Lincoln notes that “free” is a marketing tactic, not a pricing strategy.  (As a pricing strategy, free can work well as a defensive move to discourage other entrants from building free or cheap products that could threaten your core business.  It’s a hard way to build a core business.)

McClure writes (rants?)

ASSERTION #2: The default startup business model for 2010 & beyond will be subscriptions and transactions (e-commerce, digital goods).

Newsflash folks: The Internet does NOT want to be FREE… It wants to GET PAID on F&*&ing Friday, just like everybody else on the damn planet.

What does this mean?  It means you have to think about the value your customers receive from using your offering, and how that value compares to their alternatives, including the option of doing what they are doing today.  Value includes both positive and negative elements.  For example, saving time might be a positive value, whose worth depends on how much time and whose time you’re saving.  Signup time or data migration time would be a negative value.  If you can’t generate a strong value proposition and get your prospects to believe it, you’re going to be in trouble.

This can be especially hard for tech companies that create cool technology and focus on the features.  Features don’t have value.  Features can create value by providing benefits, but it’s the benefits that create value.

Get early bird pricing through December 21, and save an additional $100 with the code MIMIRAN100.

One of the sessions is: Maximizing SaaS Revenue through Sales and Pricing Discipline, presented by Reuben Swartz of Mimiran.

Maximizing SaaS Revenue through Sales and Pricing Discipline

SaaS companies often act as if they have no incremental costs, leading to lax discounting practices. As a result, margins fall and companies struggle to reach or maintain profitability. Through careful analysis and disciplined execution, companies can close deals faster and leave less money on the table. For small software companies, the results can be the difference between life and death (a company with 10% margins that can leave 2% less money on the table raises its profit by 20%).

In this session you will learn to analyze and evaluate the effectiveness of your revenue and pricing strategies, how to discount more effectively (and less), and examine how other companies have implemented these techniques.

Hope to see you in Dallas.

So what can Microsoft do? They can’t simply drop prices or give away software without further depressing their share price. Their efforts to gain online revenue through advertising have been disappointing. Vista, even more disappointing.

Microsoft’s efforts to offer a stripped down version of Windows for developing markets and netbooks is a step in the right direction. They are cannibalizing their own profits, but that’s better than having someone else cannibalize them.

But this is an incremental step. Microsoft “won” as much through clever pricing as through clever technology. They licensed their operating system cheaply (at the time) but made sure that computer makers paid them royalties regardless of whether they actually installed the system. They realized early on that they could create a whole new market for software if they could make it more affordable. Rather than charge $500 for a word processor, $500 for a spreadsheet, and $1000 for a database, they gave buyers the whole bundle for $500. How could you say no?

This helped them kill the competition and for a while, they added enough features to subsequent releases to get consumers and businesses to upgrade regularly.

The problem is that they were so good at killing the competition that they forgot how to innovate. The incremental value of each release got smaller, while even contemplating a switch let users think about using alternative applications like Google Docs, that suffice for many users. Using Windows and using Office hasn’t changed much in the past decade.

In addition to making desktop computing prettier, they need to make it faster. In theory, it should be. In reality, I stopped using Outlook when I realized that it faster to use the Google browser application directly, even with Xobni installed in Outlook. When is it faster to search the web than to search my own computer? Desktop computing should be instantaneous. It should provide a noticeably snappier experience than the web. (If this required a major rewrite that would break backwards compatibility, they could always run a virtual Windows XP or Vista instance. This works amazingly well on my Mac.)

Next, desktop computing and productivity work should look good. The templates in Office 2007 are actually a lot nicer than the ones in previous versions of Office, but they still look pretty lousy. (You can pick a template in Apple’s iWork, which has only been around for a few years, and get much better looking results.) Microsoft should spend the money to get or create some really nice looking templates. And everything on the desktop should be “HD”. PowerPoint should look nice, not grainy with clunky animations. Speaking of HD, desktop video editing is the killer app for operating systems– one of the few things it’s currently really hard to do in the Cloud. Windows Movie Maker is a joke. Build or buy a really good, easy video editing program. At this point, the DoJ won’t care if you bundle it with Windows. Make PowerPoint output to this HD format, but make it interactive, so you can give a really high quality presentation. And because the average business user won’t know how to create professional animations, have a huge gallery available for instant download. This is stuff that Linux can’t do well, and even Apple users need a fair bit of expertise (and possibly expensive extra software) to create.

Next, think about how users want to work with documents. For a software company that tries to reuse code, Microsoft makes it pretty inefficient to work with documents. Many business documents have various sections– headers, footers, standard terms and conditions, snippets copied and pasted from other documents, and some original content. But it’s hard to keep the snippets up to date. If the company changes a logo or a business address, you have to update all the documents individually. If standard legal terms change, you have to update them all individually. If a 10 page section of a proposal template changes, you have to copy and paste that into individual proposals. Office should allow users to “link” to other documents or snippets and update automatically when those links change. This would dramatically enhance productivity in many cases. (Office has made strides in this direction, but they’re clunky and they may require you to set up server software on your network, rather than allowing you to login to a virtual network.)

Finally, the internet has moved beyond the ability to insert hyperlinks and save as HTML. (Even that doesn’t always work well, as my recent attempts to view a PowerPoint presentation saved as web document demonstrated.) “Track Changes” is an awesome feature, but you still have to email around documents or set up a server. Apple beat Microsoft to the punch with its iWork.com concept, which allows users to collaborate online. Microsoft should provide a similar service, which would also include an easy way to manage the snippets I mentioned above. People with the appropriate permissions could update the snippets and apply the changes to sets of documents. This virtual space could support the automated backup of important files of any type, but with additional capabilities for Microsoft file formats or other file formats if their vendors created the right plugins. Make it easy for businesses and consumers to upload files to YouTube, Picassa, and other sites.

Now you have an operating system and a set of productivity applications that actually make people more productive. You can be better than Apple not just at the individual applications, but in the way they work together to help users perform tasks.

When it comes to pricing, you now have a lot more room, because you have created more value. For the people who don’t care about all the bells and whistles, offer the simple version of Windows with an online version of Office with basic capabilities. (Having a 3 application limit in the basic version isn’t as much of a restriction now that so many apps run in browsers– make sure users are at least running your apps.) The “standard” version should include HD authoring tools and should cost about what Windows Home costs now. The “advanced” version should encrypt users’ data, and come with a login to your company’s Windows Live intranet.

There’s a lot of talk that Microsoft should pursue subscription pricing. However, past efforts to do this raised customers’ ire when expected upgrades did not arrive during the subscription period. Until Microsoft demonstrates that it can release meaningful, compelling upgrades regularly, they should stick to licenses. (They can always offer financing to defray the upfront cost.)

What about all these extra goodies? What are they worth? They are worth spurring an upgrade cycle. They should be bundled into Windows and Office. Down the line, Microsoft can charge for them (think about moving SharePoint into the Cloud). More than falling behind the times in the pricing game, Microsoft has stood still while the value game has changed. Fixing the pricing problem and the sagging stock price start with fixing the value problem.

Despite these problems, Microsoft’s earnings have continued to climb, driven in part by savvy segmentation and pricing, which meant that almost alone among companies supplying computer “parts”, whether physical or virtual, Microsoft has been able to maintain and even raise unit prices.

However, Apple has eaten a chunk of the high end personal computer business. Linux made its deepest inroads in the “netbook” segment of cheap laptops, while Google and others threaten to move computing off the desktop and into the cloud (finally fulfilling Netscape wunderkind Marc Andresson’s arrogant if prescient quip that the browser would reduce Windows to a “poorly debugged set of device drivers”).

Microsoft has seen threats before, from IBM’s OS/2, AOL, Netscape, Sun, and others. But Microsoft’s response to the latest onslaught has been weak. Now, Microsoft is going on the offensive again, with a line of ads attacking Macs as too expensive, and a new pricing attack against Linux that has reversed market share losses in the netbook segment (see How Microsoft is fighting back (finally) at Business Week).

The problem is that Microsoft can only complain so loudly that Apple is too expensive before the obvious comparisons between Microsoft and open source solutions like Linux and Open Office make Microsoft appear over-priced. For most consumers, Linux netbooks are perfectly adequate from a software perspective (personally, I need a fullsize keyboard a decent screen– even the Macbook Air doesn’t qualify for the screen).

Allowing OEMs to ship Windows 7 at $15 per copy for the most basic version will help head off Linux, at the cost of the tremendous margins Microsoft has typically enjoyed. However, it’s better to cannibalize yourself than let someone else do it for you. Without a way to actually grow profits, though, Microsoft stock will continue to languish, talented and ambitious employees will leave, and Microsoft will lose its place as the industry’s dominant player and join IBM as another powerful behemoth.

Is the company that changed the computer industry, partly by audacious bundling (I’m talking about practically giving away Office productivity applications by 1980s standards, not the later bundling of programs with Windows), doomed to irrelevance? In a follow-up post, I’ll talk about what they could be do to regain their mojo.

First, if you don’t understand what customers value in your car market, you are in deep trouble. The Big Three carmakers are called carmakers for a reason. Their primary market is cars. However, the massive profits from trucks masquerading as SUVs covered up for a lot of sins. With a few exceptions, Detroit didn’t make cars that people really wanted. Unlike Toyota and Honda, which managed to make Corollas, Camrys, Civics, and Accords perennial best-sellers (and money makers). Fixing this is about fixing the culture at the Big Three, which could take volumes.

Second, if you look at a report of your promotions over time and you see a line that goes up over time, that should be a big red flag that you have to deal with point number 1.

Anderson starts by recounting the story of King Gillette, whose disposal razors laid the foundation for a multi-billion dollar industry. Now some companies have “razor blade” strategies. Think Hewlett Packard printers and cartridges, commoditized industrial products and high-margin services, Xbox video game consoles and games. The loss leader products in these examples have substantial marginal cost, which, along with antidumping laws, prevents companies from giving them away for free.

On the web, however, marginal costs are often close enough to zero to be zero for practical purposes. Anderson notes:

Not too cheap to meter, as Atomic Energy Commission chief Lewis Strauss said in a different context, but too cheap to matter…

From the consumer’s perspective, though, there is a huge difference between cheap and free. Give a product away and it can go viral. Charge a single cent for it and you’re in an entirely different business, one of clawing and scratching for every customer. The psychology of “free” is powerful indeed, as any marketer will tell you.

This difference between cheap and free is what venture capitalist Josh Kopelman calls the “penny gap.” People think demand is elastic and that volume falls in a straight line as price rises, but the truth is that zero is one market and any other price is another. In many cases, that’s the difference between a great market and none at all.

This concept is powerful and disruptive for problems that are amenable to web-based solutions. It’s not so powerful if you need a giant locomotive to move goods across the country. However, if information can replace the physical goods, prepare for disruption.

Microsoft, whose Windows and Office software programs generate billions of dollars in profit every quarter, thought it was immune to the web-based threat. Microsoft thought that the web could never provide rich enough functionality for users, and users would never accept a solution that required a live internet connection. Funny thing. Google just introduced technology that allows people to use its Office-like applications without an internet connection. Meanwhile, when connected to the internet, users can share documents and work collaboratively more easily than with the more fully-featured Microsoft version. Cost for Microsoft Office? About $300 for an upgrade. Cost for Google’s version? $0.00.

So where does the money come from? After all, a business is a business, and if it is to remain so, a fundamental inequality must hold true:

Value Provided to Customers > Price Paid by Customers > Cost to Provide Value

Leaving aside questions of value, the only way for a price to really be zero is if the cost is less than zero. While this may seem absurd, it’s the magic behind Google. It’s just that instead of serving customers for free, Google serves an audience to advertises for high margins. Anderson would like us to think that this is a fundamental change in the nature of business, but it’s really as old as newspapers.

Free is not a pricing strategy. It’s an advertising strategy (gather as large and valuable an audience as possible). It’s a promotional strategy (offer free services to cross-sell or up-sell other offerings). It’s a testing strategy (allow users to test your software for free, so that the premium version is more reliable).

Companies that take part in the “free” economy need to have a good strategy for monetizing what they giveaway at some point. And as Anderson points out, while we have more and more abundance in many aspects of our lives, our time and attention are scarcer than ever. The ability to offer something for nothing, even if the offering is valuable, is worthless if no one notices. Along with the abundance of the web, comes a strong network effect that Robert Frank and Philip Cook explored in The Winner Take All Society. In this global age, benefits accrue disproportionately to the “winners.” Google makes billions from “free” search. A small group of other search companies combined makes less money than Google. But offering a free search service is unlikely to generate significant profits, unless you can find a valuable and underserved niche. Similarly, a handful of popular bloggers make good money by giving away their ideas for free, and charging for ads. I am not holding my breath for this strategy to work for pricing blogs.

So we still have to provide value to customers, whether they are users or advertisers. We better be able to charge more for this value than it costs us to provide it. Otherwise we will go out of business. Anderson is right that the cost side of inequality is changing rapidly and that this can have a disruptive effect on markets. But while $0.00 may make for a catchy headline, it is not the future of business.

(Anderson, who previously wrote The Long Tail, is developing a book based on this concept, titled FREE, which will arrive in 2009.)

Josh Kopelman over at the Redeye VC blog has a great post (see image from post– click for larger image in original post) on the importance of the part of the demand curve when the price moves from “free” to “not-free.” As a venture capitalist, Josh focuses on the need to understand how hard it is to move people along this part of the curve, and the need to consider alternative revenue sources, such as advertising, to monetize free services. As pricing people, we may fall into the same trap as entrepreneurs, saying things like “it’s only a $5 a month, we’ll get 10% of the market.” $5 per month is infinitely more expensive than free, however. So people only sign up to “premium plans” if there is clear value. This is especially acute for companies that offer free and premium editions of the same product or service. How many home computer users upgrade to ZoneAlarm Pro? Or QuickTime Pro? The focus for these types of products must be entirely on business purchasers. You can certainly build a good around it, but don’t assume that you can get X% of your “free” market to start paying you.

The webinar focuses on high tech products, but many of the techniques apply across industries. Leave a comment with your feedback.

Effective Pricing and Value Capture

How a little planning can make a huge difference to product success.

Pricing sometimes seems like the forgotten “P” in the “4 P’s” of marketing. Rather than something that we bake into the product management process, it is something we throw in at the end. And often product managers have no visibility or control over what discounts apply to the list price. Unfortunately, neglecting price can have severe impact on profit. Pricing is likely the area where product managers can have the most bottom-line impact.

In this webinar, you will learn:
- Why pricing tends to get neglected (part of the problem—it’s hard)
- The consequences of this neglect and the opportunity for proactive pricing
- Price as the monetization of value
- Inside-out and Outside-in pricing
- Measuring value in different segments with the Value Price Waterfall.
- Aligning pricing policies, including list prices and discounts with product and company goals.

The webinar will include a real world case study from a software firm.

Microsoft can’t bundle free content with Windows, since that would create antitrust issues. However, the major media companies currently fear Apple’s dominance over their content more than Microsoft’s. The folks from Redmond could have negotiated a deal with the record labels to provide 50 or 100 free songs with every Zune purchase, much like the discount CD clubs. Then they could have just mirrored Apple’s pricing.

Instead, they had to go make it complicated. Perhaps the tech giant can’t help it– see this hilarious take on what would have happened if Microsoft had developed the iPod, a parody produced by Microsoft’s own marketing team.