Bargains-then-ripoffs: Innovation, pricing and lock-in in enterprise software

In industries with quick innovation cycles and switching costs, vendor profitability is often driven by the ability to “lock in” customers. Despite a large theoretical literature, there are few empirical studies on the success of vendor pricing and product strategies to achieve lock-in. This paper uses a comprehensive database of transactions in two major product lines for a large enterprise software vendor to examine the use and success of pricing and product strategies. Regarding pricing, the paper demonstrates that the vendor engages in significant “bargain-then-ripoff” pricing; customers completely new to it receive discounts that are nearly 50% greater than existing customers who are purchasing upgrades of a product. On the product side, one common lock-in strategy – the offering of broad product “suites” which span multiple product lines – appears to be of limited effectiveness. The vendor cannot limit its initial “bargain” to customers new to a product line, even if the customer has bought a different product the vendor previously. This suggests that lock-in is product-, not vendor-specific. Finally, not all customers get locked-in; I find that customers with high IT capabilities, and/or those with strong financial performance (which are very highly correlated), are likely to receive an “initial bargain” and then switch suppliers or use legacy systems, rather than pay locked-in rates. The “best” customers in terms of future revenue potential therefore avoid getting locked-in.