Pricing Software Upgrades: The Role of Product Improvement and User Costs

Production and Operations Management, Vol. 18, No. 5, September-October 2009, pp. 560–580

22 Pages Posted: 12 Nov 2013

See all articles by Ram Bala

Ram Bala

Santa Clara University - Leavey School of Business

Scott M. Carr

LECG - Washington, DC

Date Written: November 11, 2013

Abstract

The computer software industry is an extreme example of rapid new product introduction. However, many consumers are sophisticated enough to anticipate the availability of upgrades in the future. This creates the possibility that consumers might either postpone purchase or buy early on and never upgrade. In response, many software producers offer special upgrade pricing to old customers in order to mitigate the effects of strategic consumer behavior. We analyze the optimality of upgrade pricing by characterizing the relationship between magnitude of product improvement and the equilibrium pricing structure, particularly in the context of user upgrade costs. This upgrade cost (such as the cost of upgrading complementary hardware or drivers) is incurred by the user when she buys the new version but is not captured by the upgrade price for the software. Our approach is to formulate a game theoretic model where consumers can look ahead and anticipate prices and product qualities while the firm can offer special upgrade pricing. We classify upgrades as minor, moderate or large based on the primitive parameters. We find that at sufficiently large user costs, upgrade pricing is an effective tool for minor and large upgrades but not moderate upgrades. Thus, upgrade pricing is suboptimal for the firm for a middle range of product improvement. User upgrade costs have both direct and indirect effects on the pricing decision. The indirect effect arises because the upgrade cost is a critical factor in determining whether all old consumers would upgrade to a new product or not, and this further alters the product improvement threshold at which special upgrade pricing becomes optimal. Finally, we also analyze the impact of upgrade pricing on the total coverage of the market.

Keywords: pricing, market segmentation, upgrades

Suggested Citation

Bala, Ram and Carr, Scott M., Pricing Software Upgrades: The Role of Product Improvement and User Costs (November 11, 2013). Production and Operations Management, Vol. 18, No. 5, September-October 2009, pp. 560–580. Available at SSRN: https://ssrn.com/abstract=2352984

Ram Bala (Contact Author)

Santa Clara University - Leavey School of Business ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States

Scott M. Carr

LECG - Washington, DC ( email )

1725 Eye Street, NW
Suite 800
Washington, DC 20006
United States

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