Pricing online subscription services under competition

In recent times, rapid advances in the field of information technology have enabled firms selling information products (for example, in the form of a CD) to provide subscription services using remote servers. Making the product versus service decision involves a trade-off. Online subscription offerings are perceived to be of lower quality because of data security and network reliability issues but can reduce or even eliminate the credible commitment (of prices) problem typically faced by firms selling durable products. We model an infinite horizon game between two symmetric firms that choose the design architecture, that is, product or service (and consequent contracting scheme: selling or subscription) and then set prices to optimize profits. The perceived quality loss enables firms to differentiate based on design architecture/contracting scheme and make positive profits. Further, the firm that sells a product makes higher profit than the firm that offers a subscription service. However, as the discount factor increases, the presence of a seller leads to a credible commitment problem for both firms leading to a reduction in prices. The results offer an explanation for the persistence of firms selling products rather than services. Further, a firm offering a subscription service may be subject to price pressure due to the price commitment issues of a competing seller. We also extend our insights to other settings: one involving asymmetric firms and the other involving different discount rates for product quality and producer/consumer surplus.