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Capturing consumer surplus - ONCE!

(Obviously, the subject is via http://www.joelonsoftware.com/articles/CamelsandRubberDuckies.html)

I'll keep this short:

- We developed a custom ASP app in close contact with its eventual user (one of the largest Asian banks)

- We didn't do a simple custom development contract -- they didn't think we could do what they wanted, and we saw the value in offering the app as a product in the wider market.  We figured that once they saw the finished app, we'd have that much more pricing leverage and would yield much more than if we just charged them an hourly rate.

- The app is finished, and they love it.  They want it bad.  They want to own it exclusively.  Fine with us, it'll just cost them that much more.

- We're now at the point of price negotiation.  They've asked us to name a number.  Therein lays our problem.

What should we throw out there?  We have a cost basis from development (~200K), but (as my subject says) we want to charge as much as they could possibly bear without (a) scaring them off, (b) undercutting ourselves, or (c) making them think that we don't know the value of what we have -- which, of course, we don't.

There's nothing like this out there (they said they've been searching for 3 years), but the potential market might consist of *maybe* 10 similar banks.

In considering your suggestion, keep in mind:

- We've been working directly with their VP of Operations
- They dedicated a team of 6 analysts to test the app
- They already have deployment plans in the works (they really, really want this thing)

All three of those points makes me think they're expecting a high number.

So, what's the sticker price?  $800K?  $1.2M?  Five bucks?

Damn, pricing really sucks.
Pricing Sucks!
Tuesday, May 30, 2006
 
 
Make them give you a price first. Give them a deadline because you want to persue your options as quickly as possible.

You may also want lock up the maintenance, support, and enhancements contract.

Remember, your cost doesn't have anything to do with the price.
son of parnas
Tuesday, May 30, 2006
 
 
+1 for getting them to make you an offer first.  Also nip down to your local library and speed read Getting to Yes - a pretty good book on negotiation. You can't go into this cold.

All the best.
sconto
Tuesday, May 30, 2006
 
 
Whatever number you come up with, double it.

And don't underestimate the cost of the typical software maintenance contract. Most consultingware companies will force them to pay a yearly software maintenance fee of up to 20% of the licensing cost. This means that they end up re-buying the app every five years. If they will not have to pay for this then it is a huge cost savings to them. Make sure they understand this cost and use the fact that they won't have to pay it to your advantage in the initial pricing.
anon
Tuesday, May 30, 2006
 
 
I'd suggest that you decide what this is worth to you, including other future business lost, etc. if you give them an exclusive access.  If you think there are 10 other banks, and each might be willing to pay, say 1MM for an installation, plus 100K/year for support and maintenance, your 10 year value of the software is probably 20MM.

To start negotiations, use a number that you'd be deliriously happy to get (let's say there are really 20 banks you could sell to, for example).

They will understand that it is a negotiation, and come back with their own numbers.  You can explain your process at arriving at the original number, but exclusivity should really cost a lot more than just buying the software from you.

Good luck.
Dave C
Tuesday, May 30, 2006
 
 
Also keep in mind the potential market.

If there are 100 banks that would purchase it, your exclusive price should probably reflect that minus the consolidation of support costs and some fudge factor that someone else will develop a similar product and eliminate your customer's competitive advantage.

In this scenario, say I offer site licenses (not a good idea but for a different reason) for $1k. I could potentially capture $100k if I sold it normally, but since I only have to deal with one customer and I don't want him to have buyer's remorse, I would aim for at least $75k.

I strongly agree with the suggestions that you let them suggest a price, and that you read those negotiating books, but also remember which type of customer those pricing strategies are for.
TheDavid
Tuesday, May 30, 2006
 
 
The fact that Dave C and I came out with the same general advice but with different numbers and different rationales, only underscores how difficult pricing is, and why you shouldn't take it lightly.
TheDavid
Tuesday, May 30, 2006
 
 
find out what other products would costs. From the sounds of things, 1.2 million wouldn't be that ridiculous.
Patrick From an IBank Send private email
Tuesday, May 30, 2006
 
 
Get their offer, but also do their ROI yourself - estimate how much they will make/save and assume they were willing to invest the three years you mention in building it themselves.
Cade Roux Send private email
Tuesday, May 30, 2006
 
 
Back in the 80s the company I'm with started to sell an enterprise product that they thought had only 20-25 potential clients. Several years later when they reached 75 sales they had a big company party thinking they had finally reached the saturation point and this was the peak. At that time they thought there might be just a few more potential sales, but never in their wildest dreams could they reach 100. When they sold 150 everyone was amazed. They had done the impossible, but surely that was the saturation point, until there were 300 and later 600 and today thousands.

You think right now there could be 10 sales? You've got another think coming boy.
SumoRunner
Tuesday, May 30, 2006
 
 
I would love to know what their number is. It's a matter of figuring out how to get them to tell me without being absurdly blatant about it (i.e. "How much would you be willing to spend?"). The purchasing officer sent me an email asking what our price was. Replying with anything other than a price seems to make me look like an unfair negotiator. (Of course, this wouldn't be so hard if I knew what the market price was for similar functionality -- unfortuately, such an animal doesn't exist!)


@SumoRunner
That's a nice anecdote, but I would frankly rather sell an exclusive for $2M today than hope that I'll be able to find more customers tomorrow.  Obviously, that's a personal decision.
Pricing Sucks!
Tuesday, May 30, 2006
 
 
"...sent me an email asking what our price was."

This is just a standard opening practice, usually initiated as part of the procurement procedure at that company. Keep in mind, the person who sent it may be expecting shrinkwrap software, and this indeed would be the appropriate way to find out how much Oracle charges for their databases.

All you have to do is say that you're negotiating an exclusive and customized contract with [insert your contact here] for both the product and services, and you're not yet comfortable quoting a market price as the price would not necessarily reflect the company's particular needs.

If the sender is NOT your contact, suggest that they follow up with that VP. Hopefully the VP will then take care of it.
TheDavid
Tuesday, May 30, 2006
 
 
Have you consider why this customer wants exclusivity? There are only a few reasons why they might want pay a ton extra that I can think of:

1) This software could have a huge ROI and they want to prevent their competition from gaining this advantage.  This seems debious to me though since they probably don't have a good understanding of the IT practices of their competition and would have no way of know if this application suits their environments.

2) They see the value of this application and want to resell it their customers.  They may be able to bundle this application with their own products and sell it to smaller banks which they service.

3) They think they can get the exclusivity option out of you on the cheap.

Please note that none of the reasons are "to contribute to Pricing Sucks' early retirement fund."
Doug
Tuesday, May 30, 2006
 
 
@TheDavid
If only.  He (the purchasing officer) has been in on about 1/4 of our meetings -- he knows what the score is.  They simply succeeded in asking my price sooner than we were going to ask what their budget is...
Pricing Sucks!
Tuesday, May 30, 2006
 
 
+1 "...but also do their ROI yourself"

This is a special case with regards to "ROI' however.  If I was in your shoes, this would be my algorithm for pricing.  BTW - your development costs are "sunk costs" and should have no bearing on your pricing.

1) "Classic" ROI (cROI)- You should estimate a price that would give a "good" ROI.  This results in a price that you would probably use for multiple customers.  You should estimate this in this case, because if you work with the VP of OPS you will establish an expectation that you are going to charge that price.

2) Exclusive Factor (EF) - If they are asking to be "exclusive", why is that?  What is their financial or competitive gain from this.  This will be probably be a qualitative measure, but you will need to turn it into a multiplier.  This should be 1 < EF.

3) Scaling Cost (SC).  This is an estimate of what you would need to expend to create the infrastructure to support multiple clients.  Don't forget what SumoRunner said regarding customers - you may need to accommodate more than your initial projection.  These costs may grow in a decidedly none-linear fashion.

4) This gives you a Minimum Price (MP) of: MP = (cROI*EF) - SC.  Hopefully this is a positive number!!

5) Determine an upper bound (UB).  This is the tricky part, but not so tricky as it seems.  Using a price of cROI estimate the number of customers that would be easy to justify and then UB = cROI*#Cust.

6) Start negotiation with the UB.  Simply state "We have x customers at cROI.  This is $Z".  Then sit back and see what the response is.  Don't even say "We want $Z".  You can use this to get them to give you a "real" first number instead of throwing out a "firm" price that you will almost certainly get pushed off of. 

Bear in mind, they might get indignant, or pretend to be upset - but all you did is state a fact and there is nothing to apologize for.  In fact, if they get emotional, it probably means they really want your product.  If this happens, then simply say "Okay, what do you think is fair, and how do derive that?"  My guess is that using this approach will keep you well above your MP.  If they want to be exclusive, there is a reason - and it might just be because they like the idea.  At this point the question is how much is it worth *to them*.

7) Use principled negotiating to reach a price (P) of MP < P < UB.

8) Profit!

In any case, I would love to hear what you end up doing ... please post a follow-up after it is all said and done!!  Good Luck to Ya!
Loren Charnley Send private email
Tuesday, May 30, 2006
 
 
:)

I'm taking a shot here in the dark, but banks are actually fairly regulated in terms of purchasing, developing and maintaining software. I imagine they have a very specific and formal procedure that has to be followed in sequence. Including the request for proposal or request for bid.

Since you've worked with this guy, I don't think it'd hurt to call him and ask if this is the case.
TheDavid
Tuesday, May 30, 2006
 
 
Offer them a range of prices with a corresponding range of contracts (lower price=less favourable terms).
Andy Brice Send private email
Tuesday, May 30, 2006
 
 
FYI, a good book on negotiating is "Start with No!" and I've heard that "Breakthrough Business Negotiation: A Toolbox for Managers" is also very good.

Those might help you frame the situation better.
Manes
Tuesday, May 30, 2006
 
 
You might try contacting Mike (Bankstrong is his JoS name).

He has a successful startup ISV in the banking area, in the US. He might have some insight.

If you can't find him, contact me off line and I'll forward your question to him.

Or you could post with a better title that would attract his attention.
Mr. Analogy {Shrinkwrap µISV since 1995} Send private email
Tuesday, May 30, 2006
 
 
"- your development costs are "sunk costs" and should have no bearing on your pricing.
"

Generally, I agree. However, bear in mind that if they really NEED this and want it exclusive, you'll want to price it at less than what it would cost them to develop themselves, taking into account the risk that they can NOT even do it themselves, that it'll take time to market, etc.

Also, you might try proding them for info (essential for good negotiation) by thinking of the following:

- Will this product be improved/updated fairly regularly?
-Would it benefit them if the improvements were spread across lots of companies?
- Would the be concerned that other companies had this software to?
(Youve not told us much, but I doubt that an IT dept in one bank cares if an IT dept in another bank has some cool tool. The IT dept's aren't competing against one another. And they may have more in common with other IT dept's in the other bank than with thier own bank. (i.e., the Dilberts of the world have more in common with one another than with thier own PHB).
Mr. Analogy {Shrinkwrap µISV since 1995} Send private email
Tuesday, May 30, 2006
 
 
Also, it certainly seems like some sort of residual would be good, like a 15% per year maintenance contract. That protects both you and them. They guarantee some sort of ongoing support. You get some residual income.

Is there a way to price this on usage?
(Number of simultaneous users, # of processors/hosts it's on).

Oh, and I suppose that since it's an ASP that you MUST give them the source code?

If not, you might try negotiating the price. Then after they agree, ask "now, in addition to your exlusive use, do you also want the source code so you can modify it as needed" ?

(I know, sneaky, but those banks will screw you over if you're not careful).
Mr. Analogy {Shrinkwrap µISV since 1995} Send private email
Tuesday, May 30, 2006
 
 
Well, it has been many advices here and I agree with most of them except that you should not ask them to give you their figure first. Assume that they will say you 100k. You will of course get hem a figure at about 1M. The person at the bank who named this 100k may now become hard to convince that his number is so wrong. And asking for their price first looks rather unprofessional. They will know that you don't know the right price and tell you the lowest number that they think you could agree. It will be really a bad negotiation position for you.

You definitely should prepare an official and professional offer. You can write some information about how you've got your number, but in fact I don't think it's neccessary and in most cases it can do more bad than good.

What I would advise is - think of two numbers:
1) The lowest price you can sell it to them.
2) The best price you would like to get.
Then start your offer with 2) + 20%.

And another thing. Such deal will probably take quite some time to close (if it will close at all). So don't wait for that and start looking for other customers. Show your solution other prospects and get more information how good your product really is. This can give you really strong negotiation position if you will find several interested prospects.
Greg Send private email
Tuesday, May 30, 2006
 
 
Mr. Analogy writes: "... you'll want to price it at less than what it would cost them to develop themselves"

As usual, Mr. Analogy brings up a great point.  Relative to my flight of fancy regarding the pricing algorithm above, the Upper Bound needs to factor in this data.  However, don't make the mistake of assuming that your cost is the same as, or less than, their cost.  Depending on their size and development process, risk etc. - their cost could be much more than yours.
Loren Charnley Send private email
Tuesday, May 30, 2006
 
 
This is an easy one: HIRE A BROKER.

You are good at producing software applications. You are probably not good at negotiating technology IP contracts with Asian banks. There exist, on planet Earth, people who do _nothing_ but negotiate technology IP contracts with Asian banks. They live for deals like this.

Find one. Hire him or her. Pay by commission over your cost(5% of every dollar over $200,000).

This is what Adam Smith was talking about with "Gains from Trade". PS: If you don't have any leads on a broker I will gladly help you find one.
PWills Send private email
Tuesday, May 30, 2006
 
 
I recommend you contact the other potential customers too and find out if there are any. If there are, you can mention in the negotiations, that "so-and-so" company is willing to pay for this "so-and-so" much.

We once made a custom app for a bank for which they paid about 2.5 MU$D. However, that one would not be portable to other customers. But we keep on maintaining and upgrading it according to customer's wishes, at a fair price.
Handyman
Wednesday, May 31, 2006
 
 
I've not read all the other responses, so sorry if I'm repeating.

Why not offer them two prices: exclusive and non-exclusive?  If your exlusive price is far too high, they might start to consider non-exclusive rights instead of being scared off altogether.

If exclusive is too expensive for them, you could perhaps negotiate a price for a period of exclusivity (e.g. 2 years).
MB Send private email
Wednesday, May 31, 2006
 
 
Hi all -- thank you for your advice and help.

I think we have a strategy mapped out -- thanks to a few postings here, a few postings elsewhere, and a ton of help from our counsel and accountant.

I won't let the cat out of the bag as to what our strategy is though.  (As I'm sure is obvious, I'm trying to be thoroughly anonymous.)

However, I will come back when things have solidified and update everyone on what's transpired.

I've now attached an email to my posting -- if anyone wishes to correspond on this topic privately.

Thanks again!
Pricing Sucks! Send private email
Wednesday, May 31, 2006
 
 
BTW please tell us how it went when the whole game is over. I'd love to read your post-mortem.
Peter Monsson Send private email
Wednesday, May 31, 2006
 
 
+1 for the post mortem, if you're not too occupied living on the new Island you buy with the proceeds.
Mr. Analogy {Shrinkwrap µISV since 1995} Send private email
Wednesday, May 31, 2006
 
 

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