The Silicon Valley company Intoot produces checkwriting software. The program itself, Fasten, sells for $50 and includes a package of checks. Check refill packets for Fasten cost $20 to produce and Intoot sells the checks at cost. Suppose that a consumer purchases Fasten for $50 in period 1 and spends $20 on checks in each subsequent period. Assume for simplicity that the consumer uses the program for an infinite number of periods.
(a) If the interest rate is r = .10 per period, what is the present value of the stream of payments made by the consumer?
b) Fasten’s competitor produces an equally effective product called Czechwriter. Czechwriter can do everything Fasten can do and vice versa except that Fasten cannot use check refill packets that are sold by anyone other than Fasten. Czechwriter also sells for $50 and sells its checks for $20 per period. A Fasten customer can switch to Czechwriter simply by purchasing the program. This means his switching costs are
(c) Fasten is contemplating raising the price of checks to $30 per period. If so, will its customers switch to Czechwriter? Explain.
(d) Fasten contemplates raising the price of checks to $22 per period. Will its customers switch?
(e) At what price for checks will Fasten’s customers just be indifferent to switching? (Hint: Let x be this amount. Compare the present value of staying with Fasten with the present value of switching to Czechwriter.)
(f) If it charges the highest price that it can without making its customers switch, what profit does Fasten make on checks from each of its customers per period? _________ What is the present value of the profit per customer that Fasten gets if it sets the price of checks equal to the number determined in the last question? ____________ How does this compare to the customer switching cost? __________
(g) Suppose now that the cost of switching also involves several hours of data conversion that the consumer values at $100. The total cost of switching is the cost of the new program plus the data conversion cost which is
(h) Making allowances for the cost of data conversion, what is the highest price that Intoot can charge for its checks? __________ What is the present value of profit from this price? ________ How does this compare to total switching costs? __________
(i) Suppose that someone writes a computer program that eliminates the cost of converting data and makes this program available for free. Suppose that Intoot continues to price its check refill packages at $25. A new customer is contemplating buying Fasten at a price of $50 and paying $25 per period for checks, versus paying $50 for Czechwriter and paying $20 for checks. If the functionality of the software is identical, which will the consumer buy?
(j) Intoot decides to distribute a coupon that offers a discount of $50 off of the regular purchase price. What price would it have to set to make consumers indifferent between purchasing Fasten and Czechwriter?
(k) Suppose that consumers are shortsighted and only look at the cost of the software itself, neglecting the cost of the checks. Which program would they buy if Intoot offered this coupon? ___________ How might Czechwriter respond to the Fasten offer? __________