Ram Bala

Competitive Behavior-Based Price Discrimination for Software Upgrades

The introduction of product upgrades in a competitive environment is commonly observed in the software industry. When introducing a new product, a software vendor may employ behavior-based price discrimination (BBPD) by offering a discount over its market price to entice existing customers of the competitor. This type of pricing is referred to as competitive upgrade discount pricing and is possible because the vendor can use proof of purchase of a competitors product as credible evidence to offer the discount. At the same time, the competitor may offer a discount to its own previous customers in order to induce them to buy its upgrade. We formulate a game-theoretic model involving an incumbent and entrant where both firms can offer discounts to existing customers of the incumbent. Although several equilibrium possibilities exist, we establish that an equilibrium with competitive upgrade discount pricing is observed only for a unique market structure and a corresponding unique set of prices. In this equilibrium, instead of leveraging its first mover advantage, the incumbent cedes market share to the entrant. Furthermore, the profits of both the incumbent and the entrant reduce with switching costs. This implies that the use of BBPD has product design implications because firms may influence the switching costs between their products by making appropriate compatibility decisions. In addition, lower switching costs result in reduced consumer surplus. Hence, a social planner may want to increase switching costs. The resulting policy implications are different from those prevalent in other industries such as mobile telecommunications where the regulators reduced switching costs by enforcing number portability.

Detailing vs. Direct-to-Consumer Advertising in the Prescription Pharmaceutical Industry

The pharmaceutical industry has always used sales representatives to target physicians (detailing), who are a key link in sales and market share for prescription pharmaceuticals. Since August of 1997, when the Food and Drug Administration eased the restrictions on direct-to-consumer advertising (DTCA), there has been a dramatic increase in the use of DTCA by pharmaceutical firms to target end customers (patients). DTCA seems to have two different effects on pharmaceutical markets. The first is to inform patients about the availability of drugs for some ailments, thus expanding the market (constructive). The second is to persuade patients to talk about specific brands when they meet physicians, with the objective of influencing market share (combative). We consider both effects of DTCA in the presence of a detailing program in a competitive environment. We incorporate the dynamics of physician-patient interaction in a game-theoretic model where firms decide on the form of DTCA to adopt (constructive or combative) and then compete in the marketplace by choosing detailing and DTCA levels. We answer four questions: What is the impact of adopting DTCA on competitive intensity? How do optimal detailing levels for a firm change with the adoption of DTCA? How should the DTCA strategy for a firm vary depending on whether it is stronger or weaker in its degree of influence in the physicians office? Finally, under what conditions would competing firms voluntarily decide to pursue constructive DTCA?

Pharmaceutical Product Recalls: Category Effects and Competitor Response

In the pharmaceutical industry, a product recall financially impacts not only the firm undertaking the recall but also other competitors in the category since it affects physician and consumer perception of the category as a whole. Often, such competitors have to engage in defensive marketing at the category level without complete certainty about whether a recall will occur or not. Such defensive effort could then lead to a change in postrecall sales effort directed at capturing market share in that category. This decision is affected by the probability of the recall and the size of the loyal segment in the category facing the recall, i.e., physicians who will continue to prescribe the category even without marketing effort. We focus on competitor reaction to product recalls where the competitor participates in multiple product categories that exhibit (dis)economies of scope in sales effort across them. Equilibrium analysis of our game-theoretic model uncovers several managerial insights that illustrate t...

Offering Pharmaceutical Samples: The Role of Physician Learning and Patient Payment Ability

Physicians may learn about prescription drug effectiveness directly from the firm via detailing or from patient experience. Patient-mediated learning is aided by the use of free drug samples. The effective use of samples is hampered by a lack of understanding of its exact return on investment implications. We seek to fill this gap by incorporating the physicians sample allocation behavior in the firms decision making. We uncover the following implications for firms as well as policy makers. First, we find that the optimal sampling level for a drug category is a nonmonotonic function of patient payment ability and the price of the drug. Second, an increase in the cost of samples can lead to an increase in sampling and a decrease in detailing when the physicians propensity to provide sample subsidies is high. Third, when future market growth is expected to be high early stage product life cycle and/or chronic drugs and sampling efficiency is low, the use of sampling is profitable for the firm but leads to lower market coverage than when sampling is disallowed.

Differentiated or integrated: Capacity and service level choice for differentiated products

Several firms across different product-focused industries, such as Dell, GM and Keurig, offer associated services along with their products. Given that firms routinely offer a portfolio of vertically differentiated products, a crucial question facing such firms is whether such differentiation should also be extended to associated services. Service differentiation lowers cannibalization of the high-quality product by the low-quality product and increases revenues, but it requires dedicated capacity which increases the cost of offering service. This tradeoff is further confounded by the potential loss of service performance due to complexity involved in single set of resources serving multiple segments. Thus, we examine this service strategy decision along the two dimensions: cannibalization concerns and complexity involved in serving multiple segments together. We consider a firm whose customers vary in their willingness-to-pay (WTP) for product quality and their sensitivity to service levels, and can self-select across offered products. We find that even when there is no complexity involved in serving multiple segments, the differentiated service strategy may be preferred purely to prevent cannibalization. With high complexity, cannibalization concerns may increase or decrease the firm’s preference for the differentiated service strategy depending on the demand mix of higher and lower WTP customers. Cannibalization also makes the role of total demand size in the service strategy decision more pronounced. Specifically, changes in capacity costs, customer heterogeneity and product differentiation may make the differentiated service strategy more or less attractive depending on the total demand size as well as the demand mix.

Delayed Payments in Supply Chains: The Role of Moral Hazard vs. Bankruptcy

Performance-based contracting is gaining widespread acceptance in supply chains where moral hazard might prevent either or both supply chain entities from exerting the first-best effort that improves supply chain outcomes. We analyze the use of delayed payments as a performance-based contract when supply chain payoffs are lead time dependent. The buyers margin depends on lead time which is governed by costly supplier effort. For a cash-constrained supplier, the delayed payment offered by the buyer (principal) raises the possibility of bankruptcy and incentivizes the supplier (agent) to exert effort. We study the optimal balance between moral hazard and bankruptcy risk in the context of a delayed payment contract whose objective is to reduce the lead time from supplier to buyer. Modeling the buyer--supplier interaction as an infinite--horizon principal--agent game, we find that suppliers with high cost of effort are able to use the threat of bankruptcy to extract better payment terms from the buyer. Further, these suppliers also exert less effort than what would be optimal for the supply chain as a whole. We show that a payment structure that involves a bonus payment for timely delivery combined with a delayed payment coordinates the supply chain. This payment structure effectively implies buyer cost-sharing in the suppliers effort, contingent on adequate supplier performance. Our results provide buyers with a roadmap on when and how to implement delayed payments as a function of different supplier parameters such as the cost of operational effort and the wholesale price.

Software Upgrades with Price Competition

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 incumbents product could actually hurt the incumbents profit and help the entrants 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 incumbents product in the first period. Our analysis reveals that the incumbents profit is maximized when the entrant poaches some of the incumbents 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 where such pricing is enabled through digital information exchange mechanisms such as e-mails and firm web-sites etc.