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Market Provision of Custom Software: Learning Effects and Low Balling

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Author Info

  • Seungjin Whang

    (Graduate School of Business, Stanford University, Stanford, California 94305)

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    Abstract

    Due to reusability of program code and learning effects in software development, development cost of custom software typically decreases in time and experience. This creates a first-mover advantage to software developers. The paper studies whether the benefits of declining development costs are passed on to buyers in the form of lower prices when developers bid strategically. By using a model of bidding auctions we characterize equilibrium bidding strategies of two software developers. In order to become the first mover and attain future market dominance, developers find it optimal to forgo profits from the first projects. As a result, bid prices (= development cost plus a profit margin to the developer) to the buyers may not necessarily decrease over time, and even if so, not as fast as development cost drops. We also show that bidders expect a higher profit margin from a high-variance project. Thus, if there exist high-variance projects in the future, developers are more likely to submit below-cost bid prices or "low ball."

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    File URL: http://dx.doi.org/10.1287/mnsc.41.8.1343
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    Bibliographic Info

    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 41 (1995)
    Issue (Month): 8 (August)
    Pages: 1343-1352

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    Handle: RePEc:inm:ormnsc:v:41:y:1995:i:8:p:1343-1352

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    Related research

    Keywords: software economics; custom software; bidding; low-balling;

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    Cited by:
    1. Muck, Johannes & Heimeshoff, Ulrich, 2012. "First mover advantages in mobile telecommunications: Evidence from OECD countries," DICE Discussion Papers 71, Heinrich‐Heine‐Universität Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
    2. Radkevitch, U.L. & van Heck, H.W.G.M. & Koppius, O.R., 2008. "Choosing between Auctions and Negotiations in Online B2B Markets for IT Services: The Effect of Prior Relationships and Performance," ERIM Report Series Research in Management ERS-2008-004-LIS, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
    3. Radkevitch, U.L. & van Heck, H.W.G.M. & Koppius, O.R., 2008. "Coping with Costly Bid Evaluation in Online Reverse Auctions for IT Services," ERIM Report Series Research in Management ERS-2008-039-LIS, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.

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