In this paper, we explore the economics of <i>free</i> under perpetual licensing. In particular, we focus on two emerging software business models that involve a free component: <i>feature-limited freemium</i> (<i>FLF</i>) and <i>uniform seeding</i> (<i>S</i>). Under <i>FLF</i>, the firm offers the basic software version for free, while charging for premium features. Under <i>S</i>, the firm gives away for free the full product to a <i>percentage</i> of the addressable market <i>uniformly</i> across consumer types. We benchmark their performance against a conventional business model under which software is sold as a bundle (labeled as “charge for everything” or <i>CE</i>) without free offers. In the context of consumer bounded rationality and information asymmetry, we develop a unified two-period consumer valuation learning framework that accounts for both word-of-mouth (WOM) effects and experience-based learning, and use it to compare and contrast the three business models. Under both constant and dynamic pricing, for moderate strength of WOM signals, we derive the equilibria for each model and identify optimality regions. In particular, <i>S</i> is optimal when consumers significantly underestimate the value of functionality and cross-module synergies are weak. When either cross-module synergies are stronger or initial priors are higher, the firm decides between <i>CE</i> and <i>FLF</i>. Furthermore, we identify nontrivial switching dynamics from one optimality region to another depending on the initial consumer beliefs about the value of the embedded functionality. For example, there are regions where, ceteris paribus, <i>FLF</i> is optimal when the prior on <i>premium</i> functionality is either relatively low or high, but not in between. We also demonstrate the robustness of our findings with respect to various parameterizations of cross-module synergies, strength of WOM effects, and number of periods. We find that stronger WOM effects or more periods lead to an expansion of the seeding optimality region in parallel with a decrease in the seeding ratio. Moreover, under <i>CE</i> and dynamic pricing, second period price may be decreasing in the initial consumer valuation beliefs when WOM effects are strong and the prior is relatively low. However, this is not the case under weak WOM effects. We also discuss regions where price skimming and penetration pricing are optimal. Our results provide key managerial insights that are useful to firms in their business model search and implementation.
Firms nowadays are increasingly proactive in trying to strategically capitalize on consumer networks and social interactions. In this paper, we complement an emerging body of research on the engineering of word-of-mouth effects by exploring a different angle through which firms can strategically exploit the value-generation potential of the user network. Namely, we consider how software firms should optimize the strength of network effects at utility level by adjusting the level of embedded social media features in tandem with the right market seeding and pricing strategies in the presence of seeding disutility. We explore two opposing seeding cost models where seeding-induced disutility can be either positively or negatively correlated with customer type. We consider both complete and incomplete information scenarios for the firm. Under complete information, we uncover a complementarity relationship between seeding and building social media features that holds for both disutility models. When the cost of any of these actions increases, rather than compensating by a stronger action on the other dimension to restore the overall level of network effects, the firm will actually scale back on the other initiative as well. Under incomplete information, this complementarity holds when seeding disutility is negatively correlated with customer type but may not always hold in the other disutility model, potentially leading to fundamentally different optimal strategies. We also discuss how our insights apply to asymmetric networks.
This article analytically and experimentally investigates how firms can best capture the business value of information technology (IT) investments through IT contract design. Using a small sample of outsourcing contracts for enterprise information technology (EIT) projects in several industries-coupled with reviews of contracts used by a major enterprise software maker-the authors determine the common provisions and structural characteristics of EIT contracts. The authors use these characteristics to develop an analytical model of optimal contract design with principal-agent techniques. The model captures a set of key characteristics of EIT contracts, including a staged, multiperiod project structure; learning; probabilistic binary outcomes; variable fee structures; possibly risk-averse agents; and implementation risks. The model characterizes conditions under which multistage contracts enable clients to create and capture greater project value than single-stage projects, and how project staging enables firms to reduce project risks, capture learning benefits, and increase development effort. Finally, the authors use controlled laboratory experiments to complement their analytical approaches and demonstrate robustness of their key findings.
It has been argued that platform technology owners cocreate business value with other firms in their platform ecosystems by encouraging complementary invention and exploiting indirect network effects. In this study, we examine whether participation in an ecosystem partnership improves the business performance of small independent software vendors (ISVs) in the enterprise software industry and how appropriability mechanisms influence the benefits of partnership. By analyzing the partnering activities and performance indicators of a sample of 1,210 small ISVs over the period 1996-2004, we find that joining a major platform owner's platform ecosystem is associated with an increase in sales and a greater likelihood of issuing an initial public offering(IPO). In addition, we show that these impacts are greater when ISVs have greater intellectual property rights or stronger downstream capabilities. This research highlights the value of interoperability between software products, and stresses that value cocreation and appropriation are not mutually exclusive strategies in interfirm collaboration.
Strategic sourcing, defined as a firm's key business process to identify, evaluate, configure, and negotiate purchases in important spend categories while managing long-term supplier relationships, is playing a significant role in sourcing strategies. The adoption of e-sourcing, defined as the use of business software (for example, using application service providers to conduct online procurement auctions) to automate or augment the aforementioned key business process, has been growing rapidly in recent years. One often-cited benefit of e-sourcing is the predicted savings, which is appealing, given the increasing pressure on cost competitiveness faced by firms. Using queuing techniques, this paper develops an economic model that captures fundamental trade-offs in a firm's e-sourcing business process as characterized by communication complexity, frequency of use, and cost of delay. This allows comparisons of two widely adopted structures for e-sourcing; the centralized structure versus the decentralized structure. Conditions under which the centralized structure is favored over the decentralized structure and vice versa are identified and illustrated with numerical examples and case evidence. These findings are robust in other settings. The paper concludes with a discussion of managerial implications.
The past few years have seen an explosion in the number of e-market-places, including a variety of electronic exchanges in the B2B arena, but many of these have also collapsed (e.g., Chemdex/Ventro). The question addressed in this paper is what are the underlying factors that affect which transactions are likely to be supportable by B2B exchanges. In particular, we identify and study three factors: supplier management, idiosyncratic investments in information systems, and codifiability (i.e., digitalizability) of product and order-fulfillment specifications underlying transactions. We show that transaction codifiability plays a fundamental role in influencing the nature of sustainable contracting and IT investments in e-markets. Hypotheses are derived from an analytical model of codifiability in e-marketplaces; these hypotheses are supported by several case studies by the authors and others on the key success factors underlying B2B exchanges.
Enterprise Resource Planning (ERP) software systems integrate key business and management processes within and beyond a firm's boundary. Although the business value of ERP implementations has been extensively debated in trade periodicals in the form of qualitative discussion or detailed case studies, there is little large-sample statistical evidence on whether the benefits of ERP implementation exceed the costs and risks. With multiyear multi-firm ERP implementation and financial data, we find that firms that invest in ERP tend to show higher performance across a wide variety of financial metrics. Even though there is a slowdown in business performance and productivity shortly after the implementation, financial markets consistently reward the adopters with higher market valuation (as measured by Tobin's q). Due to the lack of mid- and long-term post-implementation data, future research on the long-run impact of ERP is proposed.