Economics of Free Under Perpetual Licensing: Implications for the Software Industry

Information Systems Research, 2014, Vol. 25, No. 1, pp. 173-199

Posted: 29 May 2011 Last revised: 27 Oct 2015

See all articles by Marius Florin Niculescu

Marius Florin Niculescu

Georgia Institute of Technology - Scheller College of Business

D. J. Wu

Georgia Institute of Technology - Ernest Scheller Jr. College of Business

Abstract

In this paper, we explore the economics of free under perpetual licensing. In particular, we focus on two emerging software business models that involve a free component: feature-limited freemium (FLF) and uniform seeding (S). Under FLF, the firm offers the basic software version for free, while charging for premium features. Under S, the firm gives away for free the full product to a percentage of the addressable market uniformly across consumer types. We benchmark their performance against a conventional business model under which software is sold as a bundle (labeled as 'charge-for-everything' or CE) without free offers. In the context of consumer bounded rationality and information asymmetry, we develop a unified two-period consumer valuation learning framework that accounts for both word-of-mouth (WOM) effects and experience-based learning, and use it to compare and contrast the three business models. Under both constant and dynamic pricing, for moderate strength of WOM signals, we derive the equilibria for each model and identify optimality regions. In particular, S is optimal when consumers significantly underestimate the value of functionality and cross-module synergies are weak. When either cross-module synergies are stronger or initial priors are higher, the firm decides between CE and FLF. Furthermore, we identify nontrivial switching dynamics from one optimality region to another depending on the initial consumer beliefs about the value of the embedded functionality. For example, there are regions where, ceteris paribus, FLF is optimal when the prior on premium functionality is either relatively low or high, but not in between. We also demonstrate the robustness of our findings with respect to various parameterizations of cross-module synergies, strength of WOM effects, and number of periods. We find that stronger WOM effects or more periods lead to an expansion of the seeding optimality region in parallel with a decrease in the seeding ratio. Moreover, under CE and dynamic pricing, second period price may be decreasing in the initial consumer valuation beliefs when WOM effects are strong and the prior is relatively low. However, this is not the case under weak WOM effects. We also discuss regions where price skimming and penetration pricing are optimal. Our results provide key managerial insights that are useful to firms in their business model search and implementation.

Keywords: software markets, freemium business models, economics of IS, software diffusion and adoption, software versioning, seeding strategies, product sampling

JEL Classification: B21, C70, D42, D82, D83, L86

Suggested Citation

Niculescu, Marius Florin and Wu, D. J., Economics of Free Under Perpetual Licensing: Implications for the Software Industry. Information Systems Research, 2014, Vol. 25, No. 1, pp. 173-199. Available at SSRN: https://ssrn.com/abstract=1853603 or http://dx.doi.org/10.2139/ssrn.1853603

Marius Florin Niculescu (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
404-385-3105 (Phone)

HOME PAGE: http://scheller.gatech.edu/directory/faculty/niculescu/index.html

D. J. Wu

Georgia Institute of Technology - Ernest Scheller Jr. College of Business ( email )

800 West Peachtree Street, NW
Atlanta, GA 30308
United States
404-894-4364 (Phone)
404-894-6030 (Fax)

HOME PAGE: http://mgt.gatech.edu/wu

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