Atlantic Computer Case

CASE SUMMARY

Atlantic Computers A Bundle of Pricing Options 4/4/2011

Atlantic Computers is a leading developer of high-tech servers. It has recently decided to expand its product line downwards in order to take advantage of an emerging market for basic servers. Before it can launch the “Atlantic Bundle”, Atlantic Computers must decide which pricing strategy to implement. Of the four options: Status Quo, Competition Based, Cost-Plus, and Value in Use pricing, I believe the best option is Value-in-Use pricing.

ATLANTIC COMPUTER: A BUNDLE OF PRICING OPTIONS Summary of the Situation Analysis Atlantic Computer is a manufacturer of servers and high-tech products. Two market segments exist in the server industry: High performance and Basic Servers. Atlantic Computers has held a 20% share of the High Performance market with their Radia servers being their premier product. However, the market for Basic servers is growing and this has caused Atlantic Computers to develop and introduce a Basic Server called the Tronn and a software tool called the “Performance Enhancing Server Accelerator” (PESA). The Tronn was developed mainly for the emerging US market opportunity for basic servers. The PESA would allow the Tronn to perform up to four times faster than its standard speed and make frequently requested information more accessible. Thus, bundling the Tronn and PESA made more sense. Atlantic is not concerned that the Tronn will be considered a substitute for its High Performance servers.1 Primary Question to be addressed: What pricing strategy should Atlantic Computers implement to price the Atlantic Bundle? Model Customer: In order to decide which pricing strategy to use, it is best to identify and use the basic server needs of a model customer. In this case, DayTraderJournal.com will be used as the model customer.2 DayTrader.com is seeking four basic servers for their new website where day traders will be able to review articles and relevant training information.3 Their top requirements for a basic server purchase are to minimize initial purchase costs, minimize possession costs and allow their website to process many information requests.4 Because Matzer, the head of the server division, is conservative in his estimate of the power of the “Atlantic Bundle” we will assume that two “Atlantic Bundles” is the equivalent of four Ontario Zink servers.5 Analysis There are four main types of pricing strategies from which Atlantic Computers can choose. First, Atlantic Computers could stay with the status quo and offer software tools for free. Second, it could choose competitive based pricing. Third it could choose from Cost-plus pricing. Finally, it could choose value-in use pricing. 1

Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, 1-8. DayTraderJournal.com is seeking four basic servers and minimizing initial purchase costs and subsequent possession costs are two very closely ranked considerations. Id. At 5 3 Id. At 10. Exhibit 4 4 Id. 5 Neeraj Bharadwaj, John Gordon, “Atlantic Computers: A Bundle of Pricing Options”, 5 2

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In addition to determining which pricing strategy to use, Atlantic Computers must also determine which businesses are most likely to benefit from the Atlantic Bundle. Next, Atlantic Computers will have to consider how customers are likely to react to the Atlantic Bundle. Finally, Atlantic Computers will also have to consider how competitors will respond to the recommended pricing strategy. Pricing Strategies: 1. Status Quo Pricing: The industry norm for pricing a server and software bundle is to merely include any software tools with the hardware. Atlantic Computers has always practiced this pricing strategy.6 This would require Atlantic Computers to offer the PESA software tool for free with the Tronn Server. This would make the price of two “Atlantic Bundles” $4,000.7 This would require Atlantic Computers to essentially lose the $2,000,000 cost of research and development of PESA. Furthermore, because Atlantic Computers would be giving PESA away, it would appear that there are no substantial differences between the “Atlantic Bundle” and the Zink servers. Customers would see that they are getting half of the hardware. Making a direct comparison based on hardware and price, customers would see that they could get 4 Zink servers for $6,800 whereas it would cost $8,000 for four “Atlantic Bundles”. It would be hard to justify the additional $1,200 in price. Additionally, the Tronn Server would appear to customers as very comparable to the Zink servers and it would make it difficult for Atlantic Computers to compete with and gain market shares in the basic servers segment. 2. Competition-Based Pricing: Competition-Based pricing uses the prices of competitors as a benchmark for pricing products rather than considering costs.8 The price of Ontario’s Zink servers is $1700 and conservatively speaking, two “Atlantic Bundles” is equivalent to four of Ontario’s Zink servers.9 Therefore, under the Competition-Based Pricing, the price of two “Atlantic Bundles” would be $3400 x 2 or $6800. While selling at this price would generate more profits for Atlantic Computers10, it is not certain that consumers would purchase the “Atlantic Bundle” at this price. Consumers would see that they are only getting two Tronn servers at a price that they could get four Zink servers. While the addition of the PESA software tool would make the Tronn servers the equivalent of four Zink servers, the PESA software does not work on all 6

Neeraj Bharadwaj, John Gordon, “Atlantic Computers: A Bundle of Pricing Options”, Id. at 4 8 http://www.businessdictionary.com/definition/competition-based-pricing.html 9 Neeraj Bharadwaj, John Gordon, “Atlantic Computers: A Bundle of Pricing Options”, Exhibit 3, 9 10 Exhibit 1, supra pg. 7 7

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software applications.11 Furthermore, customers would need further justification to have only half of the hardware and run the risk of one or both servers being out of commission for any given amount of time.12 Customers would likely not consider purchasing the “Atlantic Bundle” based on Competition-Based pricing because they would not see it as a fair price and worth the risk. 3. Cost-Plus Pricing: Cost-plus pricing is determined by adding the direct, indirect and fixed costs associated with a product and converting it into a per-unit cost for the product.13 A predetermined percentage is then added to these costs to provide a profit margin.14 The cost of a Tronn server is $1,538 and based on a $2,000 price, this additional markup is approximately 30%. Adding 30% to the cost of PESA would make the price $189. As the chart below details, under the cost-plus method, the price of a Tronn loaded with PESA would be $2,246 which is $546 above the Zink server. Because we are looking at this conservatively, we will assume that two Tronn servers are the equivalent of four Zink servers. Therefore, it would cost $4,492 as compared to $6,800 for the Zink servers.15 Again, It would be difficult for Atlantic to persuade customers to purchase the servers based on the Cost-Plus pricing because customers would still only see that they are getting two servers for $4,492 whereas they could get two Zink servers for $3,400 and that is $1,092 more expensive than Ontario’s Zink servers. Without further justification, customers are not likely to accept this additional cost. Cost-Plus Pricing Total Number of Tronn servers sold in 3 years Total installations of PESA assuming 50% attach rate Cost of PESA per installation ($2,000,000/10590) Price of Tronn without PESA installed (Cost + 30% markup) Price of Tronn with PESA installed (Cost + 30% markup) Price of 2 Tronn servers loaded with PESA

21,180 10,590 $189 $2000 $2,246 $4,492

4. Value-in-use Pricing: Using the Value-in-use pricing method, Atlantic Computers would determine the value that each customer would realize from the purchase of the product. Customer value can be defined as the worth, in monetary terms, of the technical, service, social, and economic benefits a customer receives in exchange for the price it pays for a product.16 In this case, the 11

Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, 6, footnote 5 Customer Value Propositions in Business Markets; Anderson, James C.; Narus, James A.; van Rossum, Wouter. Harvard Business Review, Mar2006, Vol. 84 Issue 3, p90-99 13 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, 6 14 Id. 15 Zink servers are priced at $1,700 each. 16 Customer Value Propositions in Business Markets; Anderson, James C.; Narus, James A.; van Rossum, Wouter. Harvard Business Review, Mar2006, Vol. 84 Issue 3, p90-99 12

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customer value would be the annual cost of electricity and software licensing for each server.17 It would then calculate the difference between the two figures and assume a 50-50 share of savings.18 As the chart below illustrates, when the total costs are added, a customer would potentially realize a $4,800 savings when using two Atlantic Bundles as compared to four Zink servers.19 After a 50-50 share, the total final price would be $6,400. Under this method, it is easy to show customers that they will be saving $2,400 when they buy two “Atlantic Bundles.” This would help demonstrate in monetary terms the customer’s true value of buying the “Atlantic Bundle.” Value-in-use Pricing Price of Server Electricity (Annual Cost) Software License Total Price Savings (Difference between Zink and Tronn) Total Final Customer Price (Server Price + 50-50 sharing)

Tronn x 2 Zink x 4 $4,000 $6,800 $500 $1,000 $1,500 $3,000 $6,000 $10,800 $4,800 $6,400

Value-in-use pricing is the best method: Of the four methods available for pricing the “Atlantic Bundle”, the Value-Based pricing method is the best to choose. As shown in Exhibit 1, the Competition Based pricing method will generate more profit per unit than any other method; however, it will not allow Atlantic Computers to fully demonstrate, in monetary terms, the true value of the “Atlantic Bundle.” The value-in-use pricing method allows Atlantic Computers to demonstrate to customers the true value of their product. Because the “Atlantic Bundle” is a basic server and software tool that allows it to operate at four times the speed, it is equivalent to four Zink servers. Conservatively looking at the numbers, this equates to a savings of $4,800 to a customer. Additionally, Atlantic Computers will share in the savings of customers, further adding to their profits. 1. Which market should be targeted? The target market for the “Atlantic Bundle” would be those companies that do a lot of web hosting. It is when the Tronn Server is acting as a web-server and coupled with PESA that the “Atlantic Bundle” is capable of realizing its true potential of being 4 times as fast as the basic server.20 Additionally, those companies who do a lot of file sharing would also 17

Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, Exhibit 3, 9 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, 6 19 This assumes a $250 annual cost for Electricity per server and annual license fee of $1,500 per server. Labor is not included because the cost is the same for both servers, regardless of quantity. 20 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, 8 18

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benefit from the “Atlantic Bundle” as it would still enjoy an increase in performance equivalent to 2 basic servers.21 . 2. How are customers likely to respond? At first, customers are likely to question Atlantic Computers’ reasoning for deviating from the tradition of providing performance enhancing/monitoring tools for free. This may be one of the more difficult tasks associated with pricing the “Atlantic Bundle.” Atlantic Computers will have to demonstrate to customers that the PESA software tool essentially doubles and possible quadruples the number of basic Tronn servers. They will need to emphasize that not only are they saving on the number of servers they will need to purchase, but they will also save on other costs. Atlantic Computers will also need to emphasize that it will continue to provide excellent service after purchase and provide customers with peace of mind. 3. How will Ontario’s top management likely respond? a. Short run vs. Long Run After the first year, it is projected that the “Atlantic Bundle” will only take approximately 4% of the market share of the basic share market.22 It is unlikely that Ontario would be concerned at this time and would not take any steps to counter-act. It would take until at least the second year and likely the third year before Ontario would begin to take action. At this moment, Ontario’s reaction would be to lower prices in order to stop market loss. Of course, Ontario will only be able to lower prices for a short period of time before such actions begin to drastically decrease their profits. Ontario will likely begin to copy the PESA software and begin to include it in their Zink server packages. At this time, Atlantic Computers will have recouped much of the research and development costs associated with PESA and can begin to include the software as part of the “Atlantic Bundle” at no charge. 4. Other problems associated with using Value-in-use pricing. After years of providing software tools for free with servers, it will take some persuading to get veteran salespeople on board with the value-in-use pricing method. This is especially true because the salespeople derive 30% of their pay off of commission.23 They know that they will sell more volume if they are able to sell at a lower price. Training the salespeople to show customers exactly the value they will be getting will help the salespeople understand that they will essentially be able to sell more servers at a higher cost, thereby making more money off of commission. The salespeople will need to also demonstrate points of difference

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Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, Exhibit 2 Exhibit 2. Supra pg. 8 23 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007, 5 22

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between the “Atlantic Bundle” and the next best alternative.24 Finally, the salespeople will need to stress the fact that customers will continue to get excellent service after the initial purchase. Conclusion: Atlantic Computers has decided to enter into the emerging U.S. market for basic servers. It has developed the “Atlantic Bundle” which consists of a Tronn Server and the PESA software which enables the Tronn Server to perform at the rate of four of their competitor’s basic servers. Of the four available pricing options, status quo, competition based, cost-plus and value-in-use pricing, it is recommended that Atlantic Computers implement the value-inuse pricing method. This will allow Atlantic Computers to maximize their profits by demonstrating the value of the “Atlantic Bundle” to the customer. By showing savings of $3,200 compared to the Zink server, Atlantic will be able justify the added costs. Exhibit 1 Pricing Method Status Quo Competition-Based Pricing Cost-Plus Value-in-Use

Revenue Costs Total Profits Profit/Unit $21,180,000 $18,287,420 $2,892,580 $273 $36,006,000 $18,287,420 $17,718,580 $1,673 $23,785,140 $18,287,420 $5,497,720 $519 $33,888,000 $18,287,420 $15,600,580 $1,473

Exhibit 2 100,000 80,000 60,000

Total Market

40,000

ProjectedShares

20,000 0

2001

2002

2003

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Points of difference are elements that make Atlantic Computers’ offering superior to that of Ontario’s. Customer Value Propositions in Business Markets; Anderson, James C.; Narus, James A.; van Rossum, Wouter. Harvard Business Review, Mar2006, Vol. 84 Issue 3, p90-99 7