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A Theory of pricing for information-intensive offerings

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The networked digital environment offers opportunities for innovative pricing mechanisms in the context of information-intensive offerings (IIOs), including digital movies, software packages and entreprise management solutions. In this paper, we propose a theory of pricing for IIOs that addresses the following issues: - How are optimal prices and rents for IIOs set in a variety of heterogeneous markets? - How can selling and renting be used in combination? - How does competition incur between sellers and renters of IIOs? - How does consumer aversion to risk impact selling and renting policies? - Is there a role for a two-part tariff mechanism in the context of selling and renting? - Our base model offers a simple, but flexible, structure that captures the key insight that selling requires an upfront payment that is disengaged from the realized usage patterns, whereas renting tightly links payments to usage. Consumers are differentiated in terms of their usage probability and usage utility. For any consumer, this specific decomposition of utility moderates the relative attractiveness of the selling and renting options. The model also incorporates a transaction cost parameter that reflects technology inefficiences that may be latent in the renting option. To strengthen the generality of our analysis, the model accomodates a range of market configurations. Using this simple setup, we first analyze a range the pure rent and pure sell cases. This section provides insights into specific market configuration that are amenable to selling or enting, the influence of transaction cost on the attractiveness of each option, and the prospects for seller/renter profits and consumer and economic surplus under each mechanism. Renting tightly links payments to usage; in the absence of transaction cost, renting emerges as the preferred mechanism on account of such precision. Next, we analyze the case where the seller jointly offers renting and selling. Here, we demonstrate how the seller balances the dual profit streams depending on the level of transaction cost. Such flexibility leads to higher profits than the pure rent and pure sell cases. Some unexpected results emerge in the study of competition between renters and sellers. For example, a very low transaction cost does not necessarily benefit the renter. Instead, a low transaction cost leads to a region of intercecine competition. The renter's profits are, in fact, the highest for moderate levels of transaction cost. In any case, the renter's profits in the duopoly are always lower than the seller's duopoly profits. We trace this findings to the lack of strategic flexibility on the part of the renting mechanism when compared with selling in the competitive setting. We then consider the role of consumer risk aversion. Selling demands upfront commitment - this induces some risk for consumers since the expected post-purchase usage patterns may not be realized. We show that risk aversion lowers the profitability of selling. The optimal price, however, may be relatively high when risk aversion is high. Intuitively, consumers with low usage utilities and high uncertainty prefer not to participate in the market when exposed to significant risk, leaving behind a concentration of high valuation consumers. The seller increase price to extract additional surplus from these remaining consumers. Finally, we show that a two-part tariff in the contect of renting does not improve on the pure renting solution. In this context, the two-part tariff proves unwieldly as a tool for more efficient price discrimination.

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