier-to-entry for businesses of a certain size.
Perhaps there are many businesses who can't use 50% of the functions provided by
your competitors, and simply aren't willing to pay the price for functions they won't use.
It's not uncommon to discover that customers are willing to pay your company more,
maybe without even realizing it, as long as your fees match the structure or nature of
that particular business. Decision-making can often be linked to simple and realistic
calculations of the value that might be received by using a product.
There are a wide variety of approaches, some of which can be used in conjunction with
one another that can be used when you create a value-based pricing structure. These
include user-based licensing, usage- or transaction-based licensing, site licensing,
function-oriented fees, support-based fees, customization fees, customer revenuebased
fees, and even leasing options. Needless to say, the pricing analysis can be an
enlightening experience.
Pricing strategy relies on a good understanding of customer price sensitivity. The
Information and Communication Technology (ICT) sector, including the software
industry, is no different. Yet, some issues in this industry present unique challenges.
1) Software is often a substantial investment both in relative and absolute terms
Switching can be costly. Especially as time passes and more users become versed in
the software. Beyond direct cost, maintenance and support, indirect costs such as
training and implementation also make switching difficult. As a result, customers
typically ascribe high value to reliability of the product and expected availability of the
vendor for the long term. Reliability of the software and stability of the company will
attract a less price-sensitive customer. Estimating the impact of these two factors will
have a bearing on quantifying the price/value relationship.
2) Total Cost of Ownership (TCO)
A customer may be more interested in total price when assessing the investment in
software. Often a customer expects the vendor to assume some of the risks associated
with TCO. This has given rise to pricing structures such as subscription models, which
avoid high up-front prices, spreading them over a longer period of time.
3) Value perception among segments
No uniform formula exists for assessing the benefit of a particular software. Most
vendors try to provide an ROI that estimates and quantifies potential benefits. But real
value varies from one customer to another. Segmenting customers into a number of
distinct groups based on perceived value guarantees an understanding of price
sensitivity.
4) Shifting demand
The largest proportion of software license investments are a one-time deal. A company
buys a number of modules, and license seats for users to access the modules. Buyers
may add modules or seats. Industry growth, however, is expected from new sales.
Markets become saturated. The adoption of new software starts with large companies
and eventually trickles down to smaller customers. As a product matures, growth
opportunities come from smaller customers who are more price sensitive due to less
buying power. The subscription model emerged to address this challenge.
5) Software maturity
Software maturity results from the lack of differentiation among offerings. At this point
software vendors with greater brand recognition and larger market shares benefit. This
is due to their cost leadership and greater ability to compete on price. Here is one
illustration of a method for determining software price sensitivity.
Factor Attribute Direction of
price sensitivity
1) Investment
Quality/reliability/longevity of product
primarily perceived in relation to the
reputation of the vendor
Increased
2) TCO High TCO, increasing in relative terms as
market demand shifts downwards
Increased
3) Price structure Emergence of subscription models and
outsourcing
Increased
4) Value perception
Some functionalities perceived very
valuable, and some less valuable
depending on the industry
Depends
5) Demand Rapidly shifting down to mid-market and
low mid-market
Increasing
6) Differentiation Substitutes very easy to find; increased
number of new entrants
Increasing