VERSIONING: A SHORT EXAMPLE

Problem 1
You work for ‘TekNik’ software company, which is coming up with a software called Tek-Magic
which will do wonders for your consumers. You have two segments of consumers, Cheapos and QC
(Quality conscious). Your boss wants you to evaluate whether or not you should come up with two
versions of the product, Lo-Tek and Hi-Tek or just offer one of them. You did some market research
and estimated segment size is 50 for QC and 50 for the Cheapos segment. The marginal cost of
manufacturing is the same for both versions.
Assume that these segments are already developed therefore your marketing team does not have to
invest in segment development, however your company will have to bear the product development
costs for the versions you plan to develop. The willingness to pay and other costs associated with
product development are given in the table below.
A. If you are restricted to offer only a single version of the product, which one will you offer and
at what price?
B. What are the best prices to set if you offer both the versions?
C. Would you recommend offering both the versions or only a single version? Why?
  Lo-Tek Hi-Tek

Marginal Cost $50 $50

Product Development Cost $2000 $200

Willingness to pay    

Quality Conscious(QC) $175 $275

Cheapos $125 $150

Solution to Problem 1A
If only 1 version of the product can be offered, then assume the following cases:
Case-1: Only Lo-Tek Product is offered
This can be offered to both segments or only to one segment.
If it is offered to both segments, then:
Price = $125
Then the Profit is Pr = (125-50)*50*2 – 2000 = $5,500.
If it is offered to only 1 segment, then it is profitable to offer only QC segment. Then:
Price = $175
Profit = (175-50)*50 – 2000 = $4,250
Case-2: Only Hi-Tek Product is offered
This can be offered to both segments or only to one segment.
If it is offered to both segments, then:
Price = $150
Then the Profit is Pr = (150-50)*50*2 – 200 = $9,800.
If it is offered to only 1 segment, then it is profitable to offer only QC segment. Then:
Price = $275
Profit = (275-50)*50 – 200 = $11,050
Best profit is when Hi-Tek product is offered @ $275.

Solution to Problem 1B
If both Lo-Tek & Hi-Tek versions are offered, then we need to find a pricing strategy that avoids
cannibalization from high segment to low segment. To do this, we can set a price such that we extract
the full consumer surplus from Cheapos segment and set a price for QC segment such that they are
indifferent between choosing Lo-Tek & Hi-Tek versions.
Let price of Lo-Tek be PL, and price of Hi-Tek be PH.
We have assumed PL = WTPCP = $125
Setting up the incentive compatibility constraint for QC segment:
WTPH – PH >= WTPL – PL
=> 275 – PH >= 175 – 125
=> PH <= 225
So, PH = $225
So, price of Lo-Tek = $125 and price of Hi-Tek = $225.
The profit from such a pricing strategy will be = (125-50)*50-2000 + (225-50)*50-200 = $10,300

Solution to Problem 1C
Based on the profits made, it is recommendable to sell only single version of the product – Hi-Tek
for QC segment price @ $275 since this is the most profitable for the company.
When both versions of the product are offered, there is some surplus of the QC segment that we are
unable to capture leading to lower profits compared to when only single version is offered.