CAMBRIDGE SOFTWARE CORPORATION:

QUANTITATIVE ANALYSIS
Learning Objectives:
Benefits of product variety
Factors limiting product variety
Strategic considerations in product-line pricing
III.

Quantitative Analysis:
We will first consider the product-line design and pricing decisions for the case when
CSC can offer only one version. In this case, the product-line design only involves
selecting the right version to offer. Note further that targeting/positioning decision is
synonymous with pricing decision in this case because the price selected by CSC
completely determines which of the potential 5 segments will actually buy the version
introduced by CSC. In the second part of this document, we consider the multi-version
case.

(a) Single-Version Case:

Decisions Rule: Choose the version which gives the highest contribution margin
Options: (i) Student version; (ii) Commercial version; (iii) Industrial version

Optimization Procedure (Managerial Logic):

The managerial logic involved in this case can be represented by the following decision
tree:

Student

Large
Corp

Commercial

Labs

Consultants

Industrial

Small
Business

Students

In the decision tree, there are two levels of decisions/optimizations. The first level
involves selection of the model to introduce. The second level decision is the
targeting/positioning/pricing decision. In the figure above, Consultants refers to the
fact that targeting includes Consultants and more high-end segments (i.e. Large
Corporations and labs). Note that with any decision tree analysis, to reach a
conclusion, we have to work backwards. The managerial thought process involves the
following steps:

Step 1: Suppose CSC introduces student version, what is the optimal price?
What are the relevant costs at this stage of decision making?

segment development cost

variable cost (per unit)
Why is product completion cost NOT a relevant cost at this stage?
Because, CSC management has already (hypothetically) committed itself to producing
student version. As such, it is a sunk cost because irrespective of the # of
segments served, CSC has to incur it if this version is introduced at all.
Economic Trade-off: unit contribution-margin vs. volume (# segments served); choose
the unit price which gives the maximum total contribution
Total Contribution = Unit PriceVolume - Segment Dev. Cost(s)
NOTE: Since CSC introduces only one version, individual consumers have only two
options: to buy or not to buy the version given CSCs price and their willingness-topay (economic value). Can the optimal price of CSC be different from $ 50, $ 100, $
150, $ 175 or $ 200? (These are the willingness-to-pay of the 5 segments for
student version.)

Table 1: Contribution Analysis for Modeler Student Version

Price

Segments
Served

Unit
Contribution

Seg. Dev.
Costs

Demand

$ 200
$ 175

Consultants
Consultants
Small Bus.
Consultants
Small Bus.
Large Corp.
Consultants
Small Bus.
Large Corp.
R&D, U Lab.
Consultants
Small Bus.
Large Corp.
R&D, U Lab.
Students

$ 185
$ 160

$ 200,000
$ 400,000

20,000
35,000

Total
Contribution
(000s)
$ 3,500
$ 5,200

$ 135

$ 550,000

40,000

$ 4,850

$ 85

$ 650,000

42,000

$ 2,920

$ 35/$ 15***

$ 950,000

542,000

$ 8,020

$ 150
$ 100

$ 50

***

CSC sells to student segment through college book stores which get 40 % commission

so that CSC nets only 60 % of the sale price of $ 50.

The optimal price for student version is $ 50 at which all the 5 segments are served
and the Total Contribution from this version is $ 8,020,000.

Step 2: Derive the Total Contribution IF CSC instead offered commercial

or

industrial version (Note: CSC management has already figured out its optimal
pricing policies in these contingencies.)
Table 2: Results From Contribution Analysis For
Commercial and Industrial versions
Version
Commercial

Industrial

Optimal Price
$ 225

Segments Served
Consultants
Small Bus.
Large Corp.
R&D,U Lab.
Consultants
Large Corp.
R&D,U Lab.

$ 600

Total Contribution
$ 7,750,000

$ 14, 805,000

Step 3: Choose the versions which gives the maximum Net Total Contribution (net of
estimated product (version) completion cost). Why is product completion cost a
relevant cost at this decision stage?
e.g. CSC should choose student version if
Optimal TCstudent - $ 100,000 > Optimal TCcommercial - $ 200,000
and
Optimal TCstudent - $ 100,000 > Optimal TCindustrial - $ 500,000
Table 3:Optimal Choice of Versions
Version

Optimal Price

Student

$ 50

Commercial

$ 225

Industrial

$ 600

Segments Served
Consultants
Small Bus.
Large Corp.
R&D,U Lab.
Students
Large Corp.
R&D,U Lab.
Consultants
Small Bus.
Large Corp.
R&D,U Lab.
Consultants

Net Total
Contribution
$ 7,920,000

$ 7,550,000

$ 14, 305,000

CSC should offer the Industrial version in the single-version case. The optimal
targeting/positing involves serving the three high-end segments viz. Large Corp.,
Labs and Consultants segments. With this product line design and targeting, the
optimal price is $ 600.

(b)

Multi-Version case:

Note that in the single-version case, CSC chooses to introduce the Industrial version
and serve only the 3 high-end segments. Even though Students segments (@ 500,000)
is by far the largest segment, CSC chose to ignore it because the negative price effect
(reduction in unit contribution) outweighed the positive volume effect (demand
expansion).
Is there some other way to include the Students segment?
What about offering 2 versions of Modeler, with Students segments buying one
version and other segments buying the other version?
Now, for 2-version case, there are two options: (1) Industrial and Commercial
versions; and, (2) ) Industrial and Student versions. We will consider the second
option i.e. Industrial and Student versions first because of the following
considerations: The logic for including a second version is to include the large
students segment. Now, observe that in the single-version case, if CSC were to
introduce Commercial version, it would have ignored the students segment
because the incremental contribution (net of segment development cost) was negative
at $ 1,730,000.
How should one approach the problem of optimal targeting/pricing, given that
CSC is introducing Industrial and Student versions?
To ensure that Students segment buys the Student version, it must be priced at
$50. What about the price of the Industrial version? Recall that in the single-version
case, the optimal price was $ 600 and the target segments were Large Corp., Labs and
Consultants. Would these segments still buy the Industrial version at $ 600 given
that they can buy Student version as well (i.e. CSC can not restrict these consumers
from buying Student version)?1
Below are the consumer surplus (i.e. willingness-to-pay minus price) for the two
versions of the 3 high-end segments (recall that, in the single-version case, if CSC
1

Note that in same cases, firms can and do prevent sale e.g. special student and senior citizen discount is
available only to these specific segments by requiring student ID or proof-of-age
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were to introduce Industrial version, optimal targeting excluded the Small Business
segment):
Table 4: Consumer Surplus with Industrial version @ $600 and Student
version @ $50
Student version

Industrial version

Large Corp

$100 (= $150 - $50)

$1900 (=$2500-$600)

Labs

$ 50 (=$100 - $50)

$1400 (=$2000-$600)

Consultants

$ 150 (=$200 - $50)

$ 0 (=$600-$600)

From Table 4, it is clear that while Large Corp and Labs will continue to buy
Industrial segment, Consultants segment will switch to Student version because
they get more surplus with that version.
What price should CSC charge for Industrial version, given that Student
version is priced @ $ 50?
Clearly, $ 600 is not optimal anymore because at this price, Consultants are not
buying the Industrial version. Recall that in the single-version case, CSC reduced the
price of Industrial version up to $ 600 (willingness-to-pay for industrial version
for Consultants segment) because the positive volume effect offset the negative price
effect up to the Consultants segment. Any further reduction was sub-optimal. What
about a price of $ 450 for Industrial version? Note that at this price, the Consultants
are indifferent between the two version. This changes the contribution from the
Consultants segment and the conclusion from our earlier Contribution Analysis (Table
2) that Industrial version should target Consultants segment is no longer valid.
Another thing to note at this point is that in the single-version case, if Consultant did
not buy the Industrial version, unit sales of 20,000 (segment size) was lost. In the
2-version case, however, these consumers can now buy the low-end Student version
and so sales is not lost altogether.

To answer the question of optimal pricing for Industrial version, we first

compute the Maximum Price that these 3 segments will pay for Industrial version,
given that they have the option of buying Student version @ $ 50. We use the
following formula:
Maximum Price for
Industrial version

Willingness-to-pay (EV)

for Industrial version

Surplus from
Student version

Table 5: Maximum Price for industrial version consistent

with consumer self-selection
Surplus from
Student version

Maximum Price for

Industrial version

Large Corp

$100

$2400 (=$2500-$100)

Labs

$ 50

$1950 (=$2000-$50)

Consultants

$ 150

$450 (=$600-$150)

With these effective willingness-to-pay for Industrial version (which is different

from EV), the total contribution analysis for Industrial segment yields:
Table 6: Revised Contribution Analysis for Modeler Industrial Version
Price

Segments
Served

Unit
Contribution

Seg. Dev.
Costs

Demand

$ 2400
$ 1950

Large Corp.
Large Corp.
R&D, ULab.
Large Corp.
R&D, U Lab.
Consultants

$ 2365
$ 1915

$ 150,000
$ 250,000

5,000
7,000

Total
Contribution
(000s)
$ 11,675
$ 13,155

$ 415

$ 450,000

27,000

$ 10,755

$ 450

The optimal price of Industrial version is $ 1950 and the optimal

targeting/positing for this high-end version is the 2 high-end segments viz. Large
Corp. and Labs.
Net Contribution from Industrial version is $12,655,000.

 The other 3 segments buy Student version generating a net contribution (net of
product completion cost) from this version of:
Table 7: Revised Contribution Analysis for Modeler Student Version
Demand

Unit Contribution

Total Contribution
(Net of Seg. Dev. Cost)

Consultants

20,000

$ 35

$ 500,000

Small Business

15,000

$ 35

$ 325,000

Students

500,000

$ 15

$ 7,200,000

Less:
Product Completion Cost

$ 100,000

Net Total Contribution:

$ 7, 925, 000

By offering two versions, Cambridge software earns a total net contribution of

$20,580,000, an increase of $6,275,000 versus the optimal single product offering.

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