One of the most difficult questions facing every digital startup is how much do I charge? While application pricing can be somewhat of a black art, there are some considerations that can help.
Pricing a web app is very different from pricing a tangible product where the cost is calculated based on physical worth. The costs of maintaing a web app can be incredibly low, therefore the pricing is based on value rather than a fixed unit cost.
Can You Charge For It?
The first question you need to ask is: would anybody actually pay for the product? Some applications, such as personal convenience tools may fulfill a user need but won’t necessarily provide enough value to motivate every user to want to pay for it. It might be difficult to determine this early on, but it’s a good idea to answer this question as soon as possible in order to establish a suitable revenue model.
In some instances; giving something away for free can benefit you in other ways, such as raising the profile of your business, which can then direct users to your other products.
How Much Is It Going to Cost?
The next thing to determine is how much it’s going to cost to develop and maintain your application. The most common costs relating to web app development are:
Salaries and Rent
If you have a team, they may either own an equity stake in the business or else you will be paying them a wage. You will also need a premises so the team have somewhere to work.
Bank and Merchant Fees
If you are accepting payments for your product, then you will have various fees associated with this – these will be mainly for a merchant banking account and transaction fees.
Legal Costs
If you are working with someone else, or have someone working for you – then it’s a good idea to have some legal contracts in place incase anything should go wrong. You will also need this if you are handling customers money.
Hosting and 3rd Party Services
Hosting is going to be a primary cost and also consider the cost of any third party services such as Typekit or payment gateways.
Referrals
If your product relies on referrals then you will have to pay a commission fee for each referral you receive.
Scaling
Also consider the costs associated with scaling; as your app begins to demand more features, power or storage space, the cost of hosting will increase and you may also need to consider additional team members as the product grows.
Defining Value
People don’t pay for the product, they pay for the value the product provides to them. Value is solving a customer problem and how effectively you can solve that problem. By understanding your value propositions you will be able to determine your price more effectively.
Performance – are you the fastest, most reliable or smartest application available?
Innovation – are you offering something new and innovative?
Convenience – are you providing the easiest or quickest way to solve a problem?
Quality – are people paying for superior quality?
Price – are you the cheapest or best value for money?
Revenue Models
There are various revenue models associated with web applications, the correct choice will vary depending on the product.
Asset Sales
This is the most basic model; when you bought your coffee this morning, you exchanged a one off payment for a product which you then gained ownership of; no further payments were required. This kind of model is the least common with web applications due to the nature of recurring costs.
Freemium
Chris Anderson described it as the opposite of free samples; instead of giving away 1% to sell 99%, give away 99% to sell 1%. This may sound ludicrous, but with digital products – the cost of maintaining each user is incredibly low, and it’s getting lower as the cost of hardware continues to decline.
Freemium can work in a variety of ways; you may have two products – a free product and a paid product – the revenue from the paid product covers the cost of the free one. Or, you may have two or more groups of users on a single product; a group of free users, and a group of users who are paying for advanced or different features. The minority of paying users subsidise the costs for both themselves and the free users.
A common example of this approach is freemium advertising; this is the basis for Facebook and Google. The 99% are the social users who are using the product for free, the advertisers then pay for advertising space, which pays for the the entire product, or range of products in the case of Google.
It's best to illustrate this with an example:
Your product has 100,000 users.
Each user costs £1 per year to maintain.
100,000 users = £100,000.
The average conversion rate for freemium is between 1 and 5%.
If the product has a 3% conversion rate; 100,000 ÷ 3% = 3000 paying users required.
£100,000 ÷ 3000 = £33 per paying user, per year.
Subscription
Subscription plans enable customers to pay a recurring fee every month or year. Rewards should be offered for customers willing to pay the yearly fee as you receive a larger financial commitment and the transaction costs will be less.
The only problem is; customers may be reluctant to commit to a product for a year, so having the option for customers to choose is a good idea. A monthly subscription allows users to sample the product on a short term basis which may lead to a long term commitment later on.
Tiered Pricing
Usually combined with the subscription pricing model; tiers provide users with a number of different pricing options based on the number of product features. Basic users will pay a smaller fee for a limited set of features, while advanced users will pay a higher fee for more features. Similar to freemium, the majority of users will be on the basic package while the profit comes from the users on the more expensive tier.
This pricing model needs to be kept simple and should be proportional to what you are offering. If for example, you are charging £25 per month for 10GB of space. Then it makes sense that £50 a month will provide at least 20GB.
On Demand
On Demand allows users to pay as they go. Subscription services are most suitable for users who will obtain regular use from the product; for example; project management or invoicing software. Some products may only be used occasionally and these should utilise an on demand model.
Mailchimp offer a a tiered pricing plan for regular users and an additional pay as you go plan for casual users or those who may only use the product once or twice.
Determining Your Price Based On Value
The first thing you need to determine is the recurring cost of maintaining the application. To work out the basic cost per user; use the following formula:
basic cost per user = recurring costs ÷ number of paying users
Forget about the initial cost of development – you cannot factor this into your revenue model. If your application cost £10,000 to develop you will have to recoup this in profit later on – to incorporate this in your revenue model would mean you would be over priced once this cost had been recovered. **Your revenue model should be based on recurring costs only. **
The rest of the revenue (profit) will be based on the price you place on the value you offer – unfortunately there is no formula for this. You can determine an estimate for some values proportionally; if your application can perform a task three times faster than what’s currently available, then charge roughly three times the price.
If your providing a professional product; you can charge more than a personal application. Although the cost to develop and maintain both will be similar, professional applications provide more value. An application that saves a company £20,000 per year is of higher value than a tool that allows a user to upload 2GB of photographs. This is why people are be prepared to pay $50 a month for Basecamp, but wouldn’t necessarily pay the same amount for a Flickr Pro account.
The more perceived value you provide to the customer, the more they will be prepared to pay, but it’s difficult to quantify value. You can use your competitors pricing as a rough guide – this will give you an idea of what customers in your market will pay. If you are offering a product with higher value then charge more.
Much of the art of web app pricing boils down an educated guess, there is no right or wrong answer - if your customers find value in your product and are prepared to pay a price that generates a profit for you, then you’re on the right track.