Managing the versions of a software product under variable and endogenous demand

Abstract

Software product versioning (i.e., upgrading the product after its initial release) is a widely adopted practice followed by leading software providers such as Microsoft, Oracle, and IBM. Unlike conventional durable goods, software products are relatively easy to upgrade, making upgrades a strategic consideration in commercial software production. We consider a two-period model with a monopoly software provider who develops and releases a software product to the market. Unlike previous research, we consider demand variability and endogeneity to determine the functionality of the software in the first and second period. Demand endogeneity is the impact of the word-of-mouth effect that positively relates the features in the initial release of the product to its demand in the second period. We also determine the design effort that should be spent in the first period to prepare for upgrading the product in the second period—upgrade design effort—to tap into the possible future demand. Results show that the upgrade design effort can be lower or higher when there is more market demand uncertainty. We also show that the features of the product in its initial release and upgrade design effort can be complements as well as substitutes, depending on the strength of the word-of-mouth effect. The results in this paper provide insights into how demand-side factors (market demand variability or demand endogeneity) can influence supply-side decisions (initial features and upgrade design effort). A key insight of the analysis is that a high word-of-mouth effect helps manage the product in the face of demand variability.