| Abstract:
We analyze the practice of "competitive upgrade discounts" and
"upgrade pricing" in software roduct markets. Entrant firms may offer
competitive upgrade discounts to existing customers off a rival product
to give them sufficient incentive to switch to the entrant's offering.
The incumbent firms can fight back by offering an upgrade of their
product at a discounted price to their existing customers. We find that
this problem is marked by multiple equilibria and we focus attention on
certain plausible ones. The profit maximizing equilibria for the
incumbent has many interesting features: It is marked by an upgrade
discount pricing by the entrant which enables it to capture some market
share of the incumbent in the second period. Further, contrary to some
previous findings, the profit of the incumbent reduces with switching
costs. Thus, to the extent that the incumbent can endogenize switching
costs, it may want to restrict rather than to increase these.
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