Question

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 \(80^{\prime}\) 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

Selling systems means higher immediate revenue and profits and transfers responsibilities of maintenance and repair to customers. However, selling may not create long-term revenue that leasing could. Leasing might also ensure that IBM's latest products are in the market and provide affordable solutions to customers. The decision between leasing and selling would depend on the market character, financial outlook, technology life-cycle, and potential additional services and revenue from leased equipment.

Step-by-step solution

Argument in Favor of Selling

Selling products outright means receiving a large sum of payment upfront, which can improve cash flow immediately. It also transfers the ownership and thus the maintenance and repair responsibilities to the customers, which can introduce cost savings. Moreover, a focus on selling might lead to higher revenue and profits in the short term.

Argument Against Selling

Selling might initially bring in higher revenue, but it might also result in fewer opportunities for recurring revenue. Leased equipment generally offers recurring income over a long period of time. Also, leasing could offer the flexibility to customers to upgrade their systems, which in turn, ensures that IBM’s latest products are in market. This model might enable customers to afford more expensive equipment and consistently keep them in the technology upgrade cycle.

Factors Determining Preference for Leasing or Selling

Several factors determine whether leasing or selling would be more favorable for a company like IBM. These include the characteristics of the market IBM is serving, the financial health and outlook of the company, the technology life-cycle, and the potential for additional services and revenue opportunities such as maintenance and upgrades on leased equipment.

Key concepts

Selling vs Leasing

When IBM considered strategies like price cuts to encourage more sales as opposed to leases, it touched upon a crucial decision point that many technology companies face: selling vs leasing. Selling provides immediate capital influx, which is beneficial for quick cash flow improvement and for customers who prefer to own the technology outright.

IBM needs to consider that selling can lead to significant revenue, but it also means relinquishing the chance for steady, predictable income over time. With leasing, although they receive smaller payments, these are consistent and can ensure customer retention over a longer period. Leased equipment can also be upgraded easily, keeping the technology current. For IBM, the choice could influence market competitiveness, customer relationships, and financial stability.

Cash Flow Management

Cash flow management is vital for any business, including tech giants like IBM. Immediate cash from sales aids in covering operational costs and investing in new projects or research. However, leasing establishes a different cash flow pattern, characterized by recurring payments over time, which may offer a more predictable stream of income.

Effective cash flow management requires balancing between the instant liquidity from sales and the long-term financial health secured by leasing. IBM's pricing policy decision could significantly impact its cash management strategy, favoring either immediate capital gains from sales or a consistent revenue stream from leases, which could be more beneficial in managing financial uncertainties.

Recurring Revenue

The drive towards a recurring revenue model is strong in the technology industry, and for IBM, leasing is a key ingredient in this strategy. Recurrent payments from leases can provide IBM with a stable source of income, smoothing out financial fluctuations.

Furthermore, recurring revenue can be enhanced through additional services tied to leases, such as maintenance, support, and upgrades. This model not only ensures a steady cash flow but also fosters long-term customer relationships as they rely on the company for ongoing service provisions. IBM’s pricing policy needs to align with an approach that maximizes recurrent earnings to support sustainable growth.

Technology Life-Cycle

Understanding the technology life-cycle is essential for IBM's decision on leasing versus selling. Technology evolves rapidly, and products can become outdated within a few years. Leasing allows customers to upgrade to the latest models without a significant initial expense, which in turn can keep IBM's technology at the forefront of market demand.

In contrast, selling locks in a one-time purchase, potentially leading to longer intervals between customer upgrades. This can result in a slower adoption rate of newer technologies. IBM's pricing policy must account for the pace at which their products evolve and consider how leasing might encourage quicker turnover and ongoing customer engagement with the latest advancements.