CASE SUMMARY

Atlantic Computers
A Bundle of Pricing Options
4/4/2011

Atlantic Computers is a leading developer of high-tech servers !t has recentl" decided to e#pand its product line do$n$ards in order to ta%e advantage of an emerging mar%et for &asic servers Before it can launch the 'Atlantic Bundle() Atlantic Computers must decide $hich pricing strateg" to implement Of the four options* Status +uo) Competition Based) Cost-Plus) and ,alue in Use pricing) ! &elieve the &est option is ,alue-in-Use pricing

ATLANTIC COMPUTER: A BUNDLE OF PRICING OPTIONS Summary of the Situation Ana y!i! Atlantic Computer is a manufacturer of servers and high-tech products. Two market segments exist in the server industry: High performance and Basic ervers. Atlantic Computers has held a !"# share of the High $erformance market with their %adia servers &eing their premier product. However' the market for Basic servers is growing and this has caused Atlantic Computers to develop and introduce a Basic erver called the Tronn and a software tool called the ($erformance )nhancing erver Accelerator* +$) A,. The Tronn was developed mainly for the emerging - market opportunity for &asic servers. The $) A would allow the Tronn to perform up to four times faster than its standard speed and make fre.uently re.uested information more accessi&le. Thus' &undling the Tronn and $) A made more sense. Atlantic is not concerned that the Tronn will &e considered a su&stitute for its High $erformance servers./ Primary "ue!tion to #e a$$re!!e$: 0hat pricing strategy should Atlantic Computers implement to price the Atlantic Bundle1 Mo$e Cu!tomer: 2n order to decide which pricing strategy to use' it is &est to identify and use the &asic server needs of a model customer. 2n this case' 3ayTrader4ournal.com will &e used as the model customer.! 3ayTrader.com is seeking four &asic servers for their new we&site where day traders will &e a&le to review articles and relevant training information.5 Their top re.uirements for a &asic server purchase are to minimi6e initial purchase costs' minimi6e possession costs and allow their we&site to process many information re.uests.7 Because 8at6er' the head of the server division' is conservative in his estimate of the power of the (Atlantic Bundle* we will assume that two (Atlantic Bundles* is the e.uivalent of four 9ntario :ink servers.; Ana y!i! There are four main types of pricing strategies from which Atlantic Computers can choose. <irst' Atlantic Computers could stay with the status .uo and offer software tools for free. econd' it could choose competitive &ased pricing. Third it could choose from Cost-plus pricing. <inally' it could choose value-in use pricing.
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=eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' /-B. 3ayTrader4ournal.com is seeking four &asic servers and minimi6ing initial purchase costs and su&se.uent possession costs are two very closely ranked considerations. 2d. At ; / 2d. At /". )xhi&it 7 0 2d. 1 =eera> Bharadwa>' 4ohn ?ordon' (Atlantic Computers: A Bundle of $ricing 9ptions*' ; .

2n addition to determining which pricing strategy to use' Atlantic Computers must also determine which &usinesses are most likely to &enefit from the Atlantic Bundle. =ext' Atlantic Computers will have to consider how customers are likely to react to the Atlantic Bundle. <inally' Atlantic Computers will also have to consider how competitors will respond to the recommended pricing strategy. Pri%in& Strate&ie!: 1. tatus Cuo $ricing: The industry norm for pricing a server and software &undle is to merely include any software tools with the hardware. Atlantic Computers has always practiced this pricing strategy.D This would re.uire Atlantic Computers to offer the $) A software tool for free with the Tronn erver. This would make the price of two (Atlantic Bundles* E7'""".A This would re.uire Atlantic Computers to essentially lose the E!'"""'""" cost of research and development of $) A. <urthermore' &ecause Atlantic Computers would &e giving $) A away' it would appear that there are no su&stantial differences &etween the (Atlantic Bundle* and the :ink servers. Customers would see that they are getting half of the hardware. 8aking a direct comparison &ased on hardware and price' customers would see that they could get 7 :ink servers for ED'B"" whereas it would cost EB'""" for four (Atlantic Bundles*. 2t would &e hard to >ustify the additional E/'!"" in price. Additionally' the Tronn erver would appear to customers as very compara&le to the :ink servers and it would make it difficult for Atlantic Computers to compete with and gain market shares in the &asic servers segment. 2. Competition-Based $ricing: Competition-Based pricing uses the prices of competitors as a &enchmark for pricing products rather than considering costs.B The price of 9ntarioFs :ink servers is E/A"" and conservatively speaking' two (Atlantic Bundles* is e.uivalent to four of 9ntarioFs :ink servers.G Therefore' under the Competition-Based $ricing' the price of two (Atlantic Bundles* would &e E57"" x ! or EDB"". 0hile selling at this price would generate more profits for Atlantic Computers/"' it is not certain that consumers would purchase the (Atlantic Bundle* at this price. Consumers would see that they are only getting two Tronn servers at a price that they could get four :ink servers. 0hile the addition of the $) A software tool would make the Tronn servers the e.uivalent of four :ink servers' the $) A software does not work on all
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=eera> Bharadwa>' 4ohn ?ordon' (Atlantic Computers: A Bundle of $ricing 9ptions*' 2d. at 7 4 http:HHwww.&usinessdictionary.comHdefinitionHcompetition-&ased-pricing.html 5 =eera> Bharadwa>' 4ohn ?ordon' (Atlantic Computers: A Bundle of $ricing 9ptions*' )xhi&it 5' G -6 )xhi&it /' supra pg. A /

software applications.// <urthermore' customers would need further >ustification to have only half of the hardware and run the risk of one or &oth servers &eing out of commission for any given amount of time./! Customers would likely not consider purchasing the (Atlantic Bundle* &ased on Competition-Based pricing &ecause they would not see it as a fair price and worth the risk. 3. Cost-$lus $ricing: Cost-plus pricing is determined &y adding the direct' indirect and fixed costs associated with a product and converting it into a per-unit cost for the product./5 A predetermined percentage is then added to these costs to provide a profit margin./7 The cost of a Tronn server is E/';5B and &ased on a E!'""" price' this additional markup is approximately 5"#. Adding 5"# to the cost of $) A would make the price E/BG. As the chart &elow details' under the cost-plus method' the price of a Tronn loaded with $) A would &e E!'!7D which is E;7D a&ove the :ink server. Because we are looking at this conservatively' we will assume that two Tronn servers are the e.uivalent of four :ink servers. Therefore' it would cost E7'7G! as compared to ED'B"" for the :ink servers./; Again' 2t would &e difficult for Atlantic to persuade customers to purchase the servers &ased on the Cost-$lus pricing &ecause customers would still only see that they are getting two servers for E7'7G! whereas they could get two :ink servers for E5'7"" and that is E/'"G! more expensive than 9ntarioFs :ink servers. 0ithout further >ustification' customers are not likely to accept this additional cost. Cost-$lus $ricing Total =um&er of Tronn servers sold in 5 years Total installations of $) A assuming ;"# attach rate Cost of $) A per installation +E!'"""'"""H/";G", $rice of Tronn without $) A installed +Cost I 5"# markup, $rice of Tronn with $) A installed +Cost I 5"# markup, $rice of ! Tronn servers loaded with $) A

!/'/B" /"';G" E/BG E!""" E!'!7D E7'7G!

4. Jalue-in-use $ricing: -sing the Jalue-in-use pricing method' Atlantic Computers would determine the value that each customer would reali6e from the purchase of the product. Customer value can &e defined as the worth' in monetary terms' of the technical' service' social' and economic &enefits a customer receives in exchange for the price it pays for a product./D 2n this case' the
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=eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' D' footnote ; Customer Jalue $ropositions in Business 8arkets@ Anderson' 4ames C.@ =arus' 4ames A.@ van %ossum' 0outer. Harvard Business Review' 8ar!""D' Jol. B7 2ssue 5' pG"-GG -/ =eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' D -0 2d. -1 :ink servers are priced at E/'A"" each. -2 Customer Jalue $ropositions in Business 8arkets@ Anderson' 4ames C.@ =arus' 4ames A.@ van %ossum' 0outer. Harvard Business Review' 8ar!""D' Jol. B7 2ssue 5' pG"-GG 0

customer value would &e the annual cost of electricity and software licensing for each server./A 2t would then calculate the difference &etween the two figures and assume a ;"-;" share of savings./B As the chart &elow illustrates' when the total costs are added' a customer would potentially reali6e a E7'B"" savings when using two Atlantic Bundles as compared to four :ink servers./G After a ;"-;" share' the total final price would &e ED'7"". -nder this method' it is easy to show customers that they will &e saving E!'7"" when they &uy two (Atlantic Bundles.* This would help demonstrate in monetary terms the customerFs true value of &uying the (Atlantic Bundle.* 'a ue(in(u!e Pri%in& $rice of erver )lectricity +Annual Cost, oftware Kicense Total $rice avings +3ifference &etween :ink and Tronn, Total <inal Customer $rice + erver $rice I ;"-;" sharing, Tronn x ! :ink x 7 E7'""" ED'B"" E;"" E/'""" E/';"" E5'""" ED'""" E/"'B"" E7'B"" ED'7""

'a ue(in(u!e )ri%in& i! the #e!t metho$: 9f the four methods availa&le for pricing the (Atlantic Bundle*' the Jalue-Based pricing method is the &est to choose. As shown in )xhi&it /' the Competition Based pricing method will generate more profit per unit than any other method@ however' it will not allow Atlantic Computers to fully demonstrate' in monetary terms' the true value of the (Atlantic Bundle.* The value-in-use pricing method allows Atlantic Computers to demonstrate to customers the true value of their product. Because the (Atlantic Bundle* is a &asic server and software tool that allows it to operate at four times the speed' it is e.uivalent to four :ink servers. Conservatively looking at the num&ers' this e.uates to a savings of E7'B"" to a customer. Additionally' Atlantic Computers will share in the savings of customers' further adding to their profits. 1. Which market should be targeted? The target market for the (Atlantic Bundle* would &e those companies that do a lot of we& hosting. 2t is when the Tronn erver is acting as a we&-server and coupled with $) A that the (Atlantic Bundle* is capa&le of reali6ing its true potential of &eing 7 times as fast as the &asic server.!" Additionally' those companies who do a lot of file sharing would also
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=eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' )xhi&it 5' G =eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' D -5 This assumes a E!;" annual cost for )lectricity per server and annual license fee of E/';"" per server. Ka&or is not included &ecause the cost is the same for &oth servers' regardless of .uantity. .6 =eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' B 1

&enefit from the (Atlantic Bundle* as it would still en>oy an increase in performance e.uivalent to ! &asic servers.!/ . 2. How are customers likely to respond? At first' customers are likely to .uestion Atlantic ComputersF reasoning for deviating from the tradition of providing performance enhancingHmonitoring tools for free. This may &e one of the more difficult tasks associated with pricing the (Atlantic Bundle.* Atlantic Computers will have to demonstrate to customers that the $) A software tool essentially dou&les and possi&le .uadruples the num&er of &asic Tronn servers. They will need to emphasi6e that not only are they saving on the num&er of servers they will need to purchase' &ut they will also save on other costs. Atlantic Computers will also need to emphasi6e that it will continue to provide excellent service after purchase and provide customers with peace of mind. 3. How will Ontarios top management likely respond? a. hort run vs. Kong %un After the first year' it is pro>ected that the (Atlantic Bundle* will only take approximately 7# of the market share of the &asic share market.!! 2t is unlikely that 9ntario would &e concerned at this time and would not take any steps to counter-act. 2t would take until at least the second year and likely the third year &efore 9ntario would &egin to take action. At this moment' 9ntarioFs reaction would &e to lower prices in order to stop market loss. 9f course' 9ntario will only &e a&le to lower prices for a short period of time &efore such actions &egin to drastically decrease their profits. 9ntario will likely &egin to copy the $) A software and &egin to include it in their :ink server packages. At this time' Atlantic Computers will have recouped much of the research and development costs associated with $) A and can &egin to include the software as part of the (Atlantic Bundle* at no charge. 4. 9ther pro&lems associated with using Jalue-in-use pricing. After years of providing software tools for free with servers' it will take some persuading to get veteran salespeople on &oard with the value-in-use pricing method. This is especially true &ecause the salespeople derive 5"# of their pay off of commission.!5 They know that they will sell more volume if they are a&le to sell at a lower price. Training the salespeople to show customers exactly the value they will &e getting will help the salespeople understand that they will essentially &e a&le to sell more servers at a higher cost' there&y making more money off of commission. The salespeople will need to also demonstrate points of difference

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=eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' )xhi&it ! )xhi&it !. upra pg. B ./ =eera> Bharadwa>' 4ohn B. ?ordon@ Atlantic Computer: A Bundle of $ricing 9ptions' !""A' ; 2

&etween the (Atlantic Bundle* and the next &est alternative.!7 <inally' the salespeople will need to stress the fact that customers will continue to get excellent service after the initial purchase. Con% u!ion: Atlantic Computers has decided to enter into the emerging -. . market for &asic servers. 2t has developed the (Atlantic Bundle* which consists of a Tronn erver and the $) A software which ena&les the Tronn erver to perform at the rate of four of their competitorFs &asic servers. 9f the four availa&le pricing options' status .uo' competition &ased' cost-plus and value-in-use pricing' it is recommended that Atlantic Computers implement the value-inuse pricing method. This will allow Atlantic Computers to maximi6e their profits &y demonstrating the value of the (Atlantic Bundle* to the customer. By showing savings of E5'!"" compared to the :ink server' Atlantic will &e a&le >ustify the added costs. E*hi#it + Pri%in& Metho$ tatus Cuo Competition-Based $ricing Cost-$lus Jalue-in--se

Re,enue Co!t! Tota Profit! Profit-Unit E!/'/B"'""" E/B'!BA'7!" E!'BG!';B" E!A5 E5D'""D'""" E/B'!BA'7!" E/A'A/B';B" E/'DA5 E!5'AB;'/7" E/B'!BA'7!" E;'7GA'A!" E;/G E55'BBB'""" E/B'!BA'7!" E/;'D""';B" E/'7A5

E*hi#it .
10 0,0 00 80 ,00 0 60 ,00 0 40 ,00 0 20 ,00 0 0 2 00 1 20 02 20 03 To tal Ma rket P rojectedS h ares

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$oints of difference are elements that make Atlantic ComputersF offering superior to that of 9ntarioFs. Customer Jalue $ropositions in Business 8arkets@ Anderson' 4ames C.@ =arus' 4ames A.@ van %ossum' 0outer. Harvard Business Review' 8ar!""D' Jol. B7 2ssue 5' pG"-GG 3