ATLANTIC COMPUTER: A BUNDLE OF PRICING OPTIONS

Summary of the Situation Analysis

In this case, Atlantic Computer is a manufacturer of servers and high-tech products.1

Two market segments exist in the server industry: High performance and Basic Servers.2
Atlantic Computers has held a 20% share of the High Performance market with their Radia
servers being their premier product.3 However, the market for Basic servers is growing and
this has caused Atlantic Computers to develop and introduce a Basic Server called the Tronn
and a software tool called the “Performance Enhancing Server Accelerator” (PESA).4 The
Tronn was developed mainly for the emerging US market opportunity for basic servers.5 The
PESA would allow the Tronn to perform up to four times faster than its standard speed and
make frequently requested information more accessible.6 Thus, bundling the Tronn and PESA
made more sense. Atlantic is not concerned that the Tronn will be considered a substitute for
its High Performance servers.7

Primary Question to be addressed:

What pricing strategy should Atlantic Computers implement to price the Atlantic Bundle?

Analysis
There are four main types of pricing strategies from which Atlantic Computers can
choose. First, Atlantic Computers could stay with the status 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 choose value-in use pricing.
In addition to determining which pricing strategy to use, Atlantic Computers must also
determine which businesses are most likely to benefit from the Atlantic Bundle. Next,
Atlantic Computers will have to consider how customers are likely to react to the Atlantic
Bundle. Finally, Atlantic Computers will also have to consider how competitors will respond
to the recommended pricing strategy.
.
1. Status Quo Pricing:
The industry norm for pricing a server and software bundle is to merely include any

1
Neeraj Bharadwaj, John Gordon, “Atlantic Computers: A Bundle of Pricing Options”, 2007, 2
2
Id.
3

4
5

7
software tools with the hardware. Atlantic Computers has always practiced this pricing
strategy.8 This would require Atlantic Computers to offer the PESA software tool for free with
the Tronn Server. This would require Atlantic Computers to essentially lose the $2,000,000
cost of research and development of PESA. 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 compete with and gain market shares in the basic servers segment.

2. Competition-Based Pricing:
Competition-Based pricing uses the prices of competitors as a benchmark for pricing
products rather than considering costs.9 The price of Ontario’s Zink servers is $1700 and
conservatively speaking, the Tronn loaded with the PESA software tool is equivalent to two
of Ontario’s Zink servers.10 Therefore, under the Competition-Based Pricing, the cost of the
“Atlantic Bundle” would be $1700 x 2 or $3400. While 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 server that costs 4 times the
cost of the Zink server. While the addition of the PESA software tool would make the Tronn
servers the equivalent of 4 Zink servers, the PESA software does not work on all 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. Customers would likely not consider purchasing the “Atlantic Bundle” based
on Competition-Based pricing because they would not see it as a fair price and worth the risk.

3. Cost-Plus Pricing:
Cost-plus pricing is determined by adding the direct, indirect and fixed costs associated
with a product and converting it into a per-unit cost for the product.12 A predetermined
percentage is then added to these costs to provide a profit margin.13 The cost of a Tronn server
is $1,538 and based on a $2,000 price, this additional 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 price of a Tronn loaded with PESA would be $2,246 which is $546
above the Zink server. 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 $4,492 as
compared to $6,800 for the Zink servers.14 Again, It would be difficult for Atlantic to

8
Neeraj Bharadwaj, John Gordon, “Atlantic Computers: A Bundle of Pricing Options”,
9
http://www.businessdictionary.com/definition/competition-based-pricing.html
10
Neeraj Bharadwaj, John Gordon, “Atlantic Computers: A Bundle of Pricing Options”,
11
Id
12
Id
13
Id
14
Zink servers are priced at $1,700 each.
persuade customers to purchase the servers based on the Cost-Plus pricing 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 Ontario’s Zink servers.
Without further justification, customers are not likely to accept this additional cost.

Cost-Plus Pricing
Total Number of Tronn servers sold in 3 years 21,180
Total installations of PESA assuming 50% attach rate 10,590
Cost of PESA per installation ($2,000,000/10590) $189
Price of Tronn without PESA installed (Cost + 30% markup) $2000
Price of Tronn with PESA installed (Cost + 30% markup) $2,246
Price of 2 Tronn servers loaded with PESA $4,492

4. Value-in-use Pricing:
Using the Value-in-use pricing method, Atlantic Computers 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, of the technical, service, social, and economic
benefits a customer receives in exchange for the price it pays for a product.15 In this case, the
customer value would be the annual cost of electricity and software licensing for each
server.16 It would then calculate the difference between the two figures and assume a 50-50
share of savings.17
As the chart below illustrates, when the total costs are added, a customer would
potentially realize a $4,800 savings when using two Atlantic Bundles as compared to four
Zink servers.18 After a 50-50 share, the total final price would be $6,400. Under this method,
it is easy to show customers that they will be saving $2,400 when they buy two “Atlantic
Bundles.” This would help demonstrate in monetary terms the customer’s true value of
buying the “Atlantic Bundle.”
Value-in-use Pricing
Tronn x 2 Zink x 4
Price of Server $4,000 $6,800
Electricity (Annual Cost) $500 $1,000
Software License $1,500 $3,000
Total Price $6,000 $10,800
Savings (Difference between Zink and Tronn) $4,800
Total Final Customer Price (Total Price + 50-50 sharing) $6,400

Value-in-use pricing is the best method:

15
; 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
16

17

18
This assumes a $250 annual cost for Electricity 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.
 Of the four methods available for pricing the “Atlantic Bundle”, the Value-Based pricing
method is the best to choose. As shown in Exhibit 1, the Competition Based pricing method
will generate more profit per unit than any other method, 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 basic server and software tool that allows
it to operate at four times the speed, it is equivalent to four Zink servers. Conservatively
looking at the numbers, this equates to a savings of $4,800 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 be those companies that do a lot of
web hosting. It is when the Tronn Server is acting as a web-server and coupled with PESA
that the “Atlantic Bundle” is capable of realizing its true potential of being 4 times as fast as
the basic server.19 Additionally, those companies who do a lot of file sharing would also
benefit from the “Atlantic Bundle” as it would still enjoy an increase in performance
equivalent to 2 basic servers.20
.
2. How are customers likely to respond?
At first, customers are likely to question Atlantic Computers’ reasoning for deviating
from the tradition of providing performance enhancing/monitoring tools for free. This may be
one of the more difficult tasks associated with pricing the “Atlantic Bundle.” Atlantic
Computers will have to demonstrate to customers that the PESA software tool essential
doubles and possible quadruples the number of basic Tronn servers. They will need to
emphasize that not only are they saving on the number of servers they will need to purchase,
but they will also save on other costs. Atlantic Computers will also need to emphasize that it
will continue to provide excellent service after purchase and provide customers with peace of
mind.

3. How will Ontario’s top management likely respond?

a. Short run vs. Long Run
After the first year, the “Atlantic Bundle” will only take approximately 4% of the market
share of the basic share market. It is unlikely that Ontario would be concerned at this time
and would not take any steps to counter-act. It would take until at least the second year and
likely the third year before Ontario would begin to take action. At this moment, Ontario’s
reaction would be to lower prices in order to stop market loss.

19
Neeraj Bharadwaj, John B. Gordon; Atlantic Computer: A Bundle of Pricing Options,
2007, 8
20
 Of course, Ontario will only be able to lower prices for a short period of time before such
actions begin to drastically decrease their profits. Ontario will likely begin to copy the PESA
software 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 associated with
PESA and can begin to include the software as part of the Tronn Server at no charge.

4. Other problems associated with using Value-in-use pricing.

After years of providing software tools for free with servers, it will take some persuading to
get veteran salespeople on board with the value-in-use pricing method. This is especially true
because the salespeople derive 30% of their pay off of commission.21 They know that they
will sale more volume if they are able to lower the price. Training the salespeople to show
customers exactly the value they will be getting will help the salespeople understand that they
will essentially be able to sell more servers at a higher cost, thereby making more money off
of commission.

Exhibit 1
Pricing Method Revenue Costs Total Profits Profit/Unit
Status Quo $21,180,000 $18,287,420 $2,416,030 $228
Competition-Based Pricing $36,006,000 $18,287,420 $17,242,030 $1,628
Cost-Plus $23,785,140 $18,287,420 $5,021,170 $474
Value-in-Use $33,888,000 $18,287,420 $15,124,030 $1,428

21