COMPETITION BETWEEN SOFTWARE-AS-A-SERVICE VENDORS Dan Ma - PowerPoint PPT Presentation

COMPETITION BETWEEN SOFTWARE-AS-A-SERVICE VENDORS Dan Ma Robert J. Kauffman Singapore Management University May 28, 2013

Software-as-a-Service (SaaS) • An important component of Cloud computing • Bundle software application and services • Deliver the bundle through a network • Charge based on per use/ per month (no upfront charge) • Use one “standardized” application to serve many customers; known as the “multi-tenancy” structure • Build long term business partner relationship with customers

The SaaS Market • SaaS delivery will amount to >13% of worldwide software spending • By 2015, about 24% of all software purchases will be SaaS • Global spending for SaaS: US$14.5B (2012) à US$26.5B (2016) • Big name players like IBM, SAP, Oracle, Salesforce.com, FinancialForce, Intacct • Competition exists in niche SaaS application market

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What makes the SaaS competition special? • The offering is a bundle: (Software application, IT services) Different quality levels Different functionalities Horizontal Vertical differentiation differentiation • Software is experience goods & Multi-tenant structure Incomplete information • Long term business partnership Sampling period and learning process Switching

Research Questions • What are the pricing strategy and service quality choices a SaaS vendor should employ to perform well in competition? • How much should a vendor’s applications and services be differentiated? • How should clients choose the appropriate vendor when they face incomplete information on the vendors’ offerings and the potential risk of being locked in?

Related Works • Competition with heterogeneous products (Shaked and Sutton 1983 … ) • Horizontally differentiation (in software functionalities) • Vertically differentiation (in service qualities) • The role of switching costs (Klemperer 1987, 1989, Farrell and Shapiro 1988, Cabral 2012) • Switching costs increase/reduce prices • Switching costs increase/decrease competitiveness of the market • Other SaaS business model issues • SaaS contract design (Susarla et al., 2003, 2009) • Software investment incentive (Choudhary 2007) • The impacts on traditional software market (Balasubramanian et al. 2008, Fan et al. 2009)

The Model • The Vendors: • Duopoly SaaS H and L • High and low service qualities with high and low service costs respectively • Software applications with different features (Salop circle model) • Decide the usage-based price • The Clients • Preference to application features is different • Willingness-to-pay for services is different: θ h and θ l • Face incomplete information of the application • Can sample one vendor and learn Fit Cost • Have the flexibility of switching to another vendor but incur SwitchingCost

Timeline for SaaS Vendor-Client Interactions The two SaaS vendors post prices, p H and p L , simultaneously The client will not The client must decide The client will know whether to switch to another use its chosen its FitCost for any vendor. If so, it will incur a vendor's SaaS SaaS vendor. It switching cost S. application must and learn its choose a vendor FitCost. based on its expected utility

Analysis – Clients’ Utility (I) • Backward reduction method • At time 1: switch or not switch “ Marginal switcher: ” the client who is indifferent between switching or staying with his initial choice. 1) The marginal θ j –type client of Vendor H is defined by d Hj * , where d Hj * is given by: θ j ⋅ q H – t ⋅ d Hj * – p H = θ j ⋅ q L – 0.25 ⋅ t – p L – S 2) The marginal θ j –type client of Vendor L is defined by d Lj * , where d Lj * is given by θ j ⋅ q L – t ⋅ d Lj * – p L = θ j ⋅ q H – 0.25 ⋅ t – p H – S

Analysis – Clients’ Utility (II) • At time 0: which vendor to try out • Consider a θ l -type user’s comparison: If he chooses Vendor H : 2 ⋅ d Hl * ⋅ ( θ l ⋅ q H - p H - 0.5 ⋅ d Hl * ⋅ t ) + (1 – 2 ⋅ d Hl * ) ⋅ [( θ l ⋅ q L - p L - 0 . 25 ⋅ t ) –S ] If he chooses Vendor H : 2 ⋅ d Ll * ⋅ ( θ l ⋅ q L - p L - 0 . 5 ⋅ d Ll * ⋅ t ) + (1 - 2 ⋅ d Ll * ) ⋅ [ ( θ l ⋅ q H – p H - 0.25 ⋅ t ) – S ]

Analysis – Market Segmentation

Analysis – Vendors’ Profit Optimization • The vendors assign p H and p L simultaneously to maximize profit. Vendor H : ( p H – c H ) ⋅ (2 ⋅ d Hh * + (1 – 2 ⋅ d Ll * )) – I – (1 – 2 ⋅ d Ll * ) ⋅ I Vendor L: ( p L – c L ) ⋅ (2 ⋅ d Ll * + (1 – 2 ⋅ d Hh * )) – I – (1 – 2 ⋅ d Hh * ) ⋅ I

When SwitchingCost is HIGH • Opportunistic Pricing Strategy is recommended when • High cost efficiency of SaaS ( ∆ ServiceCost/ ∆ Quality< θ l ) è SaaS H can drive L out of the market and serve all clients • Low cost efficiency of SaaS ( ∆ ServiceCost/ ∆ Quality> θ h ) è SaaS L can drive H out of the market and serve all clients • Non-Confrontational Market Segmentation Strategy is recommended when • Medium cost efficiency of SaaS ( θ l < ∆ ServiceCost/ ∆ Quality< θ h ) è SaaS H and L must coexist in the market è Each serves segment of clients based on the level of service quality preference • è No direct competition between the vendors

When SwitchingCost is LOW • SwitchingCost only benefits one SaaS vendor but hurts the other. • Lock-in power belongs to one SaaS vendor only. • High cost efficiency of SaaS ( ∆ ServiceCost/ ∆ Quality) è SwitchingCost affects SaaS H positively (higher price and higher profit) and SaaS L negatively (lower price and lower profit) • Low cost efficiency of SaaS ( ∆ ServiceCost/ ∆ Quality) è SwitchingCost affects SaaS L positively (higher price and higher profit) and SaaS H negatively (lower price and lower profit)

Vendor’s Service Quality Strategy • An SaaS vendor is able to employ appropriate quality strategy to gain exclusive lock-in power. • The concrete strategy depends on the cost function. When Δ ServiceCost Is a Convex Function of Δ Quality Given Quality L è SaaS H should choose a relatively low level of Quality H ( small quality difference) Given Quality H è SaaS L should choose a relatively low level of Quality L ( large quality difference) • The efficiency of this quality strategy decreases in SwitchingCost and clients’ vertical differentiation level ∆θ

Implications • Offer Clients Flexibility • gives clients the flexibility of sampling a vendor's SaaS offering • a marketing strategy involving free trials for potential clients • from free trial à subsidized trial? • substantial investments to increases the free trial conversion rate? • designs contracts with greater flexibility (right to opt out)

Implications • Lock in Clients beneficially • customers’ lock-in not only from data recovery • knowledge lock-in • client’s competitive advantage may be lost. • from adverse lock-in to beneficial lock-in • cooperative strategic alliance • cooperate, co-invest, and co-customize (partially for big customers)

Implication • Leverage on firm-level cost efficiency (relative efficiency) • New startups or established vendor? • Pure SaaS or mixed software vendor? • Best practice, strong management • over- and under -investment à inefficiency à competitive disadvantage.