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Market Provision of Custom Software: Learning Effects and Low Balling

Author

Listed:
  • Seungjin Whang

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

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."

Suggested Citation

  • Seungjin Whang, 1995. "Market Provision of Custom Software: Learning Effects and Low Balling," Management Science, INFORMS, vol. 41(8), pages 1343-1352, August.
  • Handle: RePEc:inm:ormnsc:v:41:y:1995:i:8:p:1343-1352
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    File URL: http://dx.doi.org/10.1287/mnsc.41.8.1343
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    Citations

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    Cited by:

    1. 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 University Rotterdam.
    2. 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 University Rotterdam.
    3. Muck, Johannes & Heimeshoff, Ulrich, 2012. "First mover advantages in mobile telecommunications: Evidence from OECD countries," DICE Discussion Papers 71, University of Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
    4. Anandasivam Gopal & Konduru Sivaramakrishnan & M. S. Krishnan & Tridas Mukhopadhyay, 2003. "Contracts in Offshore Software Development: An Empirical Analysis," Management Science, INFORMS, vol. 49(12), pages 1671-1683, December.
    5. Laurens G. Debo & L. Beril Toktay & Luk N. Van Wassenhove, 2005. "Market Segmentation and Product Technology Selection for Remanufacturable Products," Management Science, INFORMS, vol. 51(8), pages 1193-1205, August.

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