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In https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2020.360..., assuming the demand curve slopes downward, a quite reasonable guess as to the optimal point on the demand curve is ([Max willing to pay] - [marginal cost])/2.

So if doing the market research here in this post, #1 in your above list is the main thing. You want to find the reasonable upper bound before the demand goes to 0 on the price curve.

For one time sales, like in this scenario, it is a fairly simple way to price things.

3 comments

Marginal costs makes no sense for software…

Neither does it in most aspects of modern economies BTW, as it's zero or very small almost everywhere on the supply curve except in local places when the business is at capacity, and then the marginal cost is ridiculously high locally before returning to zero.

Economics are really the only domain where someone (here Maurice Allais) can receive the “nobel price” and then see his results completely ignored later on, it will never cease to amaze me.

There is quite a lot of software (mostly in B2B market) that has a very high marginal cost, where the cost of doing sales and customer-specific customization can easily dominate the fixed cost of making the pre-sale software.

- what you're talking about here isn't software, it's consulting service and (at least in all companies I worked with) this is usually billed separately from the software license itself (Edit: now that I'm thinking about it, in fact this is even mandatory in my country because of accounting rules: you can do amortization of software cost but not of service cost so you have to bill them separately, and I'd be surprise if such rule was unique to my country actually given that many countries have rules about amortization of software investments)

- if you end up with a recurring license afterwards (which is what were're talking about here because SaaS works this way) then it's not even marginal cost, it's a fixed up front cost and then you have a stream of revenue. You know it's fixed costs because you don't have to pay it again when you're billing the customer for the second year. Same if your license includes a per-seat/per-CPU price.

And the problem with the idea of “marginal cost” is that in practice almost every cost is a fixed cost.

For instance, let say you have two guys that are dedicated to the customization of your product per client. You call this customization “marginal cost” but in reality it's fixed cost, as their salary is due whether or not you have a customer's product to customize this week.

And I'm not being original here, as I said it's straight from the work of 1988 econ Nobel prize Maurice Allais.

It's not always clear cut when configuration ends and when custom code starts.

But we do bill configuration time.

Customer acquisition cost at least ticks the box of being a net expense, but it's still a one time cost.

Why does it subtract the marginal cost? According to the formula the more it costs to make the product (per customer/sale cost) the cheaper you should sell it.

I assumed they meant “+” (and that's indeed what's in the paper) which is “split the difference between max customer price and marginal cost”, but that doesn't seem particularly insightful nor worth writing a “research paper” for that… (I'm always baffled how low the bar is for submission in econ journals).

B basically any economic reasoning around “demand curve” and “marginal cost” is meaningless in real world situations.

Yes it should be a "+", thank you.

Just because marginal cost for software can be close to zero in some circumstances does not make demand curves meaningless!

Demand curve is meaningless because humans don't have a stable and rational assessment of the price they would accept to pay for something (that's why having pretty hostess and expensive packaging are a thing) and this price also depends on many contextual factors: you're OK to pay much for for a glass of Coke in a fancy restaurant that you would accept at Mc Donalds, and a business values a piece of B2B software very differently depending on at which point we are in the fiscal year.

The so-called demand curve is as useful for a business as a population-wide heartbeat distribution would be. It makes no sense to talk about “the” curve, since it changes all the time!

doesn't that slope imply monopolistic markets?