The Psychology of Software Pricing: A Masterful Overview

This month's Cambridge Product Management Network meeting covered the topic of software pricing. The presenter, Jeremy Parsons (@jdap on twitter), took us through some of the principles and examples of things that can go wrong.

Most of the 'war stories' came from the mobile telecoms market. For example, there was a dissection of the One2One "Free Forever" marketing slogan from the 1990s that resulted in them acquiring a customer community of mainly broke people (i.e. students). It led to over-subscription and network congestion, and they acquired the disparaging nickname of "One2NoOne". Today, mobile operators such as Orange and T-Mobile see a difference in peoples' perceptions of quality and value even when it's the same mobile network underlying both their services.

Jeremy knows his stuff and it's always good to listen to someone with a masterful overview of a subject and relevant case studies. His recommended reference book by the way is "The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making" by Nagle & Holden. Another good resource is the short book by Neil Davidson called "Don't just roll the dice: A usefully short guide to software pricing".

The discussion reminded me of Tversky & Kahneman research from the early 1990s on the psychology of purchasing behaviour. From what I recall, they found that a price decrease is better than a value increase; and a value decrease is better than a price increase.

There was a good example last week in  The Sun newspaper. It wrote that "Fag firms are ripping off smokers" (decode that one American readers!). The fact that upset them is that tobacco companies are reacting to cost increases by selling not 20 but 19 cigarettes in a pack at the original price for 20. The cigarette companies say that buyers prefer the fixed price and accept the decreased value as the lesser evil.

Then later when they also increase the price, it's now for 19 units only. I suppose it's for the smokers' own good in the long term.

The research by Tversky & Kahneman looked at the biases in human reasoning which make us behave irrationally (as measured by economists) but in a consistent way. When applied to pricing, much depends on the perception of value and how to make the customer perceive that they are paying average or below-average market prices. For example, most of us are more excited by the message "save £200" than we are by the prospect of changing a process to avoid a waste of £200. We work very hard to avoid losses and don't like to pay twice for the same thing. For example, if you have a $10 ticket for a show and on the way there you lose a $10 bill, there's an 88% chance you'll still go to the show. If however on the way there you lose the $10 ticket, there's only a 46% chance that you'll pay $10 for a replacement.

I suppose the equivalent in enterprise software is getting excited over a discount in the cost of annual support, without noticing it would be even cheaper to switch from the proprietary package to an open-source alternative.