Wednesday, September 17, 2008

Demystifying Technology Pricing

Once you have gotten to the stage of the technology you need and the vendor from where it will come, the next issue is to determine the price. Interestingly enough the more one delves into technology pricing models the more the reality of no set pricing becomes the norm. How vendors arrive at their price list runs from complex modeling to what the market will bear. However, looking at pricing from the buyer perspective there are some touch points that can greatly affect the price. There are many factors that will drive the price-point for the desired technology; this can be broken down into two main classes, the buyer and the vendor demographics. It is the vendor and the buyer demographics that begin to formulate ‘the price’.

Right from the starting gate, the vendor will need to know the size of the buyer organization, amount of current or intended use of the technology whether or not the buyer will need training or what other technology services will be employed. It is at that point the vendor consults their ‘price list’. Basically this ‘price list’ can be highly scientific or epitomize subjectivity in the wildest sense. The vendor price list could be built on market analysis, profitability or basically random numbers pulled out of the air. The astute buyer will always get the best price once they understand how their chosen vendor has built their ‘price list’.

The main divisional breaks on technology pricing are: hardware/software/consulting and public vendor/private vendor. These main breaks in pricing models will determine how much flexibility the buyer has with getting to a palatable price. These divisional lines sit along a continuum, the most rigid pricing of which is hardware/public company vendor and the least rigid is from software/private companies. The addition of consulting/services places the price for those services more along the continuum, rather than the extremes.

The production of hardware technology is built upon verifiable research and quantifiable components. The vendor is well aware of their variable and fixed costs of production, therefore they are cognizant of their break-even points in production. To this knowledge, add the ‘motivation’ of shareholders as in a public company and the profitability lines will be established; which infers the margins. With these strongholds on pricing, hardware technology from publically traded companies doesn’t lend itself to large discounting.

Where hardware technology organizations provide consulting/services, this is the area where the buyer can negotiate strongest. Very often the hardware vendors will loosen the reins on service margins to maintain hardware margins. To the buyer, keep in mind that empirically most vendors will charge between 2.0 and 3.5 times their cost of providing the service. The buyer’s strongest position comes when the buyer knows the vendor has idle consulting resources; as the vendor has a sunk cost with their labor pool.

The pricing model is radically different in the software technology realm. The production of software bears with it a certain number of hours of planning, programming and ultimately testing. All of these hours are verifiable and quantifiable and therefore a cost of production of the software can be derived. These costs represent fixed or sunk costs, and the company bears these costs whether one software copy is sold or one million copies are sold. Notice how different this is from hardware pricing; with software the costs are recognized when the software is built – no matter how many copies are sold. While with hardware, there is a certain fixed up front cost on the research side, however once in production each until attracts a cost. The buyer is more likely to achieve a better price if they know the vendor has considerable inventory, new models are about to be released or the purchase time is nearing the vendors fiscal year end.

The buyer should now recognize that the pricing points for software have tremendously more flexibility than those of hardware purchases. This price point flexibility is further enhanced whether the software company is public or private. Publically traded software companies have a strong external influence to meet shareholder expectations and therefore are less likely to entertain or sustain deep discounting; this is where the demographics of the purchasing organization can have tremendous influence. For the buyer, the best time to get to the right price would be through knowing about the vendor. The buyer should make it a point to find out the vendor’s year end, often four weeks to the vendor’s year end, and less so near quarter end, will make the difference between the ‘price list’ and the ‘best price’.

The buyer’s best pricing will be derived from privately held software companies. These companies tend to be smaller and often do not have a grasp of the cost of software production. To that end, they could essentially discount the software to nothing simply to ‘get the deal’. Where the buyer’s switching costs are high, a nil price on the software shackles the buyer to the vendor. This shackled relationship may or may not be in the best interest of the buyer and it must be a source of further investigation. Since the privately held enterprise may not be legislated by strong external forces, like shareholders, the concept of quarter and year-end periods are not that important to getting to the ‘right price’.

More often with software companies than with hardware companies, a considerable amount of revenue is the result of additional services. To the software company, consulting and services may be their only sustenance between sales. The services could be anything from training, data conversion to expert consulting. Like with services provided by hardware vendors, software vendors tend to offer services at 2.0 to 3.5 times the costs they incur in providing those services. As these costs represent sunk costs to the software vendor just like with the hardware vendor; this becomes an area where the buyer can realize the greatest savings.

Your responsibility to your organization goes beyond getting the right tools; it is getting the right tools, the right training and all at the right price. Recognize that the price list is only a suggestion and the right price comes down to how well the buyer and vendor can ‘work’ together on closing the deal. Keep in mind there are so many contributing factors to price; which far exceed the elementary view of “price”, as professed by economist Adam Smith.

“The real price of every thing ... is the toil and trouble of acquiring it as influenced by its scarcity”.

Adam Smith
The Wealth of Nations (1776)

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