CASE SUMMARY Atlantic Computers A Bundle of Pricing Options 4/4/2011 Atlantic Computers is a leading developer of high-tech servers.

It has recently decided to expand its product line downwards in order to take advantage of an em erging market for basic servers. Before it can launch the Atlantic Bundle, Atlanti c Computers must decide which pricing strategy to implement. Of the four options : Status Quo, Competition Based, Cost-Plus, and Value in Use pricing, I believe the best option is Value-in-Use pricing.

ATLANTIC COMPUTER: A BUNDLE OF PRICING OPTIONS Summary of the Situation Analysis Atlantic Computer is a manufacturer of servers and high-tech products. Two mark et segments exist in the server industry: High performance and Basic Servers. At lantic Computers has held a 20% share of the High Performance market with their Radia servers being their premier product. However, the market for Basic servers is growing and this has caused Atlantic Computers to develop and introduce a Ba sic Server called the Tronn and a software tool called the Performance Enhancing Server Accelerator (PESA). The Tronn was developed mainly for the emerging US mar ket opportunity for basic servers. The PESA would allow the Tronn to perform up to four times faster than its standard speed and make frequently requested infor mation more accessible. Thus, bundling the Tronn and PESA made more sense. Atlan tic is not concerned that the Tronn will be considered a substitute for its High Performance servers.1 Primary Question to be addressed: What pricing strategy s hould Atlantic Computers implement to price the Atlantic Bundle? Model Customer: In order to decide which pricing strategy to use, it is best to identify and us e the basic server needs of a model customer. In this case, DayTraderJournal.com will be used as the model customer.2 DayTrader.com is seeking four basic server s for their new website where day traders will be able to review articles and re levant training information.3 Their top requirements for a basic server purchase are to minimize initial purchase costs, minimize possession costs and allow the ir website to process many information requests.4 Because Matzer, the head of th e server division, is conservative in his estimate of the power of the Atlantic B undle we will assume that two Atlantic Bundles is the equivalent of four Ontario Zi nk servers.5 Analysis There are four main types of pricing strategies from which Atlantic Computers can choose. First, Atlantic Computers could stay with the st atus quo and offer software tools for free. Second, it could choose competitive based pricing. Third it could choose from Cost-plus pricing. Finally, it could c hoose value-in use pricing. 1 2 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options , 2007, 1-8. DayTraderJournal.com is seeking four basic servers and minimizing i nitial purchase costs and subsequent possession costs are two very closely ranke d considerations. Id. At 5 3 Id. At 10. Exhibit 4 4 Id. 5 Neeraj Bharadwaj, John Gordon, Atlantic Computers: A Bundle of Pricing Options, 5 2

In addition to determining which pricing strategy to use, Atlantic Computers mus t also determine which businesses are most likely to benefit from the Atlantic B undle. Next, Atlantic Computers will have to consider how customers are likely t o react to the Atlantic Bundle. Finally, Atlantic Computers will also have to co nsider how competitors will respond to the recommended pricing strategy. Pricing Strategies: 1. Status Quo Pricing: The industry norm for pricing a server and s oftware bundle is to merely include any software tools with the hardware. Atlant ic Computers has always practiced this pricing strategy.6 This would require Atl antic Computers to offer the PESA software tool for free with the Tronn Server. This would make the price of two Atlantic Bundles $4,000.7 This would require Atla ntic Computers to essentially lose the $2,000,000 cost of research and developme nt of PESA. Furthermore, because Atlantic Computers would be giving PESA away, i t would appear that there are no substantial differences between the Atlantic Bun dle and the Zink servers. Customers would see that they are getting half of the h ardware. Making a direct comparison based on hardware and price, customers would see that they could get 4 Zink servers for $6,800 whereas it would cost $8,000 for four Atlantic Bundles. It would be hard to justify the additional $1,200 in pr ice. Additionally, the Tronn Server would appear to customers as very comparable to the Zink servers and it would make it difficult for Atlantic Computers to co mpete with and gain market shares in the basic servers segment. 2. Competition-B ased Pricing: Competition-Based pricing uses the prices of competitors as a benc hmark for pricing products rather than considering costs.8 The price of Ontarios Zink servers is $1700 and conservatively speaking, two Atlantic Bundles is equival ent to four of Ontarios Zink servers.9 Therefore, under the Competition-Based Pri cing, the price of two Atlantic Bundles would be $3400 x 2 or $6800. While selling at this price would generate more profits for Atlantic Computers10, it is not c ertain 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 coul d get four Zink servers. While the addition of the PESA software tool would make the Tronn servers the equivalent of four Zink servers, the PESA software does n ot work on all 6 7 Neeraj . at 4 html 9 ions, Bharadwaj, John Gordon, Atlantic Computers: A Bundle of Pricing Options, Id 8 http://www.businessdictionary.com/definition/competition-based-pricing. Neeraj Bharadwaj, John Gordon, Atlantic Computers: A Bundle of Pricing Opt Exhibit 3, 9 10 Exhibit 1, supra pg. 7 3

software applications.11 Furthermore, customers would need further justification to have only half of the hardware and run the risk of one or both servers being out of commission for any given amount of time.12 Customers would likely not co nsider purchasing the Atlantic Bundle based on Competition-Based pricing because t hey would not see it as a fair price and worth the risk. 3. Cost-Plus Pricing: C ost-plus pricing is determined by adding the direct, indirect and fixed costs as sociated with a product and converting it into a per-unit cost for the product.1 3 A predetermined percentage is then added to these costs to provide a profit ma rgin.14 The cost of a Tronn server is $1,538 and based on a $2,000 price, this a dditional markup is approximately 30%. Adding 30% to the cost of PESA would make the price $189. As the chart below details, under the cost-plus method, the pri ce of a Tronn loaded with PESA would be $2,246 which is $546 above the Zink serv er. Because we are looking at this conservatively, we will assume that two Tronn servers are the equivalent of four Zink servers. Therefore, it would cost $4,49 2 as compared to $6,800 for the Zink servers.15 Again, It would be difficult for Atlantic to persuade customers to purchase the servers based on the Cost-Plus p ricing because customers would still only see that they are getting two servers for $4,492 whereas they could get two Zink servers for $3,400 and that is $1,092 more expensive than Ontarios Zink servers. Without further justification, custom ers are not likely to accept this additional cost. Cost-Plus Pricing Total Numbe r of Tronn servers sold in 3 years Total installations of PESA assuming 50% atta ch rate Cost of PESA per installation ($2,000,000/10590) Price of Tronn without PESA installed (Cost + 30% markup) Price of Tronn with PESA installed (Cost + 30 % markup) Price of 2 Tronn servers loaded with PESA 21,180 10,590 $189 $2000 $2,246 $4,492 4. Value-in-use Pricing: Using the Value-in-use pricing method, Atlantic Compute rs would determine the value that each customer would realize from the purchase of the product. Customer value can be defined as the worth, in monetary terms, o f the technical, service, social, and economic benefits a customer receives in e xchange for the price it pays for a product.16 In this case, the 11 12 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options , 2007, 6, footnote 5 Customer Value Propositions in Business Markets; Anderson, James C.; Narus, James A.; van Rossum, Wouter. Harvard Business Review, Mar2006 , Vol. 84 Issue 3, p90-99 13 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer : A Bundle of Pricing Options, 2007, 6 14 Id. 15 Zink servers are priced at $1,7 00 each. 16 Customer Value Propositions in Business Markets; Anderson, James C.; Narus, James A.; van Rossum, Wouter. Harvard Business Review, Mar2006, Vol. 84 Issue 3, p90-99 4

customer value would be the annual cost of electricity and software licensing fo r each server.17 It would then calculate the difference between the two figures and assume a 50-50 share of savings.18 As the chart below illustrates, when the total costs are added, a customer would potentially realize a $4,800 savings whe n using two Atlantic Bundles as compared to four Zink servers.19 After a 50-50 s hare, the total final price would be $6,400. Under this method, it is easy to sh ow customers that they will be saving $2,400 when they buy two Atlantic Bundles. T his would help demonstrate in monetary terms the customers true value of buying t he Atlantic Bundle. Value-in-use Pricing Price of Server Electricity (Annual Cost) Software License Total Price Savings (Difference between Zink and Tronn) Total Final Customer Price (Server Price + 50-50 sharing) Tronn x 2 Zink x 4 $4,000 $6 ,800 $500 $1,000 $1,500 $3,000 $6,000 $10,800 $4,800 $6,400 Value-in-use pricing is the best method: Of the four methods available for prici ng the Atlantic Bundle, the Value-Based pricing method is the best to choose. As s hown in Exhibit 1, the Competition Based pricing method will generate more profi t 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. Th e value-in-use pricing method allows Atlantic Computers to demonstrate to custom ers the true value of their product. Because the Atlantic Bundle is a basic server and software tool that allows it to operate at four times the speed, it is equi valent to four Zink servers. Conservatively looking at the numbers, this equates to a savings of $4,800 to a customer. Additionally, Atlantic Computers will sha re in the savings of customers, further adding to their profits. 1. Which market should be targeted? The target market for the Atlantic Bundle would be those comp anies that do a lot of web hosting. It is when the Tronn Server is acting as a w eb-server and coupled with PESA that the Atlantic Bundle is capable of realizing i ts true potential of being 4 times as fast as the basic server.20 Additionally, those companies who do a lot of file sharing would also 17 18 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options , 2007, Exhibit 3, 9 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bund le of Pricing Options, 2007, 6 19 This assumes a $250 annual cost for Electricit y per server and annual license fee of $1,500 per server. Labor is not included because the cost is the same for both servers, regardless of quantity. 20 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options, 2007 , 8 5

benefit from the Atlantic Bundle as it would still enjoy an increase in performanc e equivalent to 2 basic servers.21 . 2. How are customers likely to respond? At first, customers are likely to question Atlantic Computers reasoning for deviatin g from the tradition of providing performance enhancing/monitoring tools for fre e. This may be one of the more difficult tasks associated with pricing the Atlant ic Bundle. Atlantic Computers will have to demonstrate to customers that the PESA software tool essentially doubles and possible quadruples the number of basic T ronn servers. They will need to emphasize that not only are they saving on the n umber of servers they will need to purchase, but they will also save on other co sts. Atlantic Computers will also need to emphasize that it will continue to pro vide excellent service after purchase and provide customers with peace of mind. 3. How will Ontarios top management likely respond? a. Short run vs. Long Run Aft er the first year, it is projected that the Atlantic Bundle will only take approxi mately 4% of the market share of the basic share market.22 It is unlikely that O ntario would be concerned at this time and would not take any steps to counter-a ct. It would take until at least the second year and likely the third year befor e Ontario would begin to take action. At this moment, Ontarios reaction would be to lower prices in order to stop market loss. Of course, Ontario will only be ab le to lower prices for a short period of time before such actions begin to drast ically decrease their profits. Ontario will likely begin to copy the PESA softwa re and begin to include it in their Zink server packages. At this time, Atlantic Computers will have recouped much of the research and development costs associa ted with PESA and can begin to include the software as part of the Atlantic Bundl e at no charge. 4. Other problems associated with using Value-in-use pricing. Aft er years of providing software tools for free with servers, it will take some pe rsuading to get veteran salespeople on board with the value-in-use pricing metho d. This is especially true because the salespeople derive 30% of their pay off o f commission.23 They know that they will sell more volume if they are able to se ll at a lower price. Training the salespeople to show customers exactly the valu e they will be getting will help the salespeople understand that they will essen tially be able to sell more servers at a higher cost, thereby making more money off of commission. The salespeople will need to also demonstrate points of diffe rence 21 22 Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options , 2007, Exhibit 2 Exhibit 2. Supra pg. 8 23 Neeraj Bharadwaj, John B. Gordon; At lantic Computer: A Bundle of Pricing Options, 2007, 5 6

between the Atlantic Bundle and the next best alternative.24 Finally, the salespeo ple will need to stress the fact that customers will continue to get excellent s ervice after the initial purchase. Conclusion: Atlantic Computers has decided to enter into the emerging U.S. market for basic servers. It has developed the Atla ntic Bundle which consists of a Tronn Server and the PESA software which enables the Tronn Server to perform at the rate of four of their competitors basic server s. Of the four available pricing options, status quo, competition based, cost-pl us and value-in-use pricing, it is recommended that Atlantic Computers implement the value-inuse pricing method. This will allow Atlantic Computers to maximize their profits by demonstrating the value of the Atlantic Bundle to the customer. B y showing savings of $3,200 compared to the Zink server, Atlantic will be able j ustify the added costs. Exhibit 1 Pricing Method Status Quo Competition-Based Pr icing Cost-Plus Value-in-Use Revenue Costs Total Profits Profit/Unit $21,180,000 $18,287,420 $2,892,580 $273 $36,006,000 $18,287,420 $17,718,580 $1,673 $23,785,140 $18,287,420 $5,497,720 $5 19 $33,888,000 $18,287,420 $15,600,580 $1,473 Exhibit 2 10 00 0,0 80 0 ,00 60 0 ,00 40 0 ,00 20 0 ,00 0 2 1 00 20 02 20 03 To Ma tal rke t P rojectedS ares h 24 Points of difference are elements that make Atlantic Computers offering superior to that of Ontarios. Customer Value Propositions in Business Markets; Anderson, J ames C.; Narus, James A.; van Rossum, Wouter. Harvard Business Review, Mar2006, Vol. 84 Issue 3, p90-99 7