Nonlinear Pricing of Information Goods

Abstract

This paper analyzes optimal pricing for information goods under incomplete information,when both unlimited-usage (fixed-fee) pricing and usage-based pricing are feasible. For ageneral set of customer characteristics, it is shown that in the presence of contract administrationcosts, offering fixed-fee pricing in addition to a non-linear usage-based pricing schemeis always profit-improving, and there may be markets in which a pure fixed-fee is optimal.Moreover, it is proved that the optimal usage-based pricing schedule is independent of thevalue of the fixed-fee. These results imply that the optimal pricing strategy is never fullyrevealing. A procedure for determining the optimal combination of fixed-fee and non-linearusage-based contracts is presented.Applying these general results to specific: business contexts suggests a number of operiGtional guidelines for designing pricing schedules, and managerial insights for setting pricingpolicy. For instance, in nascent information markets, firms are most likely to profit from lowfixed-fee penetration pricing, but as these markets mature, the optimal pricing mix shouldexpand to include a wider range of usage-based pricing options. The effects of changes inproduct value and administration costs on the adoption levels of different pricing schemes,optimal quantity discounts, firm profitability and total welfare are analyzed. Strategic pricingresponses to changes in market characteristics are described, and the implications of thepaper's results for bundling and vertical differentiation of information goods are discussed.