Software Pricing

Software Pricing.

Ipswitch's IMail customers seem to be in open revolt
over a new pricing scheme. IMail is a popular email server for
Windows-based servers. Ipswitch is a normally smart company in
Massachusetts. This story will be interesting to follow for anyone
making pricing decisions about software and trying to move upmarket.

Disclosure: We use IMail for email at Fog Creek Software. The only
reason we were using IMail is for historical reasons, when we only
wanted to have one public-facing server, and it had to be Windows so it
could run FogBugz. Now that FogBugz is available for Linux, and, more
importantly, we can afford to run as many servers as we want, IMail is
a lot less compelling than Postfix or qmail, which are free.

Now, on to Ipswitch's new price strategy. Clearly, management was
drooling over the Exchange/Notes market and wondered why Microsoft was
getting so much more money for Exchange than they were getting for
IMail, and they probably misunderstood the reason. What they were
thinking was, “oh, Exchange has all these other collaboration features
besides email. Let's add some collaboration features and then we can
charge as much as Exchange. In fact if we even go halfway towards the
price of Exchange and be an even better value than Exchange. Mo' money, mo' money, mo' money!”

First mistake: they underestimated how much more Microsoft can
charge for the same junk simply because Microsoft is the market leader.
In MBA terms, Microsoft can capture a larger portion of the consumer surplus because they're the true market leader, a “safe” choice, and they have a worldwide sales force about 200 times larger than the entire staff of
Ipswitch. These are people who spend every minute of every day
explaining to customers why Exchange is great even if it isn't. Second,
Ipswitch misunderstood that Microsoft is in the market for Large
Corporate Email Systems and Ipswitch is in the market for small-medium
ISPs and smaller businesses without dedicated IT staffs. These are two
different markets with very different willingnesses to pay.

The second mistake was a fundamental pricing blunder of misframing
the value equation. The price of software has very little to do with
cost, and everything to do with perceived value. The classic book about pricing is Nagle and Holden's The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making,
a book which is offered in hardback and paperback, with the paperback
sold at a higher price than the hardback in a brilliant pricing
strategy (Thomas Nagle practices what he preaches). And one interesting
point in this book is that customers perception of value is always
based on comparisons to some baseline. IPSwitch was hoping their ISP
customers, who have never remotely considered using Exchange due to the
extremely high per-user cost, would compare their new price to
Exchange, but of course, what they really compared it to was the price
of the old version of their product, with which it compared very

By the way, if you're wondering what a good example of this strategy is, look at the four editions
of Microsoft Visual Studio. There's a super expensive “Enterprise
Architect” edition at the top of the line that hardly anyone ever buys;
it's only there to make the other prices look reasonable by comparison.
Consumers don't really know how to judge the value of software so well,
so they grope around for nearby products to use as baselines. Pricing
101 says you give them something really expensive to think about so
your product seems cheaper by comparison and thus a better value.

If Ipswitch really wanted to compete against Exchange and Notes,
first of all, they shouldn't be competing on price in that market,
because IPSwitch does not have any inherent price advantage. In fact
Microsoft probably has the price advantage in that market because they
can distribute development costs over so many more customers and they
already have a sunk cost of a huge marketing force. Never compete on price when you don't have a price advantage. If you're the small company, you don't have the price advantage.

And secondly, Ipswitch shouldn't be abandoning their existing market
to chase after an elusive new market in which they're going head-on
against Microsoft and IBM (Lotus Notes). They can't win that way.
There's a Will and Grace episode that proves it.

My sources inform me that this was a decision made by the MBAs in
the company over the strong objections of the developers. It's ironic
that the MBAs don't even get the basic MBA stuff right; this is
entirely a bad move for reasons that business school graduates should
be able to figure out without understanding the technology at all. [Joel on Software]

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