Competing on Free(mium): Digital Competition with Network Effects
56 Pages Posted: 13 Jun 2017 Last revised: 25 Feb 2019
Date Written: February 22, 2019
“Freemium” product strategies—in which a free basic version of a good is offered alongside a full “premium” paid version—have become relatively common in digital products and services. When should freemium be used? Will appropriate use of freemium be associated with high profits? Building on past research, we predict that the answer relates to the closeness of competition in the market, the strength of network effects, and the market position relative to a competitor. Our main contribution is to bring empirical evidence to systematically test whether, the strengthening of network effects, studied through the establishment of “Game Center” on the Apple App Store (in a differences-in-differences research design) influenced the use of freemium strategies and subsequent performance. Consistent with theory, we find Game Center led to increased freemium use, a consolidation of market share around market leaders, lower performance for market follower firms, and ambiguous effects on market leader performance. The theory and evidence show that freemium and network effects do not always increase performance and profits. Even as the market share of the leader grows with freemium and network effects, freemium can spur an off-setting race-to-the-bottom price competition.
Keywords: Digital Innovation, Freemium, Network Effects, Competitive Strategy
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