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Product Development and Pricing Strategy for Information Goods Under Heterogeneous Outside Opportunities


  • Ying-Ju Chen

    () (Stern School of Business, New York University, 44 West 4th Street, New York, New York 10012)

  • Sridhar Seshadri

    () (Stern School of Business, New York University, 44 West 4th Street, New York, New York 10012)


This paper considers a two-stage development problem for information goods with costless quality degradation. In our model, a seller of information goods faces customers that are heterogeneous with regard to both the marginal willingness to pay for quality and the outside opportunity. In the development stage, the seller determines the quality limit of the product. In the second stage, the seller’s problem is to design the price schedule corresponding to different quality levels, taking into account production and distribution costs.We show that versioning is optimal for the seller when customers have multiple outside options or, more generally, convex reservation utilities. In addition, we show that in the optimal solution the seller discards both low-end and high-end customers. Among those that are served, the seller offers a continuum of (inferior) versions to customers with relatively low willingness to pay, and extracts full information rent from each of them. A common version with the quality limit is offered to the rest.We further prove that the seller should offer a single version when reservation utilities are either concave or linear. Through numerical experiments, we study the sensitivity of our results to changes in the cost structure and customer utilities.

Suggested Citation

  • Ying-Ju Chen & Sridhar Seshadri, 2007. "Product Development and Pricing Strategy for Information Goods Under Heterogeneous Outside Opportunities," Information Systems Research, INFORMS, vol. 18(2), pages 150-172, June.
  • Handle: RePEc:inm:orisre:v:18:y:2007:i:2:p:150-172

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    References listed on IDEAS

    1. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
    2. Jullien, Bruno, 2000. "Participation Constraints in Adverse Selection Models," Journal of Economic Theory, Elsevier, vol. 93(1), pages 1-47, July.
    3. Eric Maskin & John Riley, 1984. "Monopoly with Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 171-196, Summer.
    4. Martin A. Lariviere, 2006. "A Note on Probability Distributions with Increasing Generalized Failure Rates," Operations Research, INFORMS, vol. 54(3), pages 602-604, June.
    5. Maggi G. & Rodriguez-Clare A., 1995. "On Countervailing Incentives," Journal of Economic Theory, Elsevier, vol. 66(1), pages 238-263, June.
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    Cited by:

    1. Ke-Wei Huang & Arun Sundararajan, 2011. "Pricing Digital Goods: Discontinuous Costs and Shared Infrastructure," Information Systems Research, INFORMS, vol. 22(4), pages 721-738, December.
    2. repec:spr:infosf:v:19:y:2017:i:4:d:10.1007_s10796-016-9638-x is not listed on IDEAS
    3. Michaela Sprenger & Tobias Mettler & Robert Winter, 0. "A viability theory for digital businesses: Exploring the evolutionary changes of revenue mechanisms to support managerial decisions," Information Systems Frontiers, Springer, vol. 0, pages 1-24.
    4. Shivendu Shivendu & Zhe (James) Zhang, 2015. "Versioning in the Software Industry: Heterogeneous Disutility from Underprovisioning of Functionality," Information Systems Research, INFORMS, vol. 26(4), pages 731-753, December.
    5. Marius F. Niculescu & D. J. Wu, 2014. "Economics of Free Under Perpetual Licensing: Implications for the Software Industry," Information Systems Research, INFORMS, vol. 25(1), pages 173-199, March.
    6. Xinming Li & Huaqing Wang, 2018. "Pricing Mechanism in Information Goods," Papers 1803.01530,
    7. Liu, Zhiyong & Li, Minqiang & Kou, Jisong, 2015. "Selling information products: Sale channel selection and versioning strategy with network externality," International Journal of Production Economics, Elsevier, vol. 166(C), pages 1-10.
    8. Ying-Ju Chen & Ke-Wei Huang, 2016. "Pricing Data Services: Pricing by Minutes, by Gigs, or by Megabytes per Second?," Information Systems Research, INFORMS, vol. 27(3), pages 596-617.
    9. repec:eee:jomega:v:75:y:2018:i:c:p:13-26 is not listed on IDEAS


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