The optimal software licensing policy under quality uncertainty

ABSTRACT

A new service model has emerged which delivers application software and services over the Web on a lease or subscription basis. Our paper studies the optimal licensing policy of a software vendor that uses that business model. We look at software vendors that are both selling (at a posted price) or leasing their products where as lessor they guarantee that the lessee will always have the latest version of the software on their desktop. We address some of the specific issues of implementing this policy at the packaged software market, including the impact of network externality, negligible marginal production costs, and upgrade compatibility. We show that by properly defining their pricing structure, software vendors can segment the market and realize effective second-degree price discrimination and show how and when software vendors can maximize their profits through the use of this new licensing policy.

REFERENCES

• 1: Bhargava, H. and V. Choudhary (2001), "One Size Fits All? Optimality Conditions for Versioning and Second-degree Price Discrimination," GSIA Working Paper 2001-10, Carnegie Mellon University.
• 2: Bucovetsky, S., and J. Chilton (1986), "Concurrent Renting and Selling in a durable Goods Monopoly under Threat of Entry," Rand Journal of Economics 17 261--278.
• 3: Bulow, J. (1982), "Durable Good Monopolists," Journal of Political Economy 90(2), 314--332.
• 4: Choudhary, V., K. Tomak, and A. Chaturvedi (1998), "Economic Benefits of Renting Software," Journal of Organizational Computing and Electronic Commerce 8(4), 277--305.
• 5: Joe Wilcox, "New Microsoft licenses may increase costs," <u>http://news.com.com/2100-1001-257390.html</u>, May 10th, 2001.
• 6: Coase, R. (1972), "Durable-Goods Monopolist," Journal of Law and economics 15, 143--149.
• 7: Preyas Desai , Devavrat Purohit, Leasing and selling: optimal marketing strategies for a durable goods firm, Management Science, v.44 n.11 Pt.2, p.19-34, Nov. 1998
• 8: Ellison, G. and D. Fudenberg (2000), "The Neo-Luddite's Lament: Excessive Upgrades in the software Industry," Rand Journal of Rconomics 31(2), 253--272.
• 9: Fudenberg, D. and J. Tirole (1998), "Upgrades, Tradeins, and Buybacks," RAND Journal of Economics 29(2), 235--258.
• 10: Gul, F., H. Sonnenschein and R. Wilson (1986), "Foundations of Dynamic Monopoly and the Coase Conjecture," Journal of Economic Theory 39, 155--190.
• 11: Katz, M. L. and C. Shapiro (1986) "Technology Adoption in the Presence of Network Externalities," Journal of Political Economy 94(4), 822--841.
• 12: Laura J. Kornish, Pricing for a Durable-Goods Monopolist Under Rapid Sequential Innovation, Management Science, v.47 n.11, p.1552-1561, November 2001 [doi>10.1287/mnsc.47.11.1552.10247]
• 13: Moorthy, K. S. (1984), "Market Segmentation, Self-Selection, and Product Line Design," Marketing Science 3(4), 288--307.
• 14: Mussa, M., and S. Rosen (1978), "Monopoly and Product Quality," Journal of Economic Theory 18(2) 301--317.
• 15: Padmanabhan, V., S. Rajiv and K. Srinivasan (1997), "New products, upgrades, and new releases: A rationale for sequential product introduction," Journal of Marketing Research 34 (4) 456--472.
• 16: Salant, S. W. (1989), "When is Inducing Self-Selection Suboptimal for a Monopolist?," Quarterly Journal of Economics, 104(2), 391--397.
• 17: Seidmann, A. and J. Zhang (2002), "The Optimal Software Licensing Policy under Quality Uncertainty," Working Paper, Simon School of Business, University of Rochester.

INDEX TERMS

Keywords:
network externality, price discrimination, risk, software licensing, upgrade compatibility