What is your software worth?

As I mentioned in passing in a previous post, I recently finished up some schooling. In the process of finishing, I've been stripped of a number of heavily subsidized student software licenses, and have been looking into replacing them with full licenses for my new job in the real world. As happens frequently with such software, there's been a certain amount of sticker shock as I look into the full retail price.

In particular, one of my most used software packages (MATLAB), which runs around $50 for a student license, costs $2000 in the private sector (plus another few thousand for various upgrades that I'll need). At first, I was pretty shocked at this price (and still am to a large extent). Despite the fact that the company will be paying for the software, I was still hesitant to ask them to purchase such expensive software.

So all of that intro is really just a way to lead into the main point of this post: how much is your software worth? Without devolving too much into my poor grasp of economics, there are two different ways to think about it:
(1) the worth of software is determined by what you're able to do with it that you couldn't without it. From this perspective, I'd say almost all software is a tremendous bargain. From the example above, having MATLAB available will unquestionably enhance my productivity by at least a factor of two (and in all likelihood, much more). From that perspective, a few thousand dollars is a steal given the productivity boost relative to, say, my salary. The same type of gross productivity gains almost certainly exist for the software you rely on in your business.

Now, there's obviously a problem with the above analysis. If I were to apply the same reasoning to, for example, food and water, I'd determine that they are also worth a great deal (as I'd be unable to survive without them, which would in all likelihood negatively impact my productivity). That brings us to

(2) The software is worth what it costs to produce. In particular, for most products, it's the average cost of producing one more copy of the software (or, maybe, the average cost of making one piece, including the first). Much like food or water, this is the reason that many software products are so cheap. Making one additional copy of a piece of software is virtually free, and assuming that many copies are sold, the same applies to the average cost.

As anyone who had taken an Econ class (or has started to take one before switching out) knows, the price of a product is set by the intersection of supply (as dictated by the "worth" in in (2)) and demand (as determined by (1)). When there is a difference between the two perspectives, there is value to be had. From the buyers perspective, they pay less than the software is worth to them, and for the seller, they earn more than the product cost to make.

For any reasonable economic situation, both sides end up benefiting, because otherwise the transaction wouldn't occur. Software, however, represents a particularly extreme case. As mentioned in (1), most software provides extreme value to the consumer in terms of productivity gains. Imagine life without email or the Internet, and the overall value of software to the user is pretty clear. As mentioned in (2), the marginal cost of an additional copy of software is almost nothing. As such, virtually any payment represents a huge benefit to the seller.

The result of all this is the extremely wide range in prices of available software. If even two competing products exist in a particular area, the price is quickly driven to basically nothing (consider webmail as an example), demonstrating how little an email product costs to produce. In contrast, if a single dominant product exists, such as Photoshop (or MATLAB, for me), the price approaches the value to the consumer, independent of production costs.

So the conclusion of all this rambling is as follows: software is basically free to produce, and as a result, it's usually cheap. But that doesn't really reflect it's worth, which is much better indicated by the monopoly-type situations in place for dominant forces like Photoshop, and specialized software like MATLAB. The next time you're pricing software, it obviously pays to shop around, but the chances are good that you're getting a great deal regardless.