Versioning in the Software Industry: Heterogeneous Disutility from Underprovisioning of Functionality

Literature has identified factors such as piracy, network externality, or concave cost of producing quality as key drivers of software versioning. However, software firms adopt versioning strategies that are often invariant across different market settings. To explain universal business practice of software versioning, we focus on “inconvenience” or disutility that users experience when software has lower functionality than what they require to accomplish tasks. In our model, users are heterogeneous on marginal valuation for functionality and the required level of functionality such that those with higher valuation have a higher required level of functionality. Users do not derive any additional utility if the software has more functionality than what they require. We show that heterogeneous disutility from underprovisioning of functionality is a sufficient condition for optimality of versioning under fairly general conditions. We also show that, as high-type users’ required level of functionality increases, the firm increases the functionality level of the high version. Yet surprisingly, the firm may decrease the functionality level of the low version if the proportion of high-type users is moderate. On the other hand, as the required level of functionality of low-type users increases, the firm may reduce the functionality level of the low version when the proportion of high-type users is high, though the functionality level of the high version remains the same. Counterintuitively, an increase in the high-type (low-type) users’ required level of functionality negatively (positively) impacts high-type users’ consumer surplus.