The problem with zero-cost products

Posted: April 6, 2017 by pauljayburns in Business models, business strategy, Entrepreneurship Articles, Home business, Internet, Practical Tips and Advice, Start-up, Uncategorized

Zero-cost products are becoming increasingly common. These are ‘knowledgeImage result for zero cost products’, often internet-based – like software, smart-phone apps, recorded music or videos – where no additional variable cost is incurred by producing one additional unit. Once developed (incurring a fixed cost) the content can be downloaded again and again, at virtually zero (variable) cost. However, the fixed costs for development could be high and still need to be recouped and reflected in the price. So how do you set your price? If you set it too high, sales might not be as good as you hope and total contribution might even not meet your fixed coats, let alone generate a profit. There is also the problem that the product itself might be easily copied, so that if you charge too high a price, but there will be an incentive to copy it.

The first thing to do, unless you wish to offer your product as ‘open source’ (e.g. Wikipedia or Linux), is to ensure that you have secured your intellectual property rights as best you can. If you need to charge for your product in order to recoup your fixed costs and make a profit you need to think about how many copies of the product you are able to sell. The next thing is to be clear about who are your intended customers and the benefits they derive from it.

If you do not expect to sell many copies and your fixed costs are high, the only way to do this is by charging a relatively high price. Whether you can do this depends on the benefits derived by the customer. For example, you might charge a large corporate client a high price for software that saves them a lot of money by streamlining their processes. You might go on to sell similar software to another corporate client at an equally high price, despite the fact that the additional costs involved in modifying the software for them are low. This is an example of differential pricing. The fact you are selling a complex product to a few clients means that they are unlikely to copy it and you can more easily assert your intellectual property rights since you know precisely who it has been sold to.

If you expect to sell many copies of the product you can afford to charge a low price. The total contribution must then cover your fixed costs and make a profit. Sales volume is the key to success, so you must have good distribution channels. For example, recorded music is a zero-cost product – once a song is recorded, the cost of downloading it is zero (although there is the fixed cost of the distribution network). Apple sells its iTunes globally for just a few cents through its iPod and iPhone networks. Apple makes a profit from selling both the music and the device. If your business idea involves smartphone Apps or music then selling it through the Apple and/or Google networks may be a good strategy. However, there still remains the problem of copying. Apple’s approach is to make purchase so cheap and easy that the customer will not be tempted to illegally copy the material, with all the extra time and risk involved.

Another option is to offer your product free and instead generate income indirectly. For example, a free-to-use website might show related advertising or offer related products to purchase (e.g. Google). Often successful websites have multiple income streams.

The next blog will give you some ideas about how to generate income from a website.


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