A guide to technology hardware pricing: New research highlights how companies can strategically price products, contrary to conventional pricing wisdom

GAINESVILLE, Fla. – In today’s modern world, we rely heavily on technology to connect with others. From Zoom-calling into a work meeting via a Mac laptop or iPhone, to asking Alexa through the Amazon Echo to set a calendar reminder for birthdays of friends and family, hardware technology products are ubiquitous in our society. In fact, in 2019, more than 60 million Americans own a smart speaker, and Apple has 1.4 billion active devices like iPhones, iPads and Macs worldwide.

On the surface, it seems those hardware products just help connect us with professional and personal contacts, but they connect us with another group – application developers. It’s the work of these application developers on products like Zoom or Alexa that help make our lives a little easier when connecting with others – the hardware products, Macs and Amazon Echoes for example, are just the vehicle for connection.

For companies that offer products made by application developers, understanding the role that hardware products play is significant when it comes to the pricing of the products they offer to consumers. New research from Amy Pan of the Warrington College of Business with Mei Lin of Singapore Management University and Quan Zheng (Ph.D. ‘18) of the University of Science and Technology of China sheds light on how companies should strategically price hardware products and charge on application developers.

In their paper, “Platform Pricing with Strategic Buyers: The Impact of Future Production Cost,” the researchers first find that it is always optimal for companies to continue to produce a low-quality product when a high-quality product is released. This is due, in part, to a decreasing in manufacturing costs over time as well as strategic relationship optimization between a company and its suppliers. The researchers point to the example of the updates made to the Amazon Echo smart speaker.

“Since the release of the original Amazon Echo in 2015, Amazon has integrated a smart home hub in the Echo Plus introduced in 2017,” Lin, Pan and Zheng write. “As the platform rolls out different versions of the hardware product sequentially, its pricing strategy is dynamic, to take into account the potential consumer market at the time of releasing a new version and the changes in production cost.”

The researchers also found that with an increase in the likelihood or magnitude of costliness reduction leads to an initial higher buyer-side price of the lower-quality product, but a reduction in the seller-side fee. In addition, an increase in the likelihood or magnitude of costliness reduction can also cause the platform to more aggressively raise buyer-side prices.

“The extent of the buyer-side demand captured initially is critical because it sets up the market demand for the future,” the researchers write. “When the platform captures fewer buyers in Period 1, more potential buyers are left for Period 2, where the expected market profitability increases because of the increased likelihood or magnitude of costliness reduction. Meanwhile, the seller-side fee is reduced because the shrunken buyer-side demand makes the platform less attractive to sellers.”

Using analytical modeling, Lin, Pan and Zheng factored in three points not previously studied when it comes to pricing hardware: the potential downward-trending production cost, product quality improvements and the strategic behaviors of consumers. Using these three points, the researchers are able to study a monopoly platform’s dynamic two-sided pricing strategy.

The results of their study have important implications for companies, as they are in sharp contrast with the conventional wisdom that lower cost leads to lower prices in a static setting, the researchers say.

With this research, companies can make better informed decisions about how to set prices when facing strategic and knowledgeable consumers and uncertain cost reduction in the future.

The full research is now featured in Production and Operations Management Journal.