products, software and annuity income

[duncan drennan]

I was chatting to a colleague last week and he was telling me about his struggle to try to find the right pricing model for a new product that they will be releasing shortly. I thought that discussing their case might bring clarity to some other situations.

In their case there is a hardware product, firmware (the program that runs on the hardware) and software.

Most of us want to create an income that is residual in its nature (i.e. work stops or slows significantly but the money keeps on going). So the question that comes up is, "How do I create a residual income, but not alienate my users?"

Now in software land (the realms of Microsoft's, HP's etc. etc.) the whole industry is built on licensing - you never own the software. You either purchase an indefinite license (like when you buy your copy of MS Office) or you pay an annual licensing fee (like fancy CAD programs etc.)

The hardware world is quite different in its nature - you don't buy a license to use your PC indefinitely, you buy the hardware and it is yours.

One of the significant differences between the two is that software licenses normally come with some service agreement for future updates and so on (i.e. by paying your yearly fee you get some level of maintenance). The licensing fees pay for the developers to maintain and develop the software.

(That was some background and I hope that it doesn't distract from the main question I'm getting to.)

There are three approaches that I've seen used,

1. Sell hardware with supporting software for a once off price
2. Sell hardware with initial software and charge a support fee to get future updates
3. Sell hardware with supporting software and enforce licensing fee by disabling product if license is not valid

Obviously each has it's place. The first one is fine if your sales are high enough to keep the cash flowing. The last is not nice as an end user as you could sit with expensive equipment and not be able to use it. The middle one is somewhere in between. Which approach to use is definitely a function of your market and product.

In a lot of ways it is really a question of sales predictions.

So, how does one go about approaching this? What models can be used to predict sales (and are they worth using if not enough data is available)?

[Dave A]

Let's look at the main factors before trying to answer that:

How quickly will the equipment/firmware need updating to remain competitive?
How quickly will the equipment/firmware become obsolete?
Where is consumer resistance the bigger problem to overcome, on outright purchase or on "rental"?

As the client: If there is no real need to update I'd be resistant to ongoing fees - unless this made initial purchase more affordable.

I'd take a very close look at it from the client's point of view before making any decisions. I'm sure I'm missing angles, but perhaps a starting point.

[duncan drennan]

I think in general there are a couple of conflicting issues.

From a client perspective you want to have future support. In this particular case updates will probably only be needed when the client changes their particular system. Conversely on the business front you need the funds to maintain the firmware/software. If there is no money, there is no business, no business, no support for clients.

That's a bit of a conflicting issue for a client - they don't want to pay continually, but they do want future support.

From the businesses side having licensing/annuity income allows you to say hire a developer who continuously works on the product maintaining and supporting clients. This is a client benefit, but one that costs. The value for each particular client depends on their support requirement.

In a lot of ways it comes down to a balance between clients' willingness to pay an annual fee and projected sales.

Will the sales be high enough to support on going development and support, or will a fee be required to make sure clients get what they want?

On the other hand you have clients who are in most cases probably happier with a single initial purchase price, and that price has a limited range for market adoption.