Software Upgrades with Price Competition
by Amit MEHRA

Abstract

In this paper, we model competition between two software product vendors, an incumbent and entrant, with specific focus on the role of switching costs. Contrary to conventional wisdom, we find that under certain conditions the switching costs imposed by the incumbent's product could actually hurt the incumbent's profit and help the entrant's profit. Additionally, we find that higher switching costs could actually result in higher consumer-surplus and social surplus. In our model, in a two period setting, the incumbent and entrant compete to sell to a mass of customers located on a Hotelling line. In the first period, the incumbent offers an initial version of the software product. In the second period, both incumbent and entrant offer improved versions of the software, with upgrade discounts to customers who have already purchased the incumbent's product in the first period. Our analysis reveals that the incumbent's profit is maximized when the entrant poaches some of the incumbent's first period customers through upgrade pricing - i.e. the incumbent would rather that some of her customers switch to the entrant than not. This is consistent with several instances of industry practice. The existence of this equilibrium requires sufficiently high switching costs. However, the profit of the incumbent in this equilibrium reduces with switching costs. This implies that to the extent the incumbent can endogenize switching costs; it prefers the switching costs to be just large enough to satisfy the existence criterion. Our model extends prior literature on duopolistic competition to the context of competition marked by price discrimination.

About the speaker

Amit Mehra is an Assistant Professor of Information Systems at the Indian School of Business. He holds a Ph.D and MS in Management Science from the W E Simon Graduate School of Business Administration, University of Rochester. He completed his Masters and Bachelors in Technology from the Indian Institute of Technology, New Delhi.  His research interests are in the areas of economics of contract design in IT based industries, open source software, studying nuances of outsourcing such as comparisons between captives and third parties and multi-sourcing, managing software product pricing and product introduction strategies and advertising on the Internet. Prior to his Ph.D, Professor Mehra worked with the accounts and finance function in Indian Railways for over seven years.