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Abstract: In this paper, we analyze how different dimensions of a seller's reputation affect pricing power in electronic markets. Given the interplay between buyers' trust and sellers' pricing power, we use text mining techniques to identify and structure dimensions of importance from feedback posted on reputation systems. By aggregating and scoring these dimensions based on the sentiment they contain, we use them to estimate a series of econometric models associating reputation with price premiums. We find that different dimensions do indeed affect pricing power differentially, and that a negative reputation hurts more than a positive one helps on some dimensions but not on others. We provide evidence that sellers of identical products in electronic markets differentiate themselves based on a distinguishing dimension of strength, and that buyers vary in the relative importance they place on different fulfillment characteristics. We highlight the importance of textual reputation feedback further by demonstrating that it substantially improves the performance of a classifier we have trained to predict future sales. Our results also suggest that online sellers distinguish themselves on specific and varying fulfillment characteristics that resemble the unique selling points highlighted by successful brands. We conclude by providing explicit examples of IT artifacts (buyer and seller tools) that use our interdisciplinary approach to enhance buyer trust and seller efficiency in online environments. This paper is the first study that integrates econometric, text mining and predictive modeling techniques toward a more complete analysis of the information captured by reputation systems, and it presents new evidence of the importance of their effective and judicious design in online markets.
User-Generated Content, Reputation Systems, Text Mining, Opinion Mining, Electronic Markets, Internet, Electronic Commerce
Abstract: This paper analyzes the optimal choice of pricing schedules and technological deterrence levels in a market with digital piracy where sellers can influence the degree of piracy by implementing digital rights management (DRM) systems. It is shown that a monopolist's optimal pricing schedule can be characterized as a simple combination of the zero-piracy pricing schedule, and a piracy-indifferent pricing schedule that makes all customers indifferent between legal usage and piracy. An increase in the quality of pirated goods, while lowering prices and profits, increases total surplus by expanding both the fraction of legal users and the volume of legal usage. In the absence of price-discrimination, a seller's optimal level of technology-based protection against piracy is shown to be at the technologically maximal level, which maximizes the difference between the quality of the legal and pirated goods. However, when a seller can price-discriminate, its optimal choice is always a strictly lower level of technology-based protection. These results are based on the following digital rights conjecture: that granting digital rights increases the incidence of digital piracy, and that managing digital rights therefore involves restricting the rights of usage that contribute to customer value. Moreover, if a digital rights management system weakens over time due to the underlying technology being progressively hacked, a seller's optimal strategic response may involve either increasing or decreasing its level of technology-based protection. This direction of change is related to whether the DRM technology implementing each marginal reduction in piracy is increasingly less or more vulnerable to hacking. Pricing and technology choice guidelines are presented, and some welfare implications are discussed.
Piracy, digital piracy, copy protection, digital rights management, DRM, information goods, nonlinear pricing, adverse selection, screening, type-dependent participation constraints, copyright, IP, intellectual property
Abstract: How are business schools thinking about developing leaders for the emerging digital economy? To answer this question, we interviewed 45 business school deans about whether knowledge about IT in business should be a part of core MBA education, and if so, how this knowledge should be delivered. A majority of deans recognize the importance of IT in business and the need for its presence in a forward looking core business curriculum that is training managers for an increasingly global and information rich future. There are three themes around which such a presence is described by them: understanding how the transformative and wealth generating potential of IT changes business and society, understanding how to make successful IT investment decisions, and facilitating innovation and creativity in the use of increasingly available data for decision making. However, a significant fraction of these deans struggle with the delivery of IT content in their core curriculum, and there is a clear divergence between the extent to which business school leadership considers IT in business important, and its realized presence in core MBA education. We identify the main reasons that contribute towards this divergence and how some schools are addressing it. Based on our findings, we outline the business importance and intellectual foundations for a natural question around which core education about IT in business can be structured, which asks "How does IT transform business and society?"
business education, MBA, information technology, electronic markets, business models, transformation, electronic commerce, ecommerce, Internet, global, globalization, networks, market creation, search, infrastructure
Abstract: This paper analyzes optimal pricing for information goods under incomplete information, when both unlimited-usage (fixed-fee) pricing and usage-based pricing are feasible, and administering usage-based pricing may involve transaction costs. It is shown that offering fixed-fee pricing in addition to a non-linear usage-based pricing scheme is always profit-improving in thepresence of any non-zero transaction costs, and there may be markets in which a pure fixed-fee is optimal. This implies that the optimal pricing strategy for information goods is almost never fully revealing. Moreover, it is proved that the optimal usage-based pricing schedule is independentof the value of the fixed-fee, a result that simplifies the simultaneous design of pricing schedules considerably, and provides a simple procedure for determining the optimal combination of fixed-fee and non-linear usage-based pricing. The introduction of fixed-fee pricing is shown to increase bothconsumer surplus and total surplus. The differential effects of setup costs, fixed transaction costs and variable transaction costs on pricing policy are described. These results suggests a number of managerial guidelines for designing pricing schedules. For instance, in nascent information markets,firms may profit from low fixed-fee penetration pricing, but as these markets mature, the optimal pricing mix should expand to include a wider range of usage-based pricing options. The extent of minimum fees, quantity discounts and adoption levels across the different pricing schemes are characterized, strategic pricing responses to changes in market characteristics are described, and the implications of the paper s results for bundling and vertical differentiation of information goodsare discussed.
Abstract: This paper analyzes optimal pricing for information goods under incomplete information, when both unlimited-usage (fixed-fee) pricing and usage-based pricing are feasible, and administering usage-based pricing may involve transaction costs. It is shown that offering fixed-fee pricing in addition to a non-linear usage-based pricing scheme is always profit-improving in the presence of any non-zero transaction costs, and there may be markets in which a pure fixed-fee is optimal. This implies that the optimal pricing strategy for information goods is almost never fully revealing. Moreover, it is proved that the optimal usage-based pricing schedule is independent of the value of the fixed-fee, a result that simplifies the simultaneous design of pricing schedules considerably, and provides a simple procedure for determining the optimal combination of fixed-fee and non-linear usage-based pricing. The introduction of fixed-fee pricing is shown to increase both consumer surplus and total surplus. The differential effects of setup costs, fixed transaction costs and variable transaction costs on pricing policy are described. These results suggests a number of managerial guidelines for designing pricing schedules. For instance, in nascent information markets, firms may profit from low fixed-fee penetration pricing, but as these markets mature, the optimal pricing mix should expand to include a wider range of usage-based pricing options. The extent of minimum fees, quantity discounts and adoption levels across the different pricing schemes are characterized, strategic pricing responses to changes in market characteristics are described, and the implications of the paper's results for bundling and vertical differentiation of information goods are discussed.
pricing, nonlinear pricing, screening, adverse selection, nonlinear pricing, information goods, digital goods, electronic markets, Internet, software pricing, ASP, second-degree price discrimination
Abstract: A number of products that display positive network effects are used in variable quantities by heterogeneous customers. Examples include corporate operating systems, infrastructure software, web services and networking equipment. In many of these contexts, the magnitude of network effects are influenced by gross consumption, rather than simply by user base. Moreover, the value an individual customer derives on account of these network effects may be related to the extent of their individual consumption,and therefore, the network effects may be heterogeneous across customers.This paper presents a model of nonlinear pricing in the presence of such network effects, under incomplete information, and with the threat of competitive entry. Both homogeneous and heterogeneous network effectsare modeled. Conditions under which a fulfilled-expectations contract exists and is unique are established. While network effects generally raise prices, it is shown that accompanying changes in consumption dependon the nature of the network effects in some cases, it is optimal for the monopolist to induce no changes in usage across customers, while in others cases, network effects raise the usage of all market participants. Optimal pricing is shown to include quantity discounts that increase with usage, and may also involve a nonlinear two-part tariff. These results highlight the impact of network effects on the standard trade-off between price discrimination and value creation, and have important implications for pricing policy.The threat of entry generally lowers profits for the monopolist, and increases customer surplus. When network effects are homogeneous across customers, the resulting entry-deterring monopoly contract is a fixedfee and results in the socially optimal outcome. However, when the magnitude of heterogeneous network effects is relatively high, there are no changes in total surplus induced by the entry threat, and the pricechanges merely cause a transfer of value from the seller to its customers. The presence of network effects, and of a credible entry threat, are also shown to increase distributional efficiency by reducing the disparity in relative value captured by different customer types. Regulatory and policy implications of these resultsare discussed.
Abstract: A number of technology products display positive network effects, and are used in variable quantities by heterogeneous customers. Examples include operating systems, infrastructure and back-end software, web services and networking equipment. This paper studies optimal nonlinear pricing for such products, under incomplete information, and with the threat of competitive entry. Both homogeneous and heterogeneous network effects are modeled. Conditions under which a fulfilled-expectations contract exists and is unique are established. While network effects generally raise prices, it is shown that accompanying changes in consumption depend on the nature of the network effects - in some cases, it is optimal for the monopolist to induce no changes in usage across customers, while in others cases, network effects raise the usage of all market participants. Optimal pricing is shown to include quantity discounts that increase with usage, and may also involve a nonlinear two-part tariff. These results highlight the impact of network effects on trade-offs between price discrimination and value creation, and have important managerial implications for pricing policy in technology markets. The need to deter competitive entry generally lowers profits for the monopolist, and increases customer surplus. When network effects are homogeneous across customers, the resulting entry-deterring monopoly contract is a fixed fee and results in the socially optimal outcome. However, when the magnitude of heterogeneous network effects is relatively high, there are no changes in total surplus induced by the entry threat, and the price changes merely cause a transfer of value from the seller to its customers. The presence of network effects, and of a credible entry threat, are also shown to increase distributional efficiency by reducing the disparity in relative value captured by different customer types. Regulatory and policy implications of these results are discussed.
network externalities, non-linear pricing, screening, adverse selection, price discrimination, information goods, software pricing, Microsoft, externality
Abstract: This paper presents an analysis of competition in wireless telecommunications that models the interdependence between spectrum availability, network infrastructure deployment, the generation of transmission technology, average traffic levels and service quality. We show that the constraints on spectrum availability and infrastructure that characterize this industry lead to service quality levels that are endogenously affected by market share, and this negative externality leads to bilaterally higher pricing power for competing providers. We incorporate the effects of these negative usage externalities into a two-stage game of quality competition with required minimum infrastructure levels, and establish two distinct kinds of fulfilled-expectations subgame perfect equilibria. Under the first equilibrium, which occurs at both very low and very high levels of average traffic, providers deploy the minimum permissible network infrastructure and price symmetrically. The second kind of equilibrium is asymmetric in both network deployment levels and pricing, though the equilibrium extent of quality differentiation is moderated by the externalities highlighted earlier. Analysis of these equilibria reveals three phases in a wireless market's evolution. In early-stage markets, providers should maintain minimum infrastructure levels and avoid active quality-based differentiation, relying instead on externality-based pricing power. As wireless markets mature, providers need to pursue an aggressive quality differentiation strategy, accompanied by continuous and rapid growth of their network infrastructure. Our model explains why the observed industry trend of relatively flat average revenue per user may be a natural equilibrium outcome during this phase, even though usage levels and value grow steadily. Finally, we identify a threshold level of average per-user traffic at which viable service quality levels and positive profits are not sustainable, and discuss how the rapidly declining profits and quality levels that precede this threshold should trigger active migration to the next generation of transmission technology
Negative externalities, vertical differentiation, quality competition, imperfect competition, congestion, cellular, mobile communication, wireless communication, 3G, UMTS, Erlang
Abstract: This paper studies competition in the presence of digital convergence, a phenomenon that has been observed in a variety of information technology industries: handheld computing, telecommunications, consumer electronics, networking, residential broadband and broadcast video, among others. Digital convergence increases the value and flexibility of products and services, but also increases the substitutability of products that were previously in distinct industries, therefore presenting a critical trade-off for managers making technological and platform scope choices. We analyze this trade-off between product value and product substitutability by developing a new model of competition in converging industries that generalizes popular models of imperfect competition, admitting endogenous product scope choices, variable substitutability across products and industry boundaries, and purchases of multiple technology products by individual consumers. We establish four different kinds of equilibria, which characterize distinct stages of digital convergence. Our results show that early stages of convergence feature increasing prices and profitability, which eventually fall if the extent of convergence progresses beyond a critical point. However, if firms can bilaterally and strategically control the degree of convergence in their industries, their equilibrium strategies can sustain higher prices and profits even when industry boundaries blur. We also describe examples of equilibria in which consumers may buy multiple general-purpose products, using each for a specialized subset of their needs, and discuss how this may lead to cyclical demand trends between specialized and general-purpose digital products. The effect of technological changes that alter the fixed costs of expanding product scope, the variable costs of production, and the breadth of customer requirements are analyzed. Managerial guidelines based on each of our results are presented.
Convergence, platform, scope, imperfect competition, product characteristics, differentiation, telecommunications convergence, media convergence, von-Neumann architecture
Abstract: This paper presents a model of local network effects in which agents connected by a social network each value the adoption of a product by a heterogeneous subset of other agents in their 'neighborhood', and have incomplete information about the structure and strength of adoption complementarities between all other agents. I show that the symmetric Bayes-Nash equilibria of this network game are in monotone strategies, can be strictly Pareto-ranked based on a scalar neighbor-adoption probability value, and that the greatest such equilibrium is uniquely coalition-proof. Each Bayes-Nash equilibrium has a corresponding fulfilled-expectations equilibrium under which agents form local adoption expectations. Examples illustrate cases in which the social network is an instance of a Poisson random graph, when it is a complete graph, a standard model of network effects, and when it is a generalized random graph. A generating function describing the structure of networks of adopting agents is characterized as a function of the Bayes-Nash equilibrium they play, and empirical implications of this characterization are discussed.
Complex networks, complex systems, network games, long tail, power law, network effects, network structure, network formation, small-world, random graph, coordination game, coalition-proof, global games
Abstract: The sustained increase in different forms of electronic interaction over the last decade has led to the emergence of a number of electronic and visible networks that connect consumers, products and businesses. In this paper, we conjecture that the visibility of these networks influences a wide variety of choices and outcomes in electronic markets, and analyze the nature and extent of influence that their visibility induces. We do so by developing an extended model of social or "peer" effects that separates network-induced social influence from demand correlations that are caused by product complementarity, by product characteristics, and by self-selected groupings. Our main analytical result provides a simple set of conditions under which the influence that visible social networks have on demand can be econometrically identified, and we show that our conditions place very minimal empirical restrictions on the structure of the networks that define the pattern of social influence. We estimate this model using data about the demand and co-purchase networks for over 250,000 books offered on Amazon.com over the period of a year. Our empirical results show that the explicit visibility of a co-purchase relationship more than triples the average influence that complementary products have on each others' demand. Furthermore, the magnitude of this social influence is higher for more popular books, for more recently published books, and varies in counter-intuitive ways with changes in pricing, secondary market activity and assortative mixing across product categories. Our paper presents new evidence quantifying the role of network "position" and the influence of visible social networks in electronic markets, highlighting the power of basing virtual shelf position or slotting on consumer preferences that are revealed through shared purchasing patterns. It also offers new results for the identification of peer effects which reverse the impossibility issue associated with the reflection problem of Manski (1993), establishing in the process that robust identification is simplified considerably when there are multiple overlapping networks mediating peer influence.
networks, social networks, peer effects, electronic commerce, ecommerce, recommender systems, identification, selection, influence
Abstract: As Internet-based commerce becomes increasingly widespread, large data sets about the demand for and pricing of a wide variety of products become available. These present exciting new opportunities for empirical economic and business research, but also raise new statistical issues and challenges. In this article, we summarize research that aims to assess the optimality of price discrimination in the software industry using a large ecommerce panel data set gathered from Amazon.com. We describe the key parameters relating to demand and cost that must be reliably estimated in order to successfully accomplish this research, and outline our approach to estimating these parameters. This includes a method for reverse engineering actual demand levels from the sales ranks reported by Amazon, and approaches to estimating demand elasticity, variable costs and the optimality of pricing choices directly from publicly available ecommerce data. Our analysis raises many new challenges to the reliable statistical analysis of ecommerce data, and we conclude with a brief summary of some salient ones.
Electronic commerce, Pricing strategy, Price discrimination, Versioning,
Abstract: The effective management of digital rights is the central challenge in many industries making the transition from physical to digital products. We present a new model that characterizes the value of these digital rights when products are sold both embedded in tangible physical artifacts, and as pure digital goods, and when granting rights permitted by one's digital rights management (DRM) platform may affect the extent of digital piracy. Our model indicates that in the absence of piracy, digital rights should be unrestricted, since a seller can use its pricing strategy to optimally balance sales between physical and digital goods. However, the threat of piracy limits the extent to which digital rights should be granted: the value of digital rights is determined not only by their direct effect on the quality of legal digital goods, but by a differential piracy effect that can lower a seller's pricing power. When the latter effect is sufficiently high, granting digital rights can have a detrimental effect on value - our model indicates that this kind of effect is more likely to be observed for digital rights that aim to replicate the consumption experience of physical goods, rather than enhancing a customer's digital experience. We test the predictions of our analytical model using data from the ebook industry. Our empirical evidence supports our theoretical results, showing that four separate digital rights each have an economically significant impact on ebook prices, and establishing that the digital rights which aim to replicate physical consumption while increasing the threat of piracy are the ones that have negative impact on seller value. We also show that if the pricing of a digital good is keyed off that of an existing tangible good, optimal pricing changes for the former should be more nuanced, rather than simply mirroring changes in the price of the latter, and we discuss the effect of the technological sophistication of potential customers on optimal pricing and rights management. Our results represent new evidence of the importance of an informed and judicious choice of the different digital rights granted by a DRM platform, and provide a new framework for guiding managers in industries that are progressively being digitized.
digital piracy, intellectual property, digital rights management, DRM, piracy, ebooks, electronic book, hedonic price, copyright, IP, law
Abstract: On-demand computing provides a new way for companies to manage and use their IT infrastructure. This model of corporate computing radically changes the way companies pay for their IT infrastructure, basing it on pay per use rather than on the fixed infrastructure investments such companies are accustomed to. A clear theoretical understanding of pricing on demand computing is thus central to the viability and growth of this nascent industry. We contribute towards such an understanding in this paper by modeling the optimal pricing of on-demand computing while taking four critical factors into account: the costs of deploying IT in-house, the business value of this IT, the scale of the provider's on-demand computing infrastructure, and the variable costs of providing on-demand computing. Three distinct pricing models emerge as optimal among all possible pricing functions for on-demand computing. These models describe when volume discounting, free usage and demand caps should be used to manage demand appropriately and profitably. We also outline a likely path that the transformation towards on demand computing will follow - under which low-usage customers are targeted initially, followed by a broadening of the market, and finally, a focus on profiting from inducing adoption by high-usage customers - and prescribe how the associated pricing models should evolve appropriately.
pricing, screening, price discrimination, second-degree price discrimination, software pricing, utility computing, ASP, application service provider
Abstract: We present a framework for measuring software quality using pricing and demand data, and empirical estimates that quantify the extent of quality degradation associated with software versioning. Using a 7-month, 108-product panel of software sales from Amazon.com, we document the extent to which quality varies across different software versions, estimating quality degradation that ranges from as little as 8% to as much as 56% below that of the corresponding flagship version. Consistent with prescriptions from the theory of vertical differentiation, we also find that an increase in the total number of versions is associated with an increase in the difference in quality between the highest and lowest quality versions, and a decrease in the quality difference between neighboring versions. We compare our estimates with those derived from two sets of subjective measures of quality, based on CNET editorial ratings and Amazon.com user reviews, and discuss competing interpretations of the significant differences that emerge from this comparison. As the first empirical study of software versioning that is based on both subjective and econometrically estimated measures of quality, this paper provides a framework for testing a wide variety of results that are based on related models of vertical differentiation, and its findings have important implications for studies that treat web-based user ratings as cardinal data.
pricing, screening, price discrimination, second-degree price discrimination, quality differentiation, adverse selection, information goods, electronic commerce, Internet, software pricing, versions, Amazon, salesrank
Abstract: We study how electronic markets that facilitate broader inter-firm transactions affect the vertical scope of emerging IT-enabled extended enterprises. We do so by modeling firms in a three-tier value chain who are each connected to a common electronic market that facilitates direct business transactions across tiers, and that lowers the search costs associated with finding an appropriate trading partner for each of them. The extent to which search costs are reduced depends on the complexity of B2B search, and the nature of the supporting technologies that the electronic market facilitates. Variation in search costs affect firms across the value chain in three key ways: by a change in the transaction costs of interaction between firms; by a change in the contracting costs associated with outsourcing owing to changes in the costs of moral hazard for delegated search, and by a change in the price dispersion of upstream input commodities. We capture each of these effects in a new model that integrates search theory into the principal-agent framework, and establish that the optimal outsourcing contract has a simple all or nothing performance-based structure under fairly general assumptions. We then apply this model to contrast the effect that different information technologies have on the relative B2B search costs of different firms in the value chain, contrasting the predicted changes of proportionate, constant and convergent changes in search costs. When integrated with a detailed analysis of the nature of B2B search, these results predicts that when B2B search is information-intensive, electronic markets will facilitate an increase in outsourcing, market-based transactions and a reduction in the vertical scope of extended enterprises. In contrast, when B2B search is primarily communication-intensive, electronic markets will lead to tighter integration and an increase in the vertical scope of the extended enterprise. Our research suggest that the nature of the information technologies and of the business activities supported by an electronic market are crucial determinants of the organizational and industry changes they induce, and our results have important implications for a variety of industries in which both technological and agency issues will influence the eventual success of global IT-facilitated extended enterprise initiatives.
outsourcing, disintermediation, B2B, business-to-business, organizational change, moral hazard, hidden effort, principal-agent, electronic commerce, value chain,
Abstract: It has been conjectured that the peer-based recommendations associated with electronic commerce lead to a redistribution of demand from popular products or "blockbusters" to less popular or "niche" products, and that electronic markets will therefore be characterized by a "long tail" of demand and revenue. In this paper, we develop a novel method to test this conjecture and we report on results contrasting the demand distributions of books in over 200 distinct categories on Amazon.com. Viewing each product as having a unique position in a hyperlinked network of recommendations between products that is analogous to shelf position in traditional commerce, we quantify the extent to which a product is influenced by its recommendation network position by using a variant of Google's PageRank measure of centrality. We then associate the average level of network influence on each category with the inequality in the distribution of its demand and revenue, quantifying this inequality using the Gini coefficient derived from the categories' Lorenz curve. We establish that categories whose products are influenced more by recommendations have significantly flatter demand distributions, even after controlling for variations in average category demand, the category's size and measures of price dispersion. Our empirical findings indicate that doubling the average influence of recommendations on a category is associated with an average increase in the relative demand for the least popular 20% of products by about 50%, and a average reduction in the relative demand for the most popular 20% by about 12%. We also show that this effect is enhanced when there is assortative mixing in the recommendation network, and in categories whose products are more evenly influenced by recommendations. The direction of these results persist across time, across both demand and revenue distributions, and across both daily and weekly demand aggregations. Our work offers new ideas for assessing the influence of networks on demand and revenue patterns in electronic commerce, and provides new empirical evidence supporting the impact of visible recommendations on the long tail of electronic commerce.
networks, social networks, electronic commerce, ecommerce, recommender systems, influence, gini coefficient
Abstract: We present a model of dynamic monopoly pricing for a good that displays network effects. In contrast with the standard notion of a rational-expectations equilibrium, we model consumers as boundedly rational, and unable either to pay immediate attention to each price change, or to make accurate forecasts of the adoption of the network good. Our analysis shows that the seller's optimal price trajectory has the following simple structure: the price is zero when the product user base is below a specific threshold, and is chosen to keep user base stationary once this threshold demand level has been attained. We show that our prescribed pricing policy is robust to a number of extensions, which include the product's user base evolving over time, a fraction of consumers being sufficiently rational to make accurate adoption forecasts, and consumers basing their choices on a mixture of a myopic and a stubborn expectation of adoption. Our results differ significantly from those that would be predicted by a model based on rational-expectations equilibrium, and are more consistent with the pricing of network goods observed in practice.
network externalities, network effects, bounded rationality, myopic, target policy
Abstract: In this paper we analyze a model of usage pricing for digital products with discontinuous supply functions, which characterizes a number of information technology-based products and services for which variable increases in demand are fulfilled by the addition of "blocks" of computing or network infrastructure. Such goods are often modeled as information goods with zero variable costs; in fact, the actual cost structure resembles a mixture of positive periodic fixed costs and zero marginal costs. This paper discusses the properties of a general solution for the optimal nonlinear pricing of such digital goods. We show that the discontinuous cost structure can be accrued as a virtual constant variable cost. This general solution is applied to solve two related extensions. First, this paper investigates the optimal technology capacity planning when the cost function is both discontinuous and declining over time. Second, we characterize the optimal costing for the discontinuous supply when it is shared by several business profit centers. Our finding suggests that the widely adopted full-cost-recovery policies are typically suboptimal.
digital goods, price discrimination, nonlinear pricing, screening, discontinuous costs, shared infrastructure, Moore's Law
Abstract: Information technology industries are often characterized by fluid boundaries, wherein firms do not compete merely with others within their own industry, but face a competitive threat from companies in other adjacent industries. This is often driven by a change over time in the scope of capabilities associated with an underlying technology, and the move towards infrastructures that are more general purpose and platform-based. Recent examples of boundaries blurring include those between the mobile computing and cellular device industries, and between the cable television and wireline voice telephony industries. As a consequence, IT industries are not described well by standard models of imperfect competition, in which the costs of entry, the scope of a product and the boundaries between industries are immutable. We study this phenomenon by developing a model of competition across IT industries with strategic choices of technological scope by firms in neighboring industries. The choice of scope affects both the extent of product differentiation for incumbent IT firms as well as the fixed costs of entry by new ones. Our analysis establishes unique symmetric equilibrium choices of scope and price, both in the absence and the presence of potential competition caused by convergence from outside one's own industry. We show that the right strategic response to a threat of convergence may be to either deter convergence in their core industry, or accommodate it while entering the neighboring industry, and that technological scope is a central strategic variable in accommodation or deterrence. We establish that the benefits of convergence to consumers can be realized before the convergence across industries actually occurs, due to preemptive responses to the threat of convergence by firms within each industry. We analyze a game of bilateral inter-industry convergence to show how gradual progress in an underlying technology can result in radical switches between isolated industries and convergent industries equilibria, leading to the periodic and sudden shifts in industry concentration and firm profitability even in the absence of technological shocks. Such shifts have been observed during the competitive crash in the computer industry, and are likely to recur in the near future on account of voice and video convergence.
ecommerce, e-commerce, electronic commerce, Internet, convergence, platform, information technology, oligopoly, imperfect competition, entry
Abstract: We present a framework for measuring software quality using pricing and demand data, and empirical estimates that quantify the extent of quality degradation associated with software versioning. Using a 7-month, 108-product panel of software sales from Amazon.com, we document the extent to which quality varies across different software versions, estimating quality degradation that ranges from as little as 8% to as much as 56% below that of the corresponding flagship version. Consistent with prescriptions from the theory of vertical differentiation, we also find that an increase in the total number of versions is associated with an increase in the difference in quality between the highest and lowest quality versions, and a decrease in the quality difference between neighboring versions. We compare our estimates with those derived from two sets of subjective measures of quality, based on CNET editorial ratings and Amazon.com user reviews, and discuss competing interpretations of the significant differences that emerge from this comparison. As the first empirical study of software versioning that is based on both subjective and econometrically estimated measures of quality, this paper provides a framework for testing a wide variety of results in IS that are based on related models of vertical di¤erentiation, and its findings have important implications for studies that treat web-based user ratings as cardinal data.
software quality, vertical differentiation, price discrimination, quality distortion, information goods, Internet, electronic commerce, economics of IS
Abstract: Information technology has radically altered the management of supply chain operations; many business partnerswho are adjacent on the supply chain can gain from entering inter-organizational information sharing (IOIS)relationships and sharing information that was previously accessible to only one of them. This situation is typical inretailer-supplier logistics management relationships. The first part of our study analyzes different forms of virtualintegration - relationships between independent companies that result in some of their operations resembling thoseof a single vertically integrated firm - and classifies them based on their models of information sharing across thesupply chain. We find that there are four primary policies that firms adopt when they exchange information acrossthe supply chain; these are EDI, vendor managed inventory (VMI), continuous replenishment (CR) and categorymanagement (CM).Typically, corporations view the development of inter-organizational information systems, and the sharing ofinformation as being targeted at increasing operational efficiency by reducing ordering costs, inventory costs andsupply lead times. Many studies have focused on studying IOIS technology issues, and estimating the valuegenerated from these arrangements using traditional models of inventory and ordering costs. However, we find thatin a number of cases, the information shared can have cross-functional value - it can also be used to improve asupplier's production planning, and to alter their marketing and sales strategies. Paradoxically, however, supplierswho receive such information feel that not only are their benefits minimal, but they often end up worse off thanbefore the IOIS was implemented.The second part of our study explains this paradox. We show how retailers and other buyers can successfullycontract to end up with more value than is generated by the sharing of information. Using game-theoretic models ofstrategic interaction, we show that this effect intensifies as the competitive value of the information to the supplier'smarketing and sales departments increases. Besides, as the value that could be generated by the sales and productiondivisions of the supplier increases, we demonstrate how the supplier loses more and more value. Furthermore, thebuyer need not actually share the information to derive these rents; we indicate why the possibility of sharing issufficient, even when the buyer cannot independently create value from that information.The practical contributions of this inter-disciplinary study are manifold. We provide a clear and lucid description ofthe different levels at which organizations share information. We also describe a fairly general modeling frameworkwhich lays the foundation for a deeper analysis of this increasingly important area. Our strategic results demonstratethat a single focus on the technological or operational aspects of IOIS can mislead managers significantly. The truecosts and benefits of these relationships can only be judged by recognizing the cross-functional impact of theinformation flows on the operational architecture, the marketing strategies of the suppliers and buyers, and thenature of competition within the respective organizations' industries.
Abstract: This paper analyzes the optimal choice of pricing schedules and technological deterrence levels in a market with digital piracy, when legal sellers can sometimes control the extent of piracy by implementing digital rights management (DRM) systems. It is shown that the seller s optimal pricing schedule can be characterized as a simple combination of the zero-piracy pricingschedule, and a piracy-indifferent pricing schedule which makes all customers indifferent between legal consumption and piracy. An increase in the level of piracy is shown to lower prices and profits, but may improve welfare by expanding the fraction of legal users and the volume of legal usage.In the absence of price-discrimination, the optimal level of technology-based protection against piracy is shown to be the technologically-maximal level, which maximizes the difference between the quality of the legal and pirated goods. However, when a seller can price-discriminate, it isalways optimal for them to choose a strictly lower level of technology-based protection. Moreover, if a DRM system weakens over time, due to its technology being progressively hacked, the optimal strategic response may involve either increasing or decreasing the level of technology-based protection and the corresponding prices. This direction of change is related to whether the technologyimplementing each marginal reduction in piracy is increasingly less or more vulnerable to hacking. Pricing and technology choice guidelines based on these results are presented, some social welfare issues are discussed, and ongoing work on the role of usage externalities in pricing and protectionis outlined.
Abstract: This paper analyzes the optimal choice of pricing schedules and technological deterrencelevels in a market with digital piracy, when legal sellers can sometimes control the extentof piracy by implementing digital rights management (DM) systems. It is shown that the seller'soptimal pricing schedule can be characterized as a simple combination of the zero-piracy pricingschedule, and a piracy-indifferent pricing schedule which makes all customers indifferent betweenlegal consumption and piracy. An increase in the level of piracy is shown to lower prices and profits,but may improve welfare by expanding the fraction of legal users and the volume of legal usage.In the absence of price-discrimination, the optimal level of technology-based protection againstpiracy is shown to be the technologically-maximal level, which maximizes the difference betweenthe quality of the legal and pirated goods. However, when a seller can price-discriminate, it isalways optimal for them to choose a strictly lower level of technology-based protection. Moreover,if a DRM system weakens over time, due to its technology being progressively hacked, the optimalstrategic response may involve either increasing or decreasing the level of technology-based protectionand the corresponding prices. This direction of change is related to whether the technologyimplementing each marginal reduction in piracy is increasingly less or more vulnerable to hacking.Pricing and technology choice guidelines based on these results are presented, and some socialwelfare issues are discussed.
Abstract: The incorporation of digital technologies into the products of diverse industries, accompaniedby a shift to von-Neumann-like platform architectures, while resulting in substantially more valuableand flexible products, also leads to increased substitutability across previously distinct markets. This paperanalyzes the economic implications of this trade-off in technology markets subject to digital convergence.We present a new model of imperfect competition that captures flexible platform scope, variability in consumerrequirements, and multiple product purchases. We specify four types of equilibrium configurations- local monopoly, kinked, competitive and non-exclusive - that emerge as outcomes of the model, anddescribe how each equilibrium structure characterizes a distinct stage of digital convergence.Our analysis establishes that as markets converge, prices always rise initially even as competing productsbecome less differentiated. However, when platform scope is largely dictated by exogenous factors, pricesand profits eventually fall as the stage of convergence progresses, though consumer surplus and totalsurplus rise. Furthermore, while convergence has the expected effect of shifting consumption patternsfrom purchasing multiple specialized products to buying a single general-purpose product, we describeexamples of equilibria in which consumers may buy multiple general-purpose products, using each fora specialized subset of their requirements. Pricing responses to changes in variable costs and consumerfunctionality needs are also discussed.When firms can make strategic choices of platform scope, we show that in any subgame perfect equilibrium,duopoly prices are always higher than monopoly prices, and industries may sustain high levels ofprofitability even when their boundaries blur. We also establish that as technological progress lowers fixedcosts, a natural outcome is for unregulated firms to over-invest in platform scope relative to the socialoptimum, and that this outcome is true under both monopoly and duopoly market structures
Abstract: An important simplifying assumption made when analyzing goods that display positive networkeffects is that potential consumers can form a rational expectation of the equilibrium demand for the good, and that they all form the same expectation, which is then fulfilled based on their consumption choices - sometimes called a rational expectations equilibrium (REE). Weexamine whether the results of these models are robust to the relaxation of this assumption. Inour model, consumers differ in their marginal utility of total demand (intensity of the networkeffect), which varies according to a given distribution (the distribution of consumer "types"), and are boundedly rational in two ways. First, only a fraction of consumers "pay attention" to price announcements in any interval of time. Second, those consumers who pay attentionmake their consumption choices based on a boundedly rational expectation of future demand.Our benchmark model is of myopic expectations, although we show how our results generalize(1) to a case in which the population of consumers contains both those who are myopic and those who are "fully rational," and (2) to a case in which consumers have expectations that are partly "stubborn". We base our analysis on a continuous-time approximation of an underlying discrete-time model. Under this approximation, the instantaneous choices of consumers continuously influence the rate at which demand adjusts over time, and a monopolist chooses a price trajectory to maximize profit. First, we show that, under fairly general assumptions about the distribution of types, the profit-maximizing rational expectations equilibrium is not a steadystate of the optimal trajectory with boundedly rational consumers. Our second theorem shows that if consumer types are uniformly distributed and consumers form myopic (or more rational) expectations, the monopolistâÃÂÃÂs optimal pricing trajectory is generated by a "target policy" withthe following properties: when current demand is below the target, the price is zero; when currentdemand is above the target, the price is the maximum possible, and when current demand is at the target, the price is chosen to keep demand stationary. We also show that the optimal demand target with boundedly rational consumers is always strictly lower than the equilibrium level of demand predicted by a model with rational expectations. Furthermore, the difference between the target demand and the rational expectations demand is higher when consumers pay attention to the monopolistâÃÂÃÂs price announcements at a lower rate. We generalize the results from this example in two ways. Our third theorem examines the case of myopic consumers and strictly concave distributions of consumer types. To find an optimal policy one must expand the set of controls to include measure-valued controls. The optimal policy is similar to the target policy of Theorem 2, except that when current demand is at the target, the monopolist chooses the "mixture" between a price of zero and the maximum possible price that keeps demand stationary. For convex consumer type distributions in the neighborhood of the uniform distribution, we give a heuristic argument to support a conjecture that the monopolist continues to choose a demand target lower than the rational expectations demand, but varies price gradually in the neighborhood of the demand target. Finally, for uniformly distributed types and consumer expectations that are both myopic and "stubborn", we show that the monopolistâÃÂÃÂs optimal pricing trajectory is generated by a target policy with the same properties as those in Theorem 2, although with a target that is strictly lower, and that increases as consumers become progressively less stubborn.(This paper is part of a program of research whose broad objective is to explore the conditionsunder which the assumption of unbounded rationality in economic models is a reasonable one).
Abstract: We present a model of dynamic monopoly pricing for a good that displays network effects. Incontrast with the standard notion of a rational-expectations equilibrium, we model consumersas boundedly rational, and unable either to pay immediate attention to each price change, or tomake accurate forecasts of the adoption of the network good. Our analysis shows that the sellerâÂÂsoptimal price trajectory has the following simple structure: the price is zero when the productuser base is below a specific threshold, and is chosen to keep user base stationary once thisthreshold demand level has been attained. We show that our prescribed pricing policy is robustto a number of extensions, which include the productâÂÂs user base evolving over time, a fraction ofconsumers being sufficiently rational to make accurate adoption forecasts, and consumers basingtheir choices on a mixture of a myopic and a "stubborn" expectation of adoption. Our resultsdiffer significantly from those that would be predicted by a model based on rational-expectationsequilibrium, and are more consistent with the pricing of network goods observed in practice.
Abstract: We define an economic network as a linked set of entities, where links are created by actual realizations of shared economic outcomes between entities. Such aggregations, which include a wide variety of Web-based product networks, are becoming increasingly available for business use. We analyze the predictive information contained in such networks using the copurchase network on Amazon where entities are books and links designate which pairs were purchased simultaneously. Our dataset covers a diverse set of books spanning over 400 categories over a period of three years with a total of over 70 million observations. We demonstrate that an entity’s future demand is more accurately predicted by combining its historical demand with that of its neighbors than by considering its demand alone. In other words, if you want to know what your state will be in the future, consider what is happening to your neighbors now. This result could apply to other economic networks where outcomes of sets of entities tend to be related and suggest substantial potential for real-time decision support systems that leverage such networks. To our knowledge, this is the first large scale study showing that an economic network contains useful distributed information for demand prediction.
network effects, economic networks, copurchase networks, predictive models, data mining
Abstract: On-demand computing provides a new way for companies to manage and use their ITinfrastructure. This model of corporate computing radically changes the way companies pay for theirIT infrastructure, basing it on "pay per use" rather than on the fixed infrastructure investments suchcompanies are accustomed to. A clear theoretical understanding of pricing on-demand computingis thus central to the viability and growth of this nascent industry. We contribute towards such anunderstanding in this paper by modeling the optimal pricing of on-demand computing while takingfour critical factors into account: the costs of deploying IT in-house, the business value of this IT,the scale of the providerâs on-demand computing infrastructure, and the variable costs of providingon-demand computing. Three distinct pricing models emerge as optimal among all possible pricingfunctions for on-demand computing. These models describe when volume discounting, free usageand demand caps should be used to manage demand appropriately and profitably. We also outlinea likely path that the transformation towards on-demand computing will follow â" under which low-usagecustomers are targeted initially, followed by a broadening of the market, and finally, a focus onprofiting from inducing adoption by high-usage customers â" and prescribe how the associated pricingmodels should evolve appropriately.
Abstract: Apart from reducing buyer search costs, web-based commerce has also enabled the use ofintelligent agent technologies that reduce seller search costs by targeting buyers, customizing,and pricing products in real-time. Our model of an electronic market with customizable productsanalyzes the pricing, profitability and welfare implications of these agent-based technologiesthat price dynamically, based on product preference and demographic information revealed byconsumers. We find that in making the trade-off between better prices and better customization,consumers invariably choose less-than-ideal products. Furthermore, this trade-off impactsbuyers on the higher end of the market more, and causes a transfer of consumer surplus towardsbuyers with a lower willingness to pay. As buyers adjust their product choices in responseto better demand agent technologies, sellers may experience reduced revenues, since the gainsfrom better buyer information are countered by the lowering of the total value created fromthe transactions. We study the strategic and welfare implications of these findings, and discussmanagerial and technology development guidelines.
Abstract: Information Systems Working Papers Series
Abstract: We study how electronic markets that facilitate broader inter-firm transactions affect the vertical scope of emerging IT-enabled extended enterprises. We do so by modeling firms in a three-tier value chain who are each connected to a common electronic market that facilitates direct business transactions across tiers, and that lowers the search costs associated with finding an appropriate trading partner for each of them. The extent to which search costs are reduced depends on the complexity of B2B search, and the nature of the supporting technologies that the electronic market facilitates. Variation in search costs affect firms across the value chain in three key ways: by a change in the transaction costs of interaction between firms; by a change in the contracting costs associated with outsourcing owing to changes in the costs of moral hazard for delegated search, and by a change in the price dispersion of upstream input commodities. We capture each ofthese effects in a new model that integrates search theory into the principal-agent framework, and establish that the optimal outsourcing contract has a simple "all or nothing" performance-based structure under fairly general assumptions. We then apply this model to contrast the effect that different information technologies have on the relative B2B search costs of different firms in the value chain, contrasting the predicted changes of proportionate, constant and convergent changes in search costs. When integrated with a detailed analysis of the nature of B2B search, these results predicts that when B2B search is information-intensive, electronic markets will facilitate an increase in outsourcing, market-based transactions and a reduction in the vertical scope of extended enterprises. In contrast, when B2B search is primarily communication-intensive, electronic markets will lead to tighter integration and an increase in the vertical scope of the extended enterprise. Our research suggest that the nature of the information technologies and of the business activities supported by an electronic market are crucial determinants of the organizational and industry changes they induce, and our results have important implications for a variety of industries in which both technological and agency issues will influence the eventual success of global IT-facilitated extended enterprise initiatives.
Abstract: This paper presents a model of local network effects in which agents in a social network each value the adoption of a product by a heterogeneous subset of other agents in their "neighborhood", and have incomplete information about the structure and strength of adoption complementarities between all other agents. It shows that the symmetric Bayes-Nash equilibria of a general adoption game are in monotone strategies, can be strictly Pareto-ranked, and the greatest such equilibrium is uniquely coalition-proof. Each Bayes-Nash equilibrium has a corresponding fulfilled-expectations equilibrium under which agents form adoption expectations locally. Examples analyze social networks that are instances of a generalized random graph, and that are complete graphs (a standard model of network effects). The structure of the network of adopting agents is characterized as a function of the equilibrium played, and empirical implications of this characterization are discussed.
Abstract: A number of unstructured or partially structured electronic secondary markets existto enable the sale and trading of goods between consumers. Many tend to be self-administeringUseNet groups, or WWW sites for niche products; however, there hasbeen significant recent growth in the number of more general web-based markets ofthis kind. Apart from facilitating reliable and liquid trade of used goods, the existenceof these markets can alter the desirability of new product, as well as products thatare complementary/compatible, and one expects to see a proliferation of such tradingforums as Internet technology continues to become more widespread and reliable, andless expensive. We present a economic framework for analyzing how these electronicsecondary markets affect the demand for a primary product. We then examine whenit is optimal for a firm to operate a market of this kind, and when their presence issocially optimal. Surprisingly, we find that in a number of cases, the presence of thesemarkets has a primary positive effect on the profitability of a new good; this leads usto conjecture that there will soon be a number of such trading forums operated bymanufacturers of primary goods. We also find that in a majority of cases, it is feasiblefor a third-party intermediary to profitably operate such a market. Key parametersthat affect the desirability of the market are the existing installed customer base, thecost of information technology, the durability of the products in question, their rateof technological obsolescence and the nature of customer preferences.
Abstract: We model the bilateral threat of entry between firms in two industries, which is characteristic of a number of IT industries. An endogenous choice of product scope by firms in each industry affects both the extent of product differentiation for incumbent oligopolists as well as the fixed costs of a potential entrant. Our analysis establishes unique symmetric equilibrium choices of scope and price, both in the absence and the presence of an entry threat. When entry is threatened bilaterally, in equilibrium, firms may symmetrically either deter entry into their core industry, or accomodate it while entering the neighboring industry. Even in the absence of technological shocks, we show how steady progress in technology can result in switching between these equilibria, leading to the periodic and sudden shifts in industry concentration and firm profitability; such shifts have been observed during the "competitive crash" in the computer industry, and more recently, on account of digital convergence.
imperfect competition, scope, entry, digital convergence, industry convergence, technological process, horizontal differentiation, location model
Abstract: This paper analyzes optimal pricing for information goods under incomplete information,when both unlimited-usage (fixed-fee) pricing and usage-based pricing are feasible. For ageneral set of customer characteristics, it is shown that in the presence of contract administrationcosts, offering fixed-fee pricing in addition to a non-linear usage-based pricing schemeis always profit-improving, and there may be markets in which a pure fixed-fee is optimal.Moreover, it is proved that the optimal usage-based pricing schedule is independent of thevalue of the fixed-fee. These results imply that the optimal pricing strategy is never fullyrevealing. A procedure for determining the optimal combination of fixed-fee and non-linearusage-based contracts is presented.Applying these general results to specific: business contexts suggests a number of operiGtional guidelines for designing pricing schedules, and managerial insights for setting pricingpolicy. For instance, in nascent information markets, firms are most likely to profit from lowfixed-fee penetration pricing, but as these markets mature, the optimal pricing mix shouldexpand to include a wider range of usage-based pricing options. The effects of changes inproduct value and administration costs on the adoption levels of different pricing schemes,optimal quantity discounts, firm profitability and total welfare are analyzed. Strategic pricingresponses to changes in market characteristics are described, and the implications of thepaper's results for bundling and vertical differentiation of information goods are discussed.
Abstract: A number of technology products display positive network effects, and are used invariable quantities by heterogeneous customers. Examples include operating systems, infrastructureand back-end software, web services and networking equipment. This paper studies optimalnonlinear pricing for such products, under incomplete information, and with the threat of competitiveentry. Both homogeneous and heterogeneous network effects are modeled. Conditions underwhich a fulfilled-expectations contract exists and is unique are established. While network effectsgenerally raise price, it is shown that accompanying changes in consumption depend on the natureof the network effects - in some cases, it is optimal for the monopolist to induce no changes in usageacross customers, while in others cases, network effects raise the usage of all market participants.Optimal pricing is shown to include quantity discounts that increase with usage, and may also involvea nonlinear two-part tariff. These results highlight the impact of network effects on trade-offsbetween price discrimination and value creation, and have important managerial implications forpricing policy in technology markets.The need to deter competitive entry generally lowers profits for the monopolist, and increasescustomer surplus. When network effects are homogeneous across customers, the resulting entry-deterringmonopoly contract is a fixed fee and results in the socially optimal outcome. However,when the magnitude of heterogeneous network effects is relatively high, there are no changes intotal surplus induced by the entry threat, and the price changes merely cause a transfer of valuefrom the seller to its customers. The presence of network effects, and of a credible entry threat, arealso shown to increase distributional efficiency by reducing the disparity in relative value capturedby different customer types. Regulatory and policy implications of these results are discussed.
Abstract: We model an oligopolistic technology market in which firms endogenously choose product scope,fixed costs are affected by exogenous technological progress, and there may be threat of entry. Ouranalysis shows that equilibrium outcomes involve substantial overinvestment in product scope,which benefit consumers and hurt firms, relative to the social optimum. Technological progressgenerally increases consumer surplus and lowers firm profits. If entry is threatened bilaterallyacross two converging markets, both either accommodate entrants from the rival market, or bothdeter entry; continuous progress in technology can cause equilibria shifts, leading to discontinuousand radical redistribution of surplus across markets.
Abstract: Co-sourcing is a new type of inter-organizational relationship, that is broader, both in operational scope and in risk sharing, than traditional outsourcing relationships. Based on a number of case studies, we develop analytical models of co-sourcing which evaluate when it is optimal, and what form it should take in a particular business environment. Our models simultaneously incorporate operational, economic and information technology factors. We find that the intensity of transactions and the level of intrinsic incentive alignment are crucial to the business partner who is more risk-averse and may sometimes find it optimal to bear the larger portion of operational and market risk in the co-sourcing relationship.
Abstract: Information technology has radically altered the management of supply chain operations; many business partners who are adjacent on the supply chain can gain from entering inter-organizational information sharing (IOIS) relationships and sharing information that was previously accessible to only one of them. This situation is typical in retailer-supplier logistics management relationships. The first part of our study analyzes different forms of virtual integration-relationships between independent companies that result in some of the operations resembling those of a single vertically integrated firm--and classifies them based on their models of information sharing across the supply chain. We find that there are four primary policies that firms adopt when they exchange information across the supply chain; these are EDI, vendor managed inventory (VMI), continuous replenishment (CR) and category management (CM). Typically, corporations view the development of inter-organizational information systems and the sharing of information as being targeted at increasing operational efficiency by reducing ordering costs, inventory costs and supply lead times. Many studies have focused on studying IOIS technology issues and estimating the value generated from these arrangements using traditional models of inventory and ordering costs. However, we find that in a number of cases, the information shared can have cross-functional value--it can also be used to improve a supplier's production planning and to alter their marketing and sales strategies. Paradoxically, however, suppliers who receive such information feel that not only are their benefits minimal, but they often end up worse off than before the IOIS was implemented. The second part of our study explains this paradox. We show how retailers and other buyers can successfully contract to end up with more value than is generated by the sharing of information. Using game-theoretic models of strategic interaction, we show that this effect intensifies as the competitive value of the information to the supplier's marketing and sales departments increases; we demonstrate how the supplier loses more and more value. Furthermore, the buyer need not actually share the information to derive these rents; we indicate why the possibility of sharing is sufficient, even when the buyer cannot independently create value from that information.
Abstract: The effective design of business processes is a subject of considerable importance to corporations today. Our research focuses on developing a theoretical framework for process design in order to provide some guidelines for mangers. The abundant context-specific case studies which exist today share many success stories but provide little in terms of a general methodological approach. In this paper we describe our general framework for the analysis and design of business processes. We outline a typical business process and critically evaluate typical pre- and post-reengineering process designs. Explicit aspects of our analysis address workflow design and task bundling, technological enabelers, and performance based incentives. We examine the effects of task size asymmetry and information, and performance control asymmetry on the optimal process design. Our results indicate that, with increased asymmetry, certain types of process designs become more desirable. Furthermore, we look at the interaction between job asymmetry and other process design factors such as knowledge intensity and level of job customization. Finally, we show how asymmetry causes process redesign to complement performance based incentive compensation. The practical implications of these results are illustrated for a variety of process design environments.
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