A new study shows how the product life cycle of some software can mean a healthy bottom line.
Managing the life cycle of a software product is a complex task. The older a product gets, the less able its users are to leverage new technologies and fulfill requirements. This makes it lucrative for customers to upgrade for added business functionality or technology compatibility.
“Users will abandon the software they’re using and pay for upgrades if doing so gives them solutions for new requirements—for example, periodic changes in tax laws that call for improvements in accounting software, like Quicken,” Mehra says.
Upgrades also make sense when the complementary products, such as hardware and operating systems, are changing. New versions of the software can leverage changes in complementary products to provide superior performance and reliability.
For the product manager, determining how frequently to issue upgrades is of paramount importance because introducing a new version provides fresh profit opportunities. At the same time, the firm must incur another round of costs for product development, testing, and marketing. The product manager cannot take a short-term view of maximizing profits from a particular upgrade, but rather should have an eye on the overall profits from the future series of upgrades to maximize the value of the product for the firm.
In the paper, the authors modeled the costs and revenues associated with a succession of upgrades. Using their market model as well as some empirical analysis, they prove that in a growing market, optimal upgrade intervals should increase consistently throughout the product’s life cycle solely because of demand and cost considerations. The tradeoffs between revenues from new and existing customers and the costs of introducing upgrades lead to these results.
“This understanding helps in managing R&D,” the authors write, “so that upgrades are ready on time and marketing efforts can be tailored to drive demand for new versions as they become available.”
Seidmann and his co-authors also looked at how product obsolescence rates affect upgrade intervals. A higher rate of obsolescence can lead to an increase in intervals for initial upgrades. They also explain why this effect may unexpectedly reverse itself later in the product’s life cycle.
The study also looks at the impact of network externalities on upgrade decisions. Products that “speak” to each other—shared software such as Microsoft Office, for example—are introduced at a faster rate than those that don’t.
“If people share it more, I can charge more, and customers will see faster upgrades,” Seidmann explains.
But their study also showed that with higher externality and more frequent product introductions, customers expect to use the product for a shorter time. And because they anticipate that each version won’t last long, they are expecting to pay less for it.
“Companies will charge a lower price than they’d charge if it were only one introduction because they know they are going to sell you a new version soon,” Seidmann says.
A company also can make internal design decisions that boost the value of an upgrade. When a new version is introduced, old and new versions of the software aren’t always compatible. If the company issues an upgrade that is designed to be incompatible with previous versions, customers will respond by upgrading. It is the only way for them to continue sharing the files generated by using the software with new adopters.
In the end, the timing of the upgrade is central to budgeting for R&D.
“Since upgrade development costs depend upon upgrade intervals, upgrade costs change over the product’s life cycle,” the authors write. “An understanding of the key tradeoffs that drive the optimal upgrade intervals helps firms plan and execute the introductions of its software upgrades more