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

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.     

Lifetime Buy Decisions with Multiple Obsolete Parts

Life‐cycle mismatch occurs when the life cycles of parts end before the life cycles of the products in which those parts are used. Lifetime buys are one tactic for mitigating the effect of part obsolescence, where a quantity of parts is purchased for the remaining life of a product. We extend prior work that determines optimal lifetime buy quantities for one product with one obsolete part by providing an analytic solution and two simple heuristic policies for the optimal lifetime buy quantities when many parts become obsolete over a product's life cycle. We determine which of our two heuristics is most accurate for different product life cycles, which yields a metaheuristic with increased accuracy. That analysis also reveals critical perspectives in making lifetime buy decisions with nonstationary life‐cycle demand patterns.     

Product Design for Life‐Cycle Mismatch

Life‐cycle mismatch occurs when the life cycle of a product does not coincide with the life cycles of the parts used in that product. This is particularly a problem with products that contain electronic components that sometimes have life spans of only two years. The cost of mitigating component obsolescence, which may require redesigning the product, is often considerable. Thus, prudent product design necessitates the selection of electronic components and product architecture, considering the cost of mitigating an obsolete design and other costs related to the design and manufacture of a product. Accordingly, we develop and analyze a model that shows how a product design can be effectively tailored to a particular product's life cycle.     

Cost Allocation in Manufacturing–Remanufacturing Operations

For firms remanufacturing their products, the total life‐cycle costs and revenues from new and remanufactured products determine their profitability. In many firms, manufacturing/sales and remanufacturing/remarketing operations are carried out in different divisions. Each division is responsible for only part of the product's life cycle. Practices regarding transfer pricing across divisions vary significantly among companies, affecting the life‐cycle profit performance of the product. In this research, we identify characteristics of transfer prices that achieve the firm‐wide optimal solution. To this end, we consider a manufacturer who also undertakes remanufacturing operations and we focus on price (quantity) decisions. We determine that a cost allocation mechanism that allocates a portion of the initial production cost to each of the two stages of the product life cycle should be used. We also conclude that cost allocation should be implemented as a fixed cost allocation, where charges to the remanufacturing division should be determined independently of the actual quantity of units remanufactured.     

Design for the Environment: Life‐Cycle Approach Using a Newsvendor Model

Introducing environmental innovations in product and process design can affect the product's cost and demand, as well as the environmental impact in different stages of its life cycle (such as manufacturing and use stages). In this article, we advance understanding on where such design changes can be most effective economically to the firm and examine their corresponding environmental consequences. We consider a profit maximizing firm (newsvendor) deciding on the production quantity as well as its environmentally focused design efforts. We focus our results along the two dimensions of demand characteristics and life‐cycle environmental impact levels, specifically functional vs. innovative products, and higher manufacturing stage environmental impact vs. higher use stage environmental impact. We also discuss the environmental impact of overproduction and how it relates to the different types of products and their salvage options. We find that although the environmental impact per unit always improves when firms use eco‐efficient or demand‐enhancing innovations, the total environmental impact can either increase or decrease due to increased production quantities. We identify the conditions for such cases by looking at the environmentally focused design efforts needed to compensate for the increase in production. We also show that the environmental impact of overproduction plays an important role in the overall environmental impact of the firm. We conclude by applying our model to different product categories.     

Flexible‐Duration Extended Warranties with Dynamic Reliability Learning

Frequent technological innovations and price declines adversely affect sales of extended warranties (EWs) as product replacement upon failure becomes an increasingly attractive alternative. To increase sales and profitability, we propose offering flexible‐duration EWs. These warranties can appeal to customers who are uncertain about how long they will keep the product as well as to customers who are uncertain about the product's reliability. Flexibility may be added to existing services in the form of monthly billing with month‐by‐month commitments or by making existing warranties easier to cancel with pro‐rated refunds. This paper studies flexible warranties from perspectives of both customers and the provider under customers' reliability learning. We present a model of customers' optimal coverage decisions and show that customers' optimal coverage policy has a threshold structure under some mild conditions. We further show that flexible warranties can result in higher profits and higher attach rates in a homogeneous market as well as in a heterogeneous market with multiple segments differing in various dimensions.     

Product Design and Supply Chain Coordination Under Extended Producer Responsibility

Extended Producer Responsibility (EPR) legislation focuses on the life‐cycle environmental performance of products and has significant implications for management theory and practice. In this paper, we examine the influence of EPR policy parameters on product design and coordination incentives in a durable product supply chain. We model a manufacturer supplying a remanufacturable product to a customer over multiple periods. The manufacturer invests in two design attributes of the product that impact costs incurred by the supply chain—performance, which affects the environmental impact of the product during use, and remanufacturability, which affects the environmental impact post‐use. Consistent with the goals of EPR policies, the manufacturer and the customer are required to share the environmental costs incurred over the product's life cycle. The customer has a continuing need for the services of the product and optimizes between the costs of product replacement and the costs incurred during use. We demonstrate how charges during use and post‐use can be used as levers to encourage environmentally favorable product design. We analyze the impact of supply chain coordination on design choices and profit and discuss contracts that can be used to achieve coordination, both under symmetric and asymmetric information about customer attributes.     

焕新计划下考虑消费者细分的产品定价策略

焕新计划是生产商为提升自身竞争优势而推出的一种促销手段，加入焕新计划的消费者在第一阶段可以享受全方位服务，在第二阶段可以享受以旧换新抵扣优惠。消费者将权衡加入焕新计划的费用、服务水平以及抵扣力度等因素决策是否在第一阶段加入焕新计划。本文假设时尚型消费者每阶段都会购买最新产品，而节俭型消费者第一阶段购买产品后在第二阶段继续使用，针对这两类消费者在实施焕新计划和不实施焕新计划两种情况下，构建两阶段模型以决策产品的最优定价；运用解析方法分析了产品的生产成本等参数对最优定价的影响；运用解析方法和数值算例方法对两模型进行对比。     

When Gray is Good: Gray Markets and Market‐Creating Investments

Gray markets arise when an intermediary buys a product in a lower‐priced, often emerging market and resells it to compete with the product's original manufacturer in a higher priced, more developed market. Evidence suggests that gray markets make the original manufacturer worse off globally by eroding profit margins in developed markets. Thus, it is interesting that many firms do not implement control systems to curb gray market activity. Our analysis suggests that one possible explanation lies at the intersection of two economic phenomena: firms investing to build emerging market demand, and investments conferring positive externalities (spillovers) on a rival's demand. We find that gray markets amplify the incentives to invest in emerging markets, because investments increase both emerging market consumption and the gray market's cost base. Moreover, when market‐creating investments confer positive spillovers, each firm builds its own market more efficiently. Thus, firms can be better off with gray markets when investments confer spillovers, provided the spillover effect is sufficiently large. These results provide a perspective on why firms might not implement control systems to prevent gray market distribution in sectors where investment spillovers are common (e.g., the technology sector) and, more broadly, why gray markets persist in the economy.     

Supply Chain Strategies for Perishable Products: The Case of Fresh Produce

This paper examines supply chain design strategies for a specific type of perishable product—fresh produce—using melons and sweet corn as examples. Melons and other types of produce reach their peak value at the time of harvest; product value deteriorates exponentially post‐harvest until the product is cooled to dampen the deterioration. Using the product's marginal value of time (MVT), the rate at which the product loses value over time in the supply chain, we show that the appropriate model to minimize lost value in the supply chain is a hybrid of a responsive model from post‐harvest to cooling, followed by an efficient model in the remainder of the chain. We also show that these two segments of the supply chain are only loosely linked, implying that little coordination is required across the chain to achieve value maximization. The models we develop also provide insights into the use of a product's MVT to develop supply chain strategies for other perishable products.     

Addressing Supply–Demand Imbalance: Designing Efficient Remanufacturing Strategies

The management of remanufacturing inventory system is often challenged by mismatched supply (i.e., returned units, called cores) and demand. Typically, the demand for remanufactured units is high and exceeds the supply early in a product's lifetime, and drops below the supply late in the lifetime. This supply–demand imbalance motivates us to study a switching strategy to facilitate the decision‐making process. This strategy deploys a push mode at the early stage of a product's lifetime, which remanufactures scarce cores to stock to responsively satisfy the high demand, and switches to a pull mode as the product approaches obsolescence to accurately match the low demand with supply. In addition, the strategy further simplifies the decision‐making process by ignoring the impact of leftover cores at the end of each decision period. We show that the optimal policy of the switching strategy possesses a simple, multi‐dimensional base‐stock structure, which aims to remanufacture units from the i best‐quality categories up to the ith state‐independent base‐stock level. An extensive numerical study shows that the switching strategy delivers close‐to‐optimal and robust performance: the strategy only incurs an average profit loss of 1.21% and a maximum of 2.27%, compared with the optimal one. The numerical study also shows when a pure push or pull strategy, a special case of the switching strategy, delivers good performance. The study offers the managerial insight that firms can use simple, easy‐to‐implement strategies to efficiently manage the remanufacturing inventory system.     

When Should a Firm Open its Source Code: A Strategic Analysis

Deciding to open the source code of a software product has advantages and disadvantages. The disadvantage is that the firm loses the revenue from the software. The advantage is that the users' network can contribute to the quality of the software code, which increases the demand for the software and for a complementary product. Demand for the complementary product also goes up, because demand for a product increases when the price of its complement decreases, and under open source, the price of the software product drops down to zero. This paper examines the strategic interactions at work here, within a duopoly framework, and tries to determine the circumstances under which it is optimal for a firm to open its code. We find that firms open the source code when there is a competitive software‐product market, a less competitive complementary‐product market, and when the complementary product is of high quality. Furthermore, it is more profitable for the firm to open the source code if its competitor also does so. When this happens the incentive to open the code can even be higher than in a monopoly situation. More intense competition induces symmetric equilibria in which both firms choose the same strategy.     

Divide and Conquer: Competing with Free Technology Under Network Effects

We study how a commercial firm competes with a free open source product. The market consists of two customer segments with different preferences and is characterized by positive network effects. The commercial firm makes product and pricing decisions to maximize its profit. The open source developers make product decisions to maximize the weighted sum of the segments' consumer surplus, in addition to their intrinsic motivation. The more importance open source developers attach to consumer surplus, the more effort they put into developing software features. Even if consumers do not end up adopting the open source product, it can act as a credible threat to the commercial firm, forcing the firm to lower its prices. If the open source developers' intrinsic motivation is high enough, they will develop software regardless of eventual market dynamics. If the open source product is available first, all participants are better off when the commercial and open source products are compatible. However, if the commercial firm can enter the market first, it can increase its profits and gain market share by being incompatible with its open source competitor, even if customers can later switch at zero cost. This first‐mover advantage does not arise because users are “locked in,” but because the commercial firm deploys a “divide and conquer” strategy to attract early adopters and exploit late adopters. To capitalize on its first‐mover advantage, the commercial firm must increase its development investment to improve its product features.     

Quality Provision with Heterogeneous Consumer Reservation Utilities

This study examines a firm's quality and price decisions when consumers differ not only in their willingness‐to‐pay for quality but also in their reservation utility for the basic product. We find that while the firm offers lower‐quality products when consumers' valuations for quality deteriorate, the optimal quality may increase with a negative shift in consumers' reservation utilities. We also investigate the optimal price and quality of the products within a vertically differentiated product line when the number of products is exogenously given. The existing literature shows that when consumers differ only in their willingness‐to‐pay for quality, the firm sets the efficient quality for consumers with the highest valuation for quality, whereas the concern for cannibalization pushes down the quality of inferior products. We find that when consumers are heterogeneous in both their reservation utility and valuation for quality, the concern for cannibalization may distort the quality upwards, even for consumers with the highest willingness‐to‐pay for quality. In addition, a low‐quality product may enjoy a higher profit margin than a high‐quality product within the product line.     

Strategic Product/Service Innovations of an Online Firm

We study the incentives that drive an online firm to make various types of innovations in a competitive environment. We develop and use a simplified price competition model between two retailers, one online and one offline. A given fraction of consumers, called the Internet penetration, comparison shop online, independent of their customer type, thereby creating two markets for the offline retailer, a captive market and a competitive market. The online product has the steeper of the two linear utility functions, which means that the customers who buy online in our model are high end. We focus on the competitive region in which both retailers are (strictly) profitable in the competitive market and consider innovations that increase high‐end appeal, low‐end appeal, and/or reduce unit cost. We find that the online firm has a strong incentive to invest in innovations that either reduce unit cost and/or, equivalently, increase the appeal to all consumers equally. Investments of this type are strategic complements: implementing one increases the value of another, so the value of two innovations of this type is more than the sum of the values of each individually. We identify a relative strength measure of the online firm such that, as its high‐end appeal increases and/or its unit cost decreases, we say that the online firm is stronger. This strength measure facilitates drawing an explicit dividing line between strong and weak online firms. If Internet penetration increases, the online firm's profits increase if and only if it is strong. If penetration increases over time, it is possible for a strong firm to turn weak and see its profits decrease and possibly disappear completely. A strong online firm has more opportunity to profit from low‐end innovations than does a weak one, while the opposite is true for high‐end innovations. Interestingly, some innovations may actually decrease the online firm's profits. We discuss the implications of our results for existing and future online innovations.     

Optimal Per‐Use Rentals and Sales of Durable Products and Their Distinct Roles in Price Discrimination

We consider a setting in which consumers experience distinct instances of need for a durable product at random intervals. Each instance of need is associated with a random utility and the consumers are differentiated according to the frequency with which they experience such instances of need. We use our model of consumer utility to characterize the firm's optimal strategy of whether to sell, rent, or do a combination of both in terms of the transaction costs and consumers' usage characteristics. We find that the two modes of operation serve different roles in allowing the firm to price discriminate. While sales allow the firm to discriminate among consumers of different usage frequencies, rentals allow it to discriminate according to consumers' realized valuations. Consequently, even when transaction costs are negligible, it is often optimal for the firm to simultaneously rent and sell its product. In addition, we find that although sales and rentals are substitutes and that the offering of sales weakly increases rental prices, it is possible that the introduction of rentals to a pure selling operation can either increase or decrease the optimal sales prices.     

Optimal Pricing of Two Successive‐Generation Products with Trade‐in Options under Uncertainty

To entice consumers to purchase both current and next generation products, many manufacturers and retailers offer trade‐in programs that allow buyers of the first generation product to trade‐in the product and purchase the new generation product at a lower price. By considering the interactions between “forward‐looking” consumers and a firm when a trade‐in program is offered, we analyze a two‐period dynamic game to determine the optimal prices of two successive‐generation products in equilibrium, and examine the conditions under which trade‐in programs are beneficial to the firm. Our model incorporates market heterogeneity (valuation of the first generation product varies among the consumer population), product uncertainty (the incremental value of the new product is uncertain before its introduction), and consumers' forward‐looking behavior (consumers take future product valuation and prices into consideration when making purchasing decisions). With the trade‐in option, we show that consumers are willing to pay a price that is higher than their valuations of the current product. Furthermore, trade‐in programs are more beneficial to the firm when: (i) the durability of the current product is high; (ii) the market heterogeneity is low; or (iii) the uncertainty level (or the expected incremental value) of the new product is high. Finally, when the incremental value of the new product is more uncertain, consumers are more willing to purchase the current product because of the “option” value of the trade‐in programs and thus trade‐in programs can be more beneficial to the firm in this case.     

面临零部件过期的产品销售与售后服务供应链合同分析

备件库存管理对产品售后服务至关重要,而零部件过期会影响备件库存的正常补货,进而延长故障修复时间,降低产品可用率.终身购买作为应对零部件过期的重要策略,被广泛运用在实践中.然而,学术论文中关于零件过期对供应链管理影响的研究并不多见.本文建立了同时考虑产品销售和售后服务情况下的供应链动态博弈模型,分析了客户的产品订购批量、供应商的定价决策以及备件终身购买批量之间的相互作用,探讨了保修期和零部件过期采购成本对合同均衡策略和供应链利润的影响.结果表明,当零部件过期采购成本较低时,供应商可以在延长保修期的同时降低备件库存数量,并允许一定程度的备件缺货水平,从而最大化提升产品可用率所带来的收益.同时,应当适当降低对备件数量的技术标准要求.而当零部件过期 采购成本较高时,供应商应当避免提供较长的保修期,并增加备件终身购买批量以减小零部件过期带来的负面影响.此时,备件数量的技术标准则可以适当提高.     

The comparison between trade-in and leasing of a product with technology innovations

Companies can adopt trade-in and/or leasing to shorten consumers׳ upgrade cycle and gain control over secondary markets. In this paper, we consider a monopolistic manufacturer who offers a technology product to a market consisting of heterogeneous consumers. We focus on an exogenous, stochastic innovation process that determines the availability of new technology and consequently, residual value of the current product. We derive the optimal pricing strategy of trade-in and leasing, respectively, examine its impact on the manufacturer׳s expected profit, and compare the performance of the two strategies. Trade-in protects the manufacturer against residual value risk and allows the flexibility of offering the option at different innovation states separately. Leasing, on the other hand, provides the manufacturer an opportunity to circumvent low new product prices and thus increases expected profit when product reuse profitability is high. The interplay between the two forces, product reuse profitability and new product price, determines the preference between trade-in and leasing. Our findings provide monopolistic manufacturers guidance on how to optimally employ the trade-in and leasing strategies.     

Investment in Facility Changeover Flexibility for Early Entry into High‐Tech Markets

A model is introduced to analyze the manufacturing‐marketing interface for a firm in a high‐tech industry that produces a series of high‐volume products with short product life cycles on a single facility. The one‐time strategic decision regarding the firm's investment in changeover flexibility establishes the link between market opportunities and manufacturing capabilities. Specifically, the optimal changeover flexibility decision is determined in the context of the firm's market entry strategy for successive product generations, the changeover cost between generations, and the production efficiency of the facility. Moreover, the dynamic pricing policy for each product generation is obtained as a function of the firm's market entry strategy and manufacturing efficiency. Our findings provide insights linking internal manufacturing capabilities with external market forces for the high‐tech and high‐volume manufacturer of products with short life cycles. We show the impact of manufacturing efficiency and a firm's ability to benefit from volume‐based learning on the dynamic pricing policy for each product generation. The results demonstrate the benefits realized by a firm that works with its manufacturing equipment suppliers to develop more efficient and flexible technology. In addition, we explore how opportunities afforded by pioneer advantage enable a firm operating a less efficient facility to realize long term competitive advantage by deploying an earlier market entry strategy.