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Chapter 11: Problem 13

Some years ago, an article appeared in the New York Times about IBM's pricing policy. The previous day, IBM had announced major price cuts on most of its small and medium-sized computers. The article said: IBM probably has no choice but to cut prices periodically to get its customers to purchase more and lease less. If they succeed, this could make life more difficult for IBM's major competitors. Outright purchases of computers are needed for ever larger IBM revenues and profits, says Morgan Stanley's Ulric Weil in his new book, Information Systems in the \(80^{\circ}\) s. Mr. Weil declares that IBM cannot revert to an emphasis on leasing. a. Provide a brief but clear argument in support of the claim that IBM should try "to get its customers to purchase more and lease less." b. Provide a brief but clear argument against this claim. c. What factors determine whether leasing or selling is preferable for a company like IBM? Explain briefly.

Short Answer

Expert verified
Selling more can help IBM boost immediate revenues, invest in product development, and cultivate customer loyalty. In contrast, leasing can provide steady revenues and retain price-conscious customers. Factors affecting the choice include financial climate, revenue goals, customer preferences, rate of technological change, and customer's financial capacity.

Step by step solution

01

Argument in Support

Purchasing means an immediate influx of capital for IBM, increasing revenues and profits. This can help in investing in product research, development, or other areas that require capital. In contrast, leasing typically involves gradual payments over an extended period. Also, ownership means customers are likely to invest further in IBM's services for maintenance and upgrades.
02

Argument Against

On the other side, leasing can provide a steady stream of revenue for IBM. This can protect IBM from drastic swings in the market and assure a certain level of financial stability. Besides, leasing might be preferred by many customers as it reduces the initial cost barrier and offers the opportunity to upgrade to newer models without a significant investment.
03

Determining Factors

The choice of leasing versus selling for IBM likely depends on several factors. These include: the financial climate and market stability, the company's immediate and long-term revenue goals, customer preferences for buying or leasing, the rate of technological changes which determines how quickly a product becomes outdated, and the order volume which can be affected by the size and the financial power of the customer.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Leasing Versus Selling

Understanding the difference between leasing versus selling is crucial for companies like IBM when devising their pricing strategies. When a company sells its products, it receives a lump sum payment upfront, which can be a significant injection of capital. For customers, purchasing implies ownership, which can translate to higher long-term costs due to maintenance and the need for eventual product replacement.

Leasing, on the other hand, offers customers the advantage of lower initial costs, preserving their capital for other uses. It provides them with the flexibility to upgrade to newer technology relatively easily. For the company, leasing can guarantee a stable, although lower, stream of revenue over time. This can help smooth out financial fluctuations, especially during uncertain economic periods. But it also means slower capital accumulation for immediate corporate needs like research and development.

How It Affects IBM's Strategy

  • IBM might push for more sales to generate immediate large revenues, critical for funding innovation and capturing market share.
  • Leasing arrangements can create a loyal customer base that is continually tied to IBM's service ecosystem.
  • The decision between selling and leasing can shape customer purchase behavior, as different financing methods appeal to different customer segments.
Revenue Models in Business

A company's revenue model dictates how it generates income from its products or services. IBM's strategic decision between selling and leasing directly influences its revenue model. Selling products results in one-time, larger transactions, which can be ideal for quick revenue generation. Leasing creates recurring revenue streams, beneficial for long-term financial planning and relationship building with clients.

IBM's Potential Revenue Models

  • Transactional: Single, one-off sales of computers and technology solutions.
  • Recurring: Income from leasing agreements, service contracts, and maintenance plans.
  • Hybrid: A combination of sales and leasing that could appeal to a broader market range.

Each model has implications not only for IBM's cash flow but also for how it invests in customer relationships and product development.

Market Stability

Market stability is essential for a business like IBM to thrive. Stable markets facilitate predictable revenue streams, aiding in strategic planning and investment. Volatile markets, however, may demand more flexible pricing strategies, where leasing can act as a buffer against market downturns by providing consistent revenue.

Influence on Pricing Strategy

  • During unstable market periods, IBM might prioritize leasing to retain customers seeking operational cost cuts.
  • In a stable market, IBM could emphasize selling to capitalize on the market's strength and secure immediate capital.

IBM's pricing strategy must also adapt to competitors' actions and economic indicators to retain its position in the market.

Customer Purchase Behavior

Customer purchase behavior is highly influential in shaping IBM's pricing strategy. This behavior is influenced by customers' financial capacity, preference for ownership or flexibility, and their perception of technological advancements. If customers favor lower upfront costs and flexibility to upgrade, they may tend towards leasing. Conversely, if they desire ownership and have the capital, they may be inclined to purchase outright.

Adapting to Purchasing Trends

  • To address customers seeking the latest tech, IBM may offer leasing to simplify the process of regularly acquiring updated equipment.
  • For customers more interested in long-term investments, selling might be promoted to appeal to their preference for ownership.

IBM needs to analyze customer behavior trends continually and adjust its sales techniques and financing options to meet evolving needs and preferences.

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Most popular questions from this chapter

As the owner of the only tennis club in an isolated wealthy community, you must decide on membership dues and fees for court time, There are two types of tennis players. "Serious" players have demand $$Q_{1}=10-P$$ where \(Q_{1}\) is court hours per week and \(P\) is the fee per hour for each individual player. There are also "occasional" players with demand $$Q_{2}=4-0.25 P$$ Assume that there are 1000 players of each type. Because you have plenty of courts, the marginal cost of court time is zero. You have fixed costs of \(\$ 10,000\) per week. Serious and occasional players look alike, so you must charge them the same prices. a. Suppose that to maintain a "professional" atmosphere, you want to limit membership to serious players. How should you set the anmul membership dues and court fees (assume 52 weeks per year) to maximize profits, keeping in mind the constraint that only serious players choose to join? What would profits be (per week)? b. A friend tells you that you could make greater profits by encouraging both types of players to join. Is your friend right? What annual dues and court fees would maximize weekly profits? What would these profits be? c. Suppose that over the years, young, upwardly mobile professionals move to your community, all of whom are serious players. You believe there are now 3000 serious players and 1000 occasional players. Would it still be profitable to cater to the occasional player? What would be the profitmaximizing annual dues and court fees? What would profits be per week?

Price discrimination requires the ability to sort customers and the ability to prevent arbitrage. Explain how the following can function as price discrimination schemes and discuss both sorting and arbitrage: a. Requiring airline travelers to spend at least one Saturday night away from home to qualify for a low fare. b. Insisting on delivering cement to buyers and basing prices on buyers' locations. c. Selling food processors along with coupons that can be sent to the manufacturer for a \(\$ 10\) rebate. d. Offering temporary price cuts on bathroom tissue. e. Charging high-income patients more than lowincome patients for plastic surgery.

If the demand for drive-in movies is more elastic for couples than for single individuals, it will be optimal for theaters to charge one admission fee for the driver of the car and an extra fee for passengers. True or false? Explain.

Elizabeth Airlines (EA) flies only one route: ChicagoHonolulu. The demand for each flight is \(Q=500-P\) EA's cost of running each flight is \(\$ 30,000\) plus \(\$ 100\) per passenger. a. What is the profit-maximizing price that EA will charge? How many people will be on each flight? What is EA's profit for each flight? b. EA learns that the fixed costs per flight are in fact \(\$ 41,000\) instead of \(\$ 30,000 .\) Will the airline stay in business for long? Illustrate your answer using a graph of the demand curve that EA faces, EA's average cost curve when fixed costs are \(\$ 30,000,\) and EA's average cost curve when fixed costs are \(\$ 41,000\) c. Wait! EA finds out that two different types of people fly to Honolulu. Type \(A\) consists of business people with a demand of \(Q_{\lambda}=260-0.4 P\). Type \(B\) consists of students whose total demand is \(Q_{\mathrm{B}}=240-0.6 P\) Because the students are easy to spot, EA decides to charge them different prices. Graph each of these demand curves and their horizontal sum. What price does EA charge the students? What price does it charge other customers? How many of each type are on each flight? d. What would EA's profit be for each flight? Would the airline stay in business? Calculate the consumer surplus of each consumer group. What is the total consumer surplus? e. Before EA started price discriminating, how much consumer surplus was the Type \(A\) demand getting from air travel to Honolulu? Type \(B\) ? Why did total consumer surplus decline with price discrimination, even though total quantity sold remained unchanged?

Suppose that BMW can produce any quantity of cars at a constant marginal cost equal to \(\$ 20,000\) and a fixed cost of \(\$ 10\) billion. You are asked to advise the CEO as to what prices and quantities BMW should set for sales in Europe and in the United States, The demand for BMWs in each market is given by $$Q_{E}=4,000,000-100 P_{E}$$ and $$Q_{u}=1,000,000-20 P_{\mathrm{U}}$$ where the subscript \(E\) denotes Europe, the subscript \(u\) denotes the United States. Assume that BMW can restrict U.S. sales to authorized BMW dealers only. a. What quantity of BMWs should the firm sell in each market, and what should the price be in each market? What should the total profit be? b. If \(\mathrm{BMW}\) were forced to charge the same price in each market, what would be the quantity sold in each market, the equilibrium price, and the company's profit?
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