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A Bundle of Pricing Options I

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A Bundle of Pricing Options I. Overview On an unseasoauably cold afternoon in Amberville, New York, in early October 2000, ]ason ]owers leaned forward in his chair, impatient for the meeting to end, so that he could get started. The yoingest product manager at Atlantic Computer, a large manufacturer of servers and other high—tech products, Jowers had joined the company just four months ago as a newly minted MIRA. Now, fresh from a management rotation that had included projects in product management, strategy, and business development, ]o'wers was getting his ?rst shot at some real responsibility. He would be responsible for developing the pricing strategy for the |tititlantic Bundle" (i.e., ?'lE new Tronn server and the PESA software tool]. lowers knew that it would not be easy to ?nd the sweet spot, but he was confident and eager for the challenge. There were just four of them at this marketing kick—off meeting: Iowers; Chris lvfatzer, head of the server division; Emily Jones, director of the division's R?rD team; and Harry Fowler, director of new product marketing. Lifatzer had started the meeting with a brief overview of the new server. The Tronn, he explained, had been developed specifically to meet an errLerging U5. marketplace opportunity. "But," he had said, "We really feel that the key to making this product a success is going to be our ability to sell ?le server with our new7 software tool." ]ones had taken it from there. The tool, called the "Performance Enhancing Server Accelerator," or PESA, would allow the Tronn to perform 11p to four times faster than its standard speed, she explained. It was speci?cally designed to make frequently requested information {e.g., ?les, data, pictures, etc.) extremely accessible. "The 'Attantic Bundle' is the sale we want."

Next, Fowler went through a slide presentation, reviewing key industry characteristics and projecting sales for the server (see Exhibit 1 for projected sales). "Ultimately, there are two main market segments in the server industry," he said, clicking to a new slide. "The largest segment, High Performance Servers, represents the traditional use of servers to run complex applications. We're talking supply chain management, enterprise resource planning, business intelligence, that ilk. This segment is expected to demand approximately 200,000 units next year and is projected to grow around 3'36 annually the following two years." He clicked over to another slide. "Atlantic has been a strong player in this segment and has captured 20% of the revenue market share. Emerging with the growth of the Internet, however, is a newer segment for Basic Servers." He paused, looking at ]ones. "It' s not all the bundle, Em; we all know that." Fowler looked back at the slide and continued his prdsentation. "Companies increasingly need basic computing capability to perform simple, repeatable tasks, such as showing website information on the Internet. This market should demand about 50,000 units in 2001, and register about a 36% compound annual growth rate through 2003." lowers nodded, taking notes on the hard copy of the slide deck he had in front of him. He wished that Fowler would wrap it up; thankfully, he appeared to be winding down. Matzer cleared his throat and jumped in. "Thanks, Harry. So that's where we stand. This was a useful review. It's good to know that we're all on the same page as we go forward." He turned toowers. "]ason, you have an opportunity to make a big splash here. Our new server, the Tronn, and the PESA software tool are going to help us enter a new market—one that has been dominated by Ontario Computer for longer than I care to remember. "But we need to get our pricing right for the 'Atlantic Bundle.' You're going to have to ?gure out which businesses are most likely to benefit ?'om our new offering. You will also need to take into consideration how customers are likely to react and how competitors are likely to respond to your recommended pricing strategy." He looked to [ones and Fowler for agreement, and seeing their nods, continued talking to Jason. "Let's set a deadline two weeks out. I'd like to see a pricing structure in place for the trade show at the beginning of November." lowers nodded as well. He knew that Matzer would want him to be ready for that show. Officially called "The Small and Medium—Size Enterprise Systems Solutions Trade Show" —SMIE for short—this event was a big deal for Atlantic Computer. Getting their pricing strategy down cold before the show was a must. II. The Necessary Backgron The meeting adjourned; Jowers headed back to his office. Seated in front of his own computer, he pulled up some secondary research that already existed within some internal company reports. He decided that it couldn't hurt to take some time and just review the market—and Atlantic's piece of it — in broad strokes. In business school, he had often found himself caught up in the details of one or another case, and had been pulled up short, more than once, by a professor saying, "Jason, you're

clearly winning the battle, but you've already lost the war. Get your head up and look out, look back and look forward. You ignore the big picture at your peril." He ?rst reviewed a document detailing the company's history. Atlantic Computer.Inc was the largest player in the overall computer industry. It had been compe?ng 1n the serveanarket for 30 years by selling its high—end performance servers, called Eadia, to large enterprise customers. The firm in general and its Server Division in particular had come to be known for providing top—notch, highly reliable products, and had developed a reputation for providing high quality, responsive post— sales assistance. This was a direct result of their overarching strategy being based on customer in?rnacy and product differentiation. He then read a memo written by Matzer conveying that the Internet had yielded a market for low— end systems, of course. Although the server market was historically characterized by complex, robust systems capable of handling critical business applications, the Internet and the proliferation of applications in the late 1990s had changed all that. For instance, a company could now build a website by utilizing several smaller basic servers that shared the work. owers pulled up a report ?om March of 1999, also prepared by Matzer. Given the projected growth for low—end, basic servers, Matzer (a 20—year veteran of the computer business} had decided to stretch the division's product line downward with the goal of introducing a model called the Tronn. by the end of 2000. His strong belief was that high perjbrmancs servers and basic servers would not be viewed as substitutes by customers. Matzer had focused a large chunk of his report on competitors—Ontario in particular. ]owers reviewed this section with interest. Then, on top of Matzer's report, he opened up Atlantic's current internal analysis of Ontario and the basic server market. Ontario Computer, Inc., a ?rm that concentrated its efforts solely on the low—end server market with its Zink product line, currently claimed 50% revenue market share in the basic server market. Ontario's Zink servers performed at approximately the same level as Atlantic's Tronn. The rest of the basic server market was made up of many smaller vendors. Unlike Atlantic, the majority of Ontario's sales were generated online. ]owers made a note of that. Given that lOntario's business model was based on operational excellence, the company had been able to drive out many nonvalueadded costs and, therefore, compete largely on price. Allen Capps, CEO of Ontario Computer, had been heard saying, "Our business model is not to be the leading innovator in product technology. Rather, our business model is to provide leading technology to customers via the most ?exible and innovative supply chain strategy possible." owers opened a ?le on the PESA's beta field tests and reviewed the results. The bottom line was ?rat Atlantic's Tronn was going to compete directly against Ontario's Zink. And the beta test had con?rmed that the PESA allowed Atlantic's low—end servers to perform up to four ?rnes faster than their standard speed when loaded with the PESA software tool. 'Ihat meant that a business customer could conceivably receive the same level of performance by buying one Tronn loaded with the PESA as compared to buying four basic servers. ]owers knew that it was a no— brainer to buy Atlantic's offering, but he also knew that getting the pricing right was crucial.

Customers were funny when it came to weighing short— and long—term investments. 1What was the right strategy??? III. Marketing the Tronn Leaded with the PESA There were several key factors in?uencing the Pricing strategy for the "Atlantic Bundle" thatowers had to keep in mind. First, he thought about the Server Division's traditional focus on hardware. This division had placed only limited emphasis on developing and selling software tools that helped to enhance the performance of their servers. For example, when the division had designed a small software management tool to help server administrators monitor the health of their systems and be more responsive regarding repairs, that tool had not been viewed as a differentiator to win deals because the sales force had historically given away software tools. That approach re?ected IvIatzer' s belief that software tools should generally be provided to customers for free. ]owers wasn't at all sure the PESA should be handled the same way. Still, Ivlatzer was a force to be reckoned with. Second. the division had long relied upon cost-plus pricing analysis [the standard approach to pricing in the industry} to determine the prices of their servers.3 For the Tronn, Matzer had followed convention and established ?'re price of the basic server at $2,D??. Third, ]owers realized that establishing the gains accruing to customers from the PESA software tool would require some careful consideration of customer segments. Based upon internal performance test results (see Exhibit 2}, customers in the web—server and file—sharing application segments appeared to be the ones that would bene?t most from the tool. owers thought back to a quick conversation he'd had with Dvlatzer the previous day. Matzer had come up to him at the coffee machine, and the talk had quickly [and not surprisingly} turned to the Tronn. "The thing is, customers will usually dedicate their basic servers to one application." he had said. Upon re?ecting on some of Matzer' s other comments, ]owers recognized the importance of conveying to prospective customers that the first—order savings effects from purchasing the "Atlantic Bundle" derived from the need to purchase fewer servers, and the second—order savings effects included lower annual electricity charges, software license fees, and labor costs {see Exhibit 3 for cost and pricing information}. owers closed all of the reports arrayed on his desktop and sent a quick email to Iairo Cadena, director of sales. The reply was back almost instantaneously, con?rming what he had already known. Cadena was looking forward to manning A?antic Computer's SMIE trade show booth with ]owers,

and was also eagerly awaiting Jo'wers's plan. He would also be happy to meet with him any ?rne and act as a sounding board. lowers read Cadena's reply and smiled, shaking his head. Cadena wouldn't be just a sounding board, he knew. S?ll, it would be good to hear what he had to say. Truth be told, ]owers wasn't sure at all why Cadena hadn't been included in the marketing meeting. He would have to ask Matzer of?ine whether that was a signi?cant omission. He thought about the company's approach to sales. Traditionally, the Server Division had relied upon a high—touch direct sales channel. Cadena's sales force compensation structure was roughly a F0316 salary and a 30% commission. Clearly that fact was going to color Cadena's view of the pricing strategy. L-{aybe that was it. Still, it was important to hear Cadena's point of view; his people would eventually be the ones primarily in charge of generating demand. ful?lling demand, and providing post-sales assistance. At the trade show, though, ]owers would get a shot at talking to prospective customers himself. He would be the point person assigned to discuss the new server and software tool with visitors at Atlantic's SME booth. The information gained from the trade show would allow Cadena to eventually develop a sales script and other marketing collateral {e.g., sell sheets} that his sales staff and his third—party business partners could leverage when offering the servers to small and medium— sized business customers. But he had to go into the trade show ready to test a theory; otherwise, they wouldn't learn anything tangible. IV. Planning the Strategy The phone rang; it was his boss, Harry Fowler, offering his assistance. "Jason I don't yet know you well enough to know how you prefer to work, but I usually ?nd it useful to think out loud. If you'd like to take some ?rne and brainstorm in hunt of a white board, I'd be glad to help." lowers thanked him and suggested meeting early the next morning. No lack of people willing to pitch in, he thought to himself. But having too many opinions at this stage wouldn't be useful, either for the Atlantic Bundle or for Jowers' career. Everyone wanted to help; everyone wanted to in?uence his thinking. Not that that was a bad thing, but it was clear that tradition and position were ?avoring how Jones, Fowler, hiatzer, and Cadena were thinking about the Tronn and PESA. lowers had to be the one with the clear head. owers began to contemplate the major decision for his I[I'mtober 15 presentation to IMatzer and the management teanL He thought that it would be most effective if he were to identify an exemplary customer from the most viable segment in discussing his proposed pricing strategy. In reviewing sonre of the sales leads that Cadena had passed along, ]owers decided that Day'I'rader]o1nnal.con1 (see Exhibit at for a customer pro?le} could serve as an exemplary customer that would be visi?ng their sales booth. From the completed sales lead sheet, it was evident that this customer was seeking four basic servers, and that minimizing initial purchase costs and subsequent possession costs were two very closely ranked considerations {i.e. "key buying criteria"). Iowers started to contemplate the first-order and second—order savings that this customer would enjoy by purchasing the Tronn server in conjunc?on with the PESA as opposed to buying four basic servers. He knew that Matzer and his colleagues were quite conservative, so he decided that it would be best to compare two basic servers loaded with the PESA software tool versus four basic servers.

He thought about the alternative approaches that could be utilized to develop the pricing strategy for the Atlantic Bundle for the exemplary customer. The "usual suspects" included status—quo pricing, competition—based pricing, and cost-plus pricing. Then there was value—in—use pricing—an alternative he'd read about in a working paper just a few menths ago.'1 This latter option would require him to demonstrate the savings to the customer from purchasing the Atlantic Bundle versus buying four ICll'ntario Zirrk servers [i.e., identifying the savings the customer would realize from having to buy fewer servers, utilize less labor and electricity, and secure fewer software application licenses]. I lowers stood up, walked around his desk, and tried to stretch out his back. Ultimately, he thought, he could go one of four routes: 1. Stick with company tradition by charging only for hardware and give the PESA software tool away for tree. 2. Charge a price equal to what the customer would pay for four Ontario Zink servers. 3. Charge a price based on a cost—plus approach to pricing PESA [based on software tool's development costs]?r 4. Charge a price based on value—in—use pricing.l5 He sat back down to identify the critical tasks that he needed to complete. First, he needed to calculate the price that he should charge DayTradeIIournaLcom for the Atlantic Bundle utilizing the four aforementioned approaches. He would then have to recommend one of these alternatives for this customer. This would require him to not only convey the pricing strategy that would optimize value capture for Atlantic, but also describe any implementation issues that could possibly arise. For example, he recalled that the industry norm was to give away software tools. If he were to recommend one of the other alternatives, he'd better be ready to answer how he could break from what was already a well—established tradition in the industry. In addition, he knew that he would have to think more broadly about the top-line revenue implications from each of the four alternative pricing strategies. He knew that he could undertake a quick "back of the envelope" calculation utilizing the total estimated sales for the Atlantic Bundle over the upcoming three years to effectively convey the gains from his recommended pricing strategy.

The second agenda item would be to sketch out for Cadena how to get the Division's sales force to charge for (and not give away) the PESA. 1What could he recommend to get Cadena's hardwart.L oriented sales force to understand and sell the value of the PESA software tool effectively? He recalled again the working Paper he had read on value—in—use pricing. According to the authors, business managers in the United States and Europe were reporting that the phrase, "We can save you money!" had become a generic blanket statement. Almost every prospective supplier was saying it. ]owers thought about the possibility of developing a simple role—playing exercise in order to convey to his senior management team how an Atlantic salesperson could effectively demonstrate the value created for Day'I'raderJo-urnalcom, and overcome the potential objectioils that the customer was likely to raise. He knew that his calculations could easily be generalized to evaluate the savings likely to be achieved by other customers who were seeking to utilize the basic servers for rimming websites or file sharing would experience. The ?nal item that he needed to address in his presentation stemmed from a comment made at the orientation meeting regarding anticipating the main competitor's likely reaction. He thought that he could address that by preparing a response to the following question: How is Ontario Zink's senior management team lilcely to react to the threat posed by the Atlantic Bundle? lowers stood up once again, grabbed his jacket, and headed toward the door. It was time to get a sandwich and a beverage and contemplate the situation. He had a good outline, he felt. But now the hard work was going to begin. It was time to start filling in that outline with details. Over the next week or so, he was going to have to make some decisions.

Exhibit 1 Projected Market Volumes by Segment (in units) 350,000 300,000 250,000 200,000 High Performance segment 150,000 Basic segment 100,000 50,000 0 2001 2002 2003 50,000 70,000 92,000 Basic segment (Units) 200,000 205,000 210,500 High Performance segment (Units) 250,000 275,000 302,500 Total Estimated Market for Servers (Units)

Exhibit 2 Test Results from PESA Software on Tronn Servers on a Variety of Application Types a b Atlantic Internal Performance Testing Results July 22 2000 Tronn Tronn Application Tested with PESA without PESA High Performance/ Computer Intensive Workloads 180 187 (e.g., running complex scientific models) Graphics Applications 280 281 (e.g., creating custom graphics/ videos) Enterprise Applications 264 254 (e.g., supply chain management) e-Mail Applications 341 300 (e.g., Microsoft Outlook, Lotus Notes) I File Sharing 812 404 (e.g., shared storage and data backup applications) Web Services 2222 542 (e.g., running websites such as www.espn.com)

Exhibit 3 Salient Pricing Information Labor (# of Cost of servers an Electricity Application "administrator" COST INFORMATION (per server) (annual cost) Software Licenses can manage Basic Server $250 $750 High Performance server $400 $750 20 Atlantic Computer Price per Server Cost per Server Tronn (Basic) $2,000 $1,538 Radia (High Performance) $11,000 $7,586 Ontario Computer Zink (Basic) $1,700 $1,214 Other customer expense information: Cost of Electricity: Charge for heating and cooling servers, etc. Cost of Software Application Licenses: Assume application software is licensed "per server." The average per server application software license is $750. Examples of Application Software are supply chain management software, customer relationship management software, web application software. PESA is a software tool, not application software. Cost of Labor: A server administrator's annual salary is $80,000. R&D Costs for Atlantic: PESA Software development costs = $2,000,000

Exhibit 4 Customer Profiles Sample "Web Server" Basic Server (New SME) Customer Profile: Customer Name/Size: Day TraderJournal.com (15 employees) Address: 11325 Magic Bean Drive, San Jose, CA Business Description: With the increasing popularity of day trading fueled by the growth of the Internet, Day Trader Journal has identified an unmet market need for providing training information and tips to prospective day traders. Day Trader Journal online will generate revenue by selling advertising space to other companies who are attempting to reach the day trader market. Server Need: Web servers to host the company's new website, Day TraderJournal.com, where day traders can review articles and relevant training information. Top 3 Requirements: (i.e., ranking of "key buying criteria" for basic server purchase) 1. Minimize our acquisition costs 2. Minimize our possession costs (i.e., total cost of ownership) 3. Allow our website to process many information requests Sample "File Sharing" Basic Server (New SME) Customer Profile: Customer Name/Size: Look Sharp Advertising (65 employees) Address: 580 Madison Avenue, New York, NY Business Description: Look Sharp Advertising designs customer-facing marketing communications materials such as brochures, websites, and advertisements. It works primarily with business clients building integrated marketing communications programs. Server Need: File servers to help layout designers share graphics, text, and layouts. Top 3 Requirements: (i.e., ranking of "key buying criteria" for basic server purchase) 1. Minimize our possession costs 2. Make highly requested information among employees readily available (e.g., graphics and images) Availability of top-notch post-sales support Sample High-Performance Server Customer Profile: Customer Name/Size: Human Genome Institute for DNA Modeling and Mapping (HGIDMM) (100 employees) Address: 100 Massachusetts Avenue, Cambridge, MA Business Description: HGIDMM is attempting to map the human genome and model the potential effects of various experimental medications on humans. With the increasing expense of medical trials, big pharmaceutical companies are looking for better ways to evaluate the potential efficacy of new drugs before going to trial. HGIDMM wants to help these companies expedite the process and thereby reduce new product development costs. Server Need: They currently own a Radia to perform complex, one-time model simulations of the effect of medication on individuals with various DNA specifications. Top 3 Requirements: (i.e., ranking of "key buying criteria" for high performance server purchase) Capable of maximizing speed of mathematical computations in complex model simulations. Availability of outstanding customer support (24x7) 3. Flexible payment terms