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Abstract
Many software firms, especially mobile app providers, offer perpetually free basic products to users, but premiums are charged for access to the additional features or functionalities. While the free offering helps capture potential customers, it might cannibalize the sales of premium goods or services. This paper adopts a game theoretical approach to examine the impact of free offering on the competition between two firms in the presence of network effects. The firms can either offer a free core product and a paid service or offer them as a bundle. The core product has stand-alone value and can be used separately but the value-added service has no value without the core product. We derive the market equilibria and present conditions under which the free offering strategy outperforms the bundling strategy. We show that when a firm’s core product has a sufficient advantage in product quality, it is better for this firm to sell the bundle but for the other to use free strategy. However, if the core products are similar in terms of quality, it is optimal for them to use the same strategies. Whether to offer a free product depends largely on the core products’ quality. We also show that the firms may be caught in a prisoner’s dilemma when both adopt the free strategy. Finally, we find that the profitability of the firm that offers a free product always increases in network effects intensity and market size, but this is not the case for the firm that sells the bundle. This study contributes to understanding the behavior of feature-limited free offering in a duopoly setting. Our findings also provide insights into the design of free product and the impact of network effects on the firms’ offering decisions.
Acknowledgments
The authors are grateful for valuable and constructive feedback from the Editor in Chief, Vladimir Zwass, and three anonymous reviewers. The authors also thank Haiyang Feng for help with the analysis. Guofang Nan is grateful for financial support from the National Science Foundation of China under Grant Nos. 71271148 and 71471128. Minqiang Li is grateful for financial support from the Distinguished Young Scholars of China under Grant 70925005. All opinions and errors are the authors’ own.
Supplemental File
Supplemental data for this article can be accessed on the publisher’s website at http://dx.doi.org/10.1080/07421222.2016.1172457
Notes
1. Microsoft reveals how it will make money giving away software, 2015, 1. www.theverge.com/2015/3/16/8227847/how-microsoft-makes-money/.
3. Apple promotes strange new game type in iOS App Store, “Pay Once and Play,” www.forbes.com/sites/insertcoin/2015/02/13/apple-promotes-strange-new-game-type-in-ios-app-store-pay-once-and-play-2/2015/.
4. Office for iPad Product Guide, www.microsoft.com/en-us/download/details. aspx?id=42561/.
5. We consider cases where the duopoly firms’ whole products are horizontally differentiated so that under equal prices some consumers prefer the whole product provided by Firm 1 while others prefer the whole product provided by Firm 2. We can model vertical differentiation by considering that the firms’ whole products have different quality, one with quality 5. and the other with quality
. This would lead to a bias in favor of the firm with a higher quality of the whole product. The problem can be solved similarly; and the results become more complicated but the insights remain unaffected.
6. Going Freemium: One Year Later, 2010, http://blog.mailchimp.com/going-freemium -one-year-later/.
Additional information
Notes on contributors
Zan Zhang
Zan Zhang ([email protected]) is a Ph.D. candidate in the Department of Information Management and Management Science, College of Management and Economics, Tianjin University, China. Her research interests include pricing of information goods and Internet service, and uncertain information processing. Her recent papers have appeared in Knowledge-Based Systems and Information Sciences.
Guofang Nan
Guofang Nan ([email protected]; corresponding author) is a professor at the College of Management and Economics, Tianjin University. He received his Ph.D. in management information systems from the College of Management and Economics, Tianjin University in 2004. His research interests are primarily in the area of economics of information systems and Internet services. His papers have appeared in Knowledge-Based Systems, Soft Computing, IEEE Transactions on Multimedia, IEEE Systems Journal, and other journals.
Minqiang Li
Minqiang Li ([email protected]) is a professor in the Department of Information Management and Management Science, College of Management and Economics, Tianjin University. He received a Ph.D. in systems engineering and management science from Tianjin University. His research interests cover management science and decision support, IT strategy, e-commerce, data mining and business intelligence, and evolutionary computation. His papers have appeared in IEEE Transactions on Neural Networks and Learning Systems, Pattern Recognition, European Journal of Operational Research, Information Sciences, Knowledge-Based Systems, and other venues.
Yong Tan
Yong Tan ([email protected]) is the Neal and Jan Dempsey Professor of Information Systems at the Michael G. Foster School of Business, University of Washington. His research interests include electronic and social commerce, economics of information systems, social networks, and software engineering. His research has been published in Management Science, Information Systems Research, Journal of Management Information Systems, MIS Quarterly, Operations Research, INFORMS Journal on Computing, IEEE/ACM Transactions on Networking, IEEE Transactions on Software Engineering, IEEE Transactions on Knowledge and Data Engineering, and other journals. He served as an associate editor of Information Systems Research and is an associate editor of Management Science.
