This paper studies the competition between two software vendors: one offering software as a service (SaaS) and the other providing on-premises software, both facing software upgrades with different customizability and implementation costs. We build a theoretical model to explore the vendor's pricing and market segmentation strategies. We find that (1) enhancing the customizability of SaaS software does not necessarily benefit the SaaS vendor, nor does it necessarily harm the on-premises vendor, depending on the current level of the SaaS software's customizability; (2) The SaaS vendor generally prefers pay-per-use pricing to subscription pricing because it can not only serve more consumers but also help relieve competition pressure from the on-premises vendor; (3) Adopting a hybrid model is not necessarily profit enhancing. Specifically, while the SaaS vendor always benefits from adopting a hybrid pricing strategy, the on-premises vendor may be better off by either not offering or offering a SaaS version with limited customizability, even if it does not make sales. Nevertheless, both vendors adopting a hybrid model leads to socially efficient competition outcome, where both vendors and consumers are better off, a win-win-win scenario.
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