Freemium as an Optimal Strategy for Market Dominant Firms

Zijun (June) Shi (), Kaifu Zhang () and Kannan Srinivasan ()
Additional contact information
Zijun (June) Shi: Tepper School of Business, Carnegie Mellon University, Pittsburgh, Pennsylvania 15213
Kaifu Zhang: Tepper School of Business, Carnegie Mellon University, Pittsburgh, Pennsylvania 15213
Kannan Srinivasan: Tepper School of Business, Carnegie Mellon University, Pittsburgh, Pennsylvania 15213

Marketing Science, 2019, vol. 38, issue 1, 150-169

Abstract: Despite its immense popularity, the freemium business model remains a complex strategy to master and often a topic of heated debate. Adopting a generalized version of the screening framework, we ask when and why a firm should endogenously offer a zero price on its low-end product when users’ product usages generate network externalities on each other. In the standard screening framework without network effects, freemium never emerges as optimal, and the firm always chooses the efficient price point for its low-end product. We show that even with network effects, freemium is typically not optimal. When network effects are identical across products (“symmetric”), the firm has greater incentive to expand its network size and may find it profitable to sell to the low-end customers. However, this does not lead to freemium as an equilibrium strategy. Instead, the firm should offer a low-end product to attract customers, while keeping its price positive. Freemium can only emerge if the high- and low-end products provide different levels of (“asymmetric”) marginal network effects. In other words, the firm would set a zero price for its low-end product only if the high-end product provided larger utility gain from an expansion of the firm’s user base. In contrast to conventional beliefs, a firm pursuing the freemium strategy might increase the baseline quality on its low-end product above the “efficient” level, which seemingly reduces differentiation.

Keywords: analytic models; game theory; pricing; network externality; product quality (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

Downloads: (external link)
https://doi.org/10.1287/mksc.2018.1109 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormksc:v:38:y:2019:i:1:p:150-169

Access Statistics for this article

More articles in Marketing Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().