QTX is a sales support server that allows multiple users to simultaneously maintain their sales account databases. These databases covers contact information, quote histories, copies of all communications, and links to the customer's corporate database for shipping records. The basic QTX package consists of a processor, chassis, hard drive, and network interface, with a manufacturing cost of $500. The package provided simultaneous access for 10 users to the system, referred to as 10 "seats." Each seat represented one accessing employee. The product line consisted of 10-, 20-, and 30-seat capacity QTX servers. Each incremental 10 seats required $200 of additional manufacturing cost. Yearly sales were at the rate of 4,000 units across all sizes. In initial sales, approximately 30 percent of customers bought the 30-seat unit, 40 percent bought the 20-seat unit, and 30 percent bought the 10-seat unit. Customers who needed more than 30 seats typically went to competitors servicing the medium-to-large company market segment.
Clearwater set a per-seat manufacturer's suggested retail price (MSRP) that decreased with higher quantity seat purchases, reflecting the customer perception of declining manufacturing cost per seat. Clearwater also saw this as advantageous because it encouraged customers to maximize their initial seat purchase.
Clearwater typically sold its products through value-added resellers (VARs). A VAR was typically a small local firm that provided sales and support to end users. The value added by these resellers was that they provided a complete solution to the end user/customer from a single point of purchase and had multiple information technology products available from various vendors. Using VARs reduced Clearwater's sales and service expense significantly and increased its market coverage.
These intermediaries operated in several steps. First, the VAR combined the QTX from Clearwater with database software from other suppliers to form a turnkey customer solution. Second, the VAR loaded the software with customer-specific information and linked it to the customer's existing sales history databases. Finally, the VAR installed the product at the customer's site and trained the customer on its use. Clearwater sold the QTX to resellers at a 50 percent discount from the MSRP, allowing the VARs to sell to the end user at or below the MSRP. The discount allowed the VARs room to negotiate with the customer and still achieve a profit.
Initially, the expectation had been that the 30-seat unit would be the largest volume seller. In order to gain economies of scale in manufacturing, reduce inventory configurations, and reduce engineering design and testing expense to a single assembly, Clearwater decided to manufacture only the 30-seat server with the appropriate number of seats "enabled" for the buyer. Clearwater was effectively "giving away" extra memory and absorbing the higher cost rather than manufacturing the various sizes. If a customer wanted a 10-seat server, the company shipped a 30-seat capable unit, with only the requested 10 seats enabled through software configuration. The proposed upgrade was, in reality, allowing customers to access capability already built into the product.
Clearwater knew that many original customers were ready to use the additional capacity in the QTX. Some customers had added seats by buying a second box, but because the original product contained the capability to expand by accessing the disabled seats, Clearwater saw an opportunity to expand the product line and increase sales to a captive customer base. Customers could double or triple their seat capacity by purchasing either a 10- or a 20-seat upgrade and getting an access code to enable the additional number of seats. No other competitor offered the possibility of an upgrade. To gain additional seats from the competitor, the customer purchased and installed an...