This article is part 2 of a series; if you haven’t read part 1 yet, you can find it here.
Types of Products and Licenses
In the first pricing article, we discussed thoughts about the type of product(s) you are planning to sell as well as various channels by which you can reach your target market. Now we will get into how these decisions affect what pricing model you choose, starting with some of the basics.
Roughly speaking, we can categorize “stuff people sell” into two categories: products and services. But note that this is somewhat fuzzy and confusing: “product” is also used to mean both of these things (as in a Product Manager might manage both products and services). For our purposes, I’ll define a “product” as something that is pretty tightly defined, i.e. you can find it on a price list, you don’t need to write up a custom quote that explains what the customer will be receiving, and so on. A “service” means something that isn’t tangible or physical, and that will typically require some sort of custom explanation for the customer as to what they get if they purchase the service. Services are usually delivered hourly and under some sort of generic line item, like “Installation Services,” with the quote or Statement of Work then explaining exactly what is to be installed and where.
That said, one can often take a service and “productize” it to make it more consumable. For example, you might take a penetration testing service which is usually billed based on the number of websites and devices to be scanned, and convert it into an offering that covers 3 websites and 50 devices at a fixed price.
The line between products and services is getting ever more blurry as more and more things we thought were products, like our operating systems and even our cars, are being converted to subscription services. This is usually justified with the claim that the product needs to be continually updated, and thus the customer needs to pay for access to those updates.
With that in mind, I’ll note that when someone “buys” something today, it might not mean what you think it means. Ultimately what the customer is buying is whatever rights they are granted in the End User License Agreement or Terms of Service offered by the seller. These contracts can really say pretty much anything, but roughly speaking most license types can be broken down into these categories:
- Outright purchase: Once the customer pays for the product, they “own” it and can use it forever for most legal purposes. This is most applicable to physical goods, like when you buy, say, a book and bring it home. You can read the book, you can sell, lend, or give it to others, you can use it as a doorstop, and so on. No, you can’t copy from the book and publish it as your own work―so there are some constraints―but you have many rights. The price the customer pays up front is the end of the story.
- Perpetual license with maintenance: This model combines an up front purchase with some kind of regular maintenance, e.g. software patching and updates. In other words, this splits the cost of the product into two parts: a price to purchase the product, and a price to keep it up to date. Once the maintenance contract expires, the customer is allowed to continue to use the product in perpetuity with the caveat that the product may not continue to function as intended. This is often used for software or equipment which is installed on-premise, with the customer downloading patches or receiving maintenance service for some number of years. After the maintenance stops, the product will probably work until something breaks.
- One-time use: This category is for consumables like gas for your car, or the one-time purchase of credits for the use of a service. Once the product or service is used up or completed, it’s no longer available to the customer.
- Subscription: Under this model the customer pays for the right to use a product (or service) only for as long as the subscription is active. Normally vendors will use some mechanism to stop the product from working once the subscription expires: logins might no longer work, an installed product might fail a checkin with a backend service, or content may no longer be delivered. Subscriptions are used for all sorts of things: newspapers, streaming services, software, etc. Even your health plan is a kind of subscription that gives you access to special pricing until the plan ends.
To an extent, what we think of as a “product” somewhat aligns with outright purchases and perpetual licensing, whereas “services” more easily align with subscriptions (or one-time use). Outright purchases of software were very common historically but have mostly converted to subscriptions with the advent of cloud services and streaming. Even stuff we thought was pretty obviously a “product” that we could buy, download, and install is now very often is sold as a subscription.
Example Pricing Models
To make all this a little more concrete, let’s consider a few products and the different ways we could sell them:
- An antivirus software product for businesses: AV software always requires signature updates to stay current on the latest threats, so an outright purchase isn’t feasible. The product isn’t a consumable, so one-time use doesn’t make sense either. But you could, and I have, sold AV software under both license+maintenance and subscription models.
- A cloud-hosted email service: Since this is hosted in the cloud by the vendor it is going to require ongoing operational costs, and major parts of the service will be outside of the customer’s direct control. Subscription is probably the only option, here.
- Training curriculum delivered via LMS: This one is tricky, because it depends on how you think about where the value is. Is the value in access to the service and, say, a businesses’ ability to send their employees to take the training? Or is the value in the training content itself, which will likely only be viewed once by an individual? You could sell this as an outright purchase, as one-time use, or as a subscription, depending on your target market and how you expect people to consume the content.
Without getting into the details of actual license agreements it should be clear by now that before you even think about pricing, you need to think about how you will sell your product and under which type of licensing scheme. Each choice will affect how you will price your product.
License Metrics
Products may or may not be sold as a single item. It doesn’t make sense to buy yourself 20 Netflix subscriptions, for example, but you can buy 20 candy bars. The most basic unit for multi-item (a.k.a. “volume”) sales is just that, a generic unit (or “each”), and is used when you are selling multiples of distinct items. For many other products other units of measurement might be used―gallons, for example, or gigabytes. Don’t get confused with bundled product: your cable internet subscription may come with 300MB download speed, but you aren’t buying 300 individual MB/s of download―you can’t choose to buy 298 instead, for example.
In general, when you price a product you should align the unit of measurement with the value delivered by the product, and/or the incremental costs per unit delivered. For a discrete widget or an hourly service, this is generally pretty obvious―but you can easily sell hourly services under a retainer model (pre-pay for N hours up-front) as well. Note that defining the product value isn’t always trivial; I recently worked with a company that built an AI service into which you loaded a bunch of documents, and then you could ask it questions which it would answer by analyzing the document contents. Initially they thought that the value was derived from all the input content and hence their pricing was based on the storage size for the documents. They quickly discovered that many clients were loading a smaller-than-anticipated number of docs into the system and running many more queries than expected―the real value is in the analysis engine itself.
When you think about selling your product at volume, consider the following:
- How customers are used to buying similar products. You can choose to do what everyone else is doing, or you can choose to change up the model if it gives you a competitive advantage (but note that you may face resistance to change). A decade ago, most people purchased cars up front; now many people pay for their car using a monthly lease (a subscription!).
- How your product delivers value: what leads a customer to buy more than one of your product? More streaming of gigabytes means more people can use the service at higher quality; more antivirus installations covers more of your devices. In many cases, you may want to license based on the amount of consumption (water, GB of data, etc), the number of devices, or the number of people (employees, family members) who will be covered by the product.
- Incremental costs as you sell more of your product. This will vary widely depending on the type of product, but some general rules: physical items will have a fixed per-unit manufacturing cost, which may decrease at scale; downloadable software has minimal incremental cost, since you are just copying bytes; hosted or cloud-delivered software will incur an increased cost per unit of bandwidth and/or compute.
- Think about the extremes. What does it mean if a customer buys 1 unit versus a million units? Is there a lot of overhead cost to setting up each individual customer? Does the incremental cost get lower per unit for much larger deployments (economies of scale)?
You can of course implement hybrid metric schemes, perhaps a base license plus volume add-ons or optional extensions. The end goal is to implement a volume licensing scheme that (a) has a natural “fit” with the perceived value of the product, (b) doesn’t bankrupt you if your customers buy in large (or many many small) quantities, (c) doesn’t allow your customers to “cheat” by buying small quantities but actually using large quantities, and (d) isn’t so complex or burdensome that managing/measuring the licensing metric itself deters sales (or has a high cost).