Understanding purchasing processes, pricing and switching costs

You must seriously understand your customers’ purchasing processes when you set your software prices. If you’re selling to businesses, then there will be a number of pricing boundaries that you need to think twice about before crossing. Also you need to understand the pricing and switching costs involved in buying your product at your advertised price.

Ignore them at your peril! As an example:

  • If you sell a product at £10 or under then an end user will probably buy it themselves and charge it to his personal credit card (and may not even reclaim from the company).
  • Up to £50, he or she might charge it to his card and claim it back from the company via some expense form that needs to be approved.
  • Up to £995, he might borrow his boss’s company credit and charge it directly to the company, and complete some documentation around this purchase.
  • At £1000+ and above, he has to explain the reasons to his boss BEFORE purchasing and then complete some paperwork to justify the purchase.
  • At £5,000+, this is getting to be a really serious purchase and he probably has to the head of his department.
  • At £20,000 he will almost certainly have to talk to his MD.

At each stage, not only does the cost increase, but the hassle does too. If you can work out where these boundaries are then it’s worth pricing your software just under a boundary rather than just over it. Please also not, these boundaries can and will change as the level of authorisation will be tightened up during hard times, and if the management style of the company changes.

Once you cross a boundary, you can increase your prices up to the next boundary level without too much difficulty. For example to persuade somebody to spend £20 instead of £10 is relatively easier than to get them ready to spend in the first place. This is yet one more reason to provide multi-user discounts and bundles.

If you’re selling to a larger organization, then the person you are selling to should help you understand these boundaries, and assist you navigating through the purchasing process for their business.  Always ask, ‘who else needs to approve this purchase?’

If you’re trying to persuade people to switch to your product from a competitor’s, then you must position the price to overcome the switching costs your potential customers will face.  For example, if you try and persuade a customer to switch from his old accounting system to your superior one.

First you will need to arrive at a price to overcome the economic switching costs. It will almost certainly take time (= £ money) to migrate his data and files to a format that the new system can process.  More importantly it will take time and training to learn the new menu layouts and shortcuts.

Then you will need to overcome the psychological switching costs. People mostly overvalue what they have, and undervalue what they don’t have – the old saying is perceived wisdom that ‘a bird in the hand is worth 2 in the bush’.

Another powerful psychological factor people struggle to overcome is the emotional attachment to money they’ve already invested.  Rationally, it’s gone. Your customer should not care that he’s already spent £200 on his garbage old software.  But he will.  In my work with many investors over the past 25 years and the really successful ones would prefer a ‘stop loss’ strategy, rather than holding only a ‘paper loss’.   It is a hard thing to learn – it is a sunk cost, you will never be able to recover it!

There are some things you can do to reduce the risk and cost related to switching costs.  It may even work to your advantage.  For example:

  • Early versions of Microsoft Word not only opened WordPerfect files, but had a dedicated section in the help for WordPerfect users, and even allowed you to use the WordPerfect shortcut keys.
  • Open Office & Libre Office which are open source word processing and spread sheet applications – they allow you to open files saved by Microsoft Word, and save them in the same format so they can be opened by users still using Word, or save them in a more open format.

These strategies have two effects. First they reduced the psychological and economic impact of switching to Word and then to Open Office. Secondly, once if a customer has switched, they will have invested time and energy into using the new software.  This means they have incurred additional new switching costs, which will then stop them from switching back.

This series of articles is aimed at software companies who want to sell and deliver profitable software and grow their business – so keep coming back here for more.  Or if you cannot wait and want a free discussion with Phil about the specifics relating to your business,  call or email directly our details are here.

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