As I took over as the Interim CEO in March of 1985, we were hemorrhaging cash badly. We were selling Ethernet boards at a list price of about $2000, though average selling price after discounts was about $800.. Cost of the manufacturing boards at volume was about $350. So hardware was fairly priced and had a healthy gross margin of 56%. Software was priced at about $60 per copy after discounts., It seemed as a healthy price because it had almost no associated manufacturing cost. We had revenue of about $5 million in 1984 and cost and expenses had added to about $7.5 million. We had lost about $2.5 million in the previous year. We were still losing about $150K a month when I took over and had about a million dollar in the bank. Situation was pretty dire , with roughly about six months of runway. VCs had told us in no uncertain terms that we should not expect any more money from them. As I mentioned before I immediately cut the expenses by one third, thereby extending runway to about 9 months.
After I simplified the business and put a very sharp focus on our goals, I had time to reflect on things. We had a plan to sell about about 10,000 units of hardware and software in 1985. we were going to barely break even with that plan. Software was going to produce a revenue of $300K while hardware was going to have $8 million in revenue. I had 12 software and three hardware engineers. It dawned on me that even if I sold 20,000 units, software business was not going to be profitable. Software had been priced to help sell hardware.
We already had quality problem with our software and most of the incoming customer support calls were for software. I realized that it was not possible to do quality job and provide quality support for our customers at those prices. Situation just did not make sense to me at all. I remember from my childhood a saying ” Mehenga roye ek baar; Sasta roye baar baar ( expensive stuff makes you cry once but cheap one makes you cry over and over)”. I decided to raise software prices 10 fold over night. Every body, including my board thought I was crazy. But I felt I had to do it to provide quality that customers deserved. New prices stuck, though some customers whined about them no body dropped out. Very soon I was able to improve quality of the software and also improved the customer support substantially. couple of months later every body felt good about it; we were seen as a quality vendor and we were being paid to be a quality vendor.
Our business had also been transformed from OEM to end-users. End users were buying from us directly to connect their PCs to their UNIX boxes and DEC minicomputers. It just did not make sense to price software equally for all those machines. PC’s were priced at about $2000, Unix machines about $15,000 and DEC minicomputers around $75,000. I noticed DEC was charging about $30,000 for the DECnet connections as against our price of about $2,600. Functionality and utility was same. I had my answer. If DEC users were willing to pay $30,000, why can I not charge them $15,000? So instead of selling components I bundled networking connections in to a box and put a single price on it. Customers will buy a box that will include every thing they needed: Hardware, software, transceivers, mounting plates, cables etc. I also upped the guarantee to full money back if the customer was not satisfied. These boxes were sold at $2,500 for PCs, $5,000 for UNIX and $15,000 for minicomputers.
It simplified the business further, improved the margins, increased customer satisfaction. In process, I had increased software prices almost 100 fold. Every body, including myself and my board, was feeling like a winner.
The main lesson I learnt was that price has nothing to do with the cost. It is the value pricing that wins the business and value is in the eyes of customer!