How Freemium Gets Consumers to Pay a Premium: The Role of Loss-Aversion

67 Pages Posted: 2 May 2017 Last revised: 25 Aug 2018

See all articles by Nishant Mishra

Nishant Mishra

KU Leuven

Sajjad Najafi

University of Michigan, Stephen M. Ross School of Business

Sami Najafi Asadolahi

Santa Clara University - Leavey School of Business

Andy Tsay

Santa Clara University - Leavey School of Business

Date Written: August 23, 2018

Abstract

We consider the optimal pricing of a freemium product offered by a firm to consumers who are loss-averse with stochastic and endogenous reference points, and the role of the consumers' surprise on their purchase decision about the premium version, after experiencing the free version. We formulate the problem as a multistage Stackelberg game and investigate its equilibrium by determining the consumers' optimal purchase plan, the firm's optimal price to charge for the premium version, and the optimal quality level that the firm sets for the premium version. We show that a consumer becomes more willing to buy the premium version if he becomes somewhat dissatisfied to realize that the free version's value is lower than his expectation. This result goes against the common advice by practitioners that the firms must under-promise and over-deliver to ensure higher profitability. We show that the somewhat-dissatisfied consumer is not only more willing to buy the premium version, but he also could pay a price higher than its realized value. This is a result that does not occur when the consumer is satisfied or entirely dissatisfied with the free version. It also explains the real phenomenon in which many consumers run up massive bills in using freemium products. We show that, increasing the premium version's quality could cause the firm to optimally reduce its price, which is in contrast to our common quality-price intuition: a higher quality product should be sold more expensively. When the quality, price and the consumer's purchase plan are jointly optimized, we show that, the optimal price can increase in the order quantity. This behavior counters the common expectation that when the firm has more available units it should sell them cheaper to avoid the risk of unsold inventory.

Keywords: Stackelberg Game; Freemium; Loss aversion; Pricing; Personal Equilibrium; Gain-Loss Utility

Suggested Citation

Mishra, Nishant and Najafi, Sajjad and Najafi Asadolahi, Sami and Tsay, Andy, How Freemium Gets Consumers to Pay a Premium: The Role of Loss-Aversion (August 23, 2018). Available at SSRN: https://ssrn.com/abstract=2961548 or http://dx.doi.org/10.2139/ssrn.2961548

Nishant Mishra

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Sajjad Najafi

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Ave
Ann Arbor, MI 48109
United States

Sami Najafi Asadolahi (Contact Author)

Santa Clara University - Leavey School of Business ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States

Andy Tsay

Santa Clara University - Leavey School of Business ( email )

500 El Camino Real
Dept of Info Systems & Analytics (ISA)
Santa Clara, CA California 95053
United States

HOME PAGE: http://www.scu.edu/business/isa/faculty/tsay.cfm

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