Product development and pricing strategy for information goods under heterogeneous outside opportunities

Ying Ju Chen, Sridhar Seshadri

Research output: Contribution to journalArticlepeer-review


This paper considers a two-stage development problem for information goods with costless quality degradation. In our model, a seller of information goods faces customers that are heterogeneous with regard to both the marginal willingness to pay for quality and the outside opportunity. In the development stage, the seller determines the quality limit of the product. In the second stage, the seller's problem is to design the price schedule corresponding to different quality levels, taking into account production and distribution costs. We show that versioning is optimal for the seller when customers have multiple outside options or, more generally, convex reservation utilities. In addition, we show that in the optimal solution the seller discards both low-end and high-end customers. Among those that are served, the seller offers a continuum of (inferior) versions to customers with relatively low willingness to pay, and extracts full information rent from each of them. A common version with the quality limit is offered to the rest. We further prove that the seller should offer a single version when reservation utilities are either concave or linear. Through numerical experiments, we study the sensitivity of our results to changes in the cost structure and customer utilities.

Original languageEnglish (US)
Pages (from-to)150-172
Number of pages23
JournalInformation Systems Research
Issue number2
StatePublished - Jun 2007
Externally publishedYes


  • Heterogeneous outside opportunities
  • Information goods
  • Price discrimination
  • Quality degradation
  • Versioning

ASJC Scopus subject areas

  • Information Systems
  • Computer Networks and Communications
  • Information Systems and Management
  • Library and Information Sciences


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