On a number of technology blogs, a bit of grumbling has started over the price of software bought from Apple’s AppStore. So let me just explain what this is.
I’m sure you are aware of the iPhone, one of the hottest consumer electronics products in the last 12 months. About a month and a half ago, Apple introduced an updated version of the product, the iPhone 3G. As the phone is basically a small portable computer, Apple also introduced what they call the AppStore, a section of iTunes where iPhone users can download small software applications. The AppStore has been a huge success, with hundreds of these iPhone applications available, selling more then $30m worth of software in the first month despite the fact that a majority of the apps are available for free.
Each developer set his or her own application price, or decides to give the app away for free, though most chargeable apps sell for $2.99 – $9.99. And on various technology blogs, I'm starting to hear about one of the world’s most common pricing mistakes. Developers are complaining, to whomever wants to listen, saying things like “I used my gut feel to price my app at $9.99 and it did not sell very well, so I dropped the price to $2.99 and sure I’m selling more but I’m getting less revenue”. This is a classic example of the perils of price elasticity. Price elasticity is a fancy name for how the demand of a product or service changes with the price. If the demand changes little with the price, then the price elasticity is low (or inelastic); if it changes a lot, price elasticity is high (elastic).
Once the elasticity curve is known, it is easy to generate a revenue curve. The revenue curve points out the best or optimum price, where the combination of price and demand generates the maximum revenue. If your market is elastic, and most markets are, selling your product at the optimum price point is crucial for the business results of your company, and can easily mean the difference between market leadership and marginalization.
These AppStore developers have a very unique advantage in the way they can discover the price elasticity curve for their product by simple trial and error. An advantage virtually no other company has. They sell software, so revenue max is also profitability max, they promote their product to a “closed” marketplace as they only compete with other software companies in the AppStore, and they can change the price as often as they wish.
So an AppStore developer can start with a price of, say, $9.99, wait a month, note the demand, change the price to $6,99, wait a month, note the demand, change the price to $4.99, wait a month note the demand and so forth. After plotting 5 to 6 demand points, all with prices taken out of thin air, it will be easy to set the optimum price, the price that will give the developer maximum revenue and profits. Of course, during this process, the company is losing revenue; leaving money on the table to define the lower-than-optimum demand points and forsaking sales volume to define the higher-than-optimum demand points.
Any company can do the same. Whether you are selling farm equipment, data storage, shovels, or boxed software the process is identical, but, because you don’t have the advantages of easily changing your prices on a platform like the AppStore, the process will be longer – probably a few years. And chances are that by the time you are done, your marketplace will have changed so much it will be time to start the process all over again. Not to mention that in the process, you will give up millions in lost revenues and margin.
So when you priced your product, did you use some combination of “gut feel”, “I know exactly what the market will bear”, or the all-too-frequent “our cost plus x % markup”? If you did, what are the chances that by sheer luck you will hit the optimum price point? If you were one of the very few who found that price point by luck, you probably have revenues beyond your wildest dreams. But if not, chances are much higher you are struggling to meet the numbers. If your company is like 99% of companies out there, you can easily gain 10% – 20% in revenue, double your growth rate, and double profitability by knowing the price elasticity of your product, and optimizing your price accordingly. Think about it. What would price optimization mean for your company?
And if experimenting with different price levels and seeing how they affect demand is not a realistic possibility at your company, as the cost in lost business is too high, how will you be able to define the optimum price?
With warm summer regards,
Per Sjofors
Founder & Managing Partner
Atenga Inc
www.atenga.com
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9 comments:
Hi Per,
this sounds a little theortical to me. Though i will not call it theorethical in case you explain how you handle the customer confusion with the changing price? I often read bad comments on the appstore after price changes occured. How would you handle it, what is your experience here?
Cheers,
Nils
Hi Nils,
There is a couple of thinks you can do to mitigate the confusion:
1 - You can run special price promotions to define the lower price points while keeping the list price unchanged.
2 - You can increase the price in conjunction with a new version, or new names, of the software. Because you increase the price, and to them you have to defend the price increase with added features and value.
3 - You may be able to un-bundle or bundle features in such way that price changes are not as obvious to the potential customers.
The point I'm trying to make is that customers that are bitching and moaning does not pay YOUR bills because the don't buy your product. It may well be more profitable for you to serve fewer customers but make more money on each customer. That is why knowing the demand curve is so important.
Hope this helps.
Per Sjofors
Great thoughts.
If you were to roll out an iPhone App next week, would you start at a low "introductory rate", say $.99 and increase it later - or would you start higher, say $3.99, and decide if you need to lower it later?
Also, it appears that some are using lower pricing to attempt to get into Apple's highly visible Top 100 category, then increase price later(then decrease it, etc).. Any thoughts on this practice?
Thanks for your insight
How can you sit there a say it's ok for companies to change prices on apps? Do you not understand how often these people are changing the price? I bought an app two weeks ago for 9 dollars and now it's 1.99 how the fuck is that ok? So what your saying is fuck everybody and make money? Go from 9 dollars to 2 dollars and then to 6 dollars back to 9 and down to 1 dollar all in a few months what gives these companies the right to change the price 100s of times in a month if they want? I've also bought an app and the same day they change the price shouldn't I be able to get a refund? Fuck no I can't there should be a limit on how many times a company can change the price! I have also bought an app and a month later it was free! It's sad that apple let's companies rip people off all I have to say is if the app was any good they wouldn't have to lower the price but most of the apps in the app store are shit and the only way companies can make money is cheat people well I've got a big fuck you to those companies I can see changing the price once maybe even twice but when it's every week it gets beyond retarded fuck apple
I would encourage Anonymous to check in with his local gas station to find out how often and how many times you can change the price. Up or down. I assume you are still buying gas.....
The fact is that once you bought an App you don't often go back and check the price, so companies should not have fear of experimenting.
For John, you should absolutely use an introductory rate as opposed to a low price, and you should try to offer different version of your product, at different price, to capture the maximum of your clients willingness to pay. One suggestion may be:
Light version $1.99 intro offer $0.99
Regular version $2.99
Pro version $3.99 intro offer $3.29
Hi Per,
you see what I meant with angry comments :-)
I'm not sure if the comparison with has prices is valid. Gas is no a product like an app. And people are quite used ro the changing prices...
Although I like your introducary price stratgey. Starting low with communicating tto get higher on a specific date is fair and leads to the point. Even Anonymous shouldn't blame one as a liar.
Cheers,
Nils
I don't think the change price is the way to go.
it's bad for a company, users will always wait for the lower price.
I'm currently taking an economics course in college. I'm a returning student who quit 6 years ago and am now finishing. We're studying price elasticity now and I found myself looking for various articles online when I ran across this blog post. Per, I do agree with your idea for introductory pricing and experimenting. If a person is to run a business and run it successfully, he/ she has to know the optimum price point. In regards to the Iphone I believe that if one is willing and able to spend the money on such a device, then a price change in an app shouldn't be a concern. Anonymous said he bought a game that was deleted the same day. Are you using this phone for business or as a glorified gaming console? If you want to play games, buy a PSP or DS.
It's been a pleasure to read this post, It really helped me to open up my eyes. Thanks for publishing.
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