Quality differentiation and adoption costs: The case for interorganizational information system pricing

Firms which employ a new technology to increase the quality of goods sold often require that customers adopt some aspect of the technology, and this adoption is typically costly. This study proposes a model of goods supported by interorganizational information systems (IOSs) that captures the effects of increased quality and customer adoption costs. The model is developed for monopoly and duopoly, assuming non-IOS goods continue to be viable. Supporting the hypothesis that adoption costs act as a barrier to customers using IOS, our general results raise the possibility of a subsidy for IOS adoption, particularly when the added value after adoption is indispensable and when IOS adopters purchase quantities similar to or greater than those they would purchase without IOS. Consistent with the notion that firms are better off with differentiated goods to reduce direct competition, duopoly results confirm that if one firm has an IOS then that firm should offer only the IOS-supported good and abandon the unsupported good to the competitor. These results also make clear that both firms can be made better off by only one introducing the IOS. Moreover, not only can the IOS result in benefits to both firms, but in aggregate customers may also be better off. In designing an IOS, any reduction in the cost of information technology inputs, or in the cost of increasing attributes such as timeliness, accuracy and fineness, results in a superior IOS offering, increasing the quality of the IOS-supported good. Prices for goods sold, however, do not necessarily increase with the quality of IOS support.