Optimal pricing for new product entry under free strategy

Abstract

A growing number of firms in software industry are embracing free entry strategy to promote product adoption. The prevalence of free strategy can be partly attributed to the positive network externalities exhibited by the information goods. In this paper, we model a new firm’s entry into an existing market with the free strategy. Consumers can use the new product’s basic functionality for free and pay a subscription fee for accessing the add-ons. The entrant firm’s new product infringes on the market in one of the three ways: homogeneous product competition, high-end encroachment and low-end encroachment. We find that the equilibrium market structure varies across the three settings. In particular, there exists a Bertrand equilibrium when the new firm provides a homogeneous product. When the new firm offers a heterogeneous product, our results show that the network externalities intensify the price competition and thus lead to a reduction in the profits. Moreover, whether the new firm should encroach on the existing market with high-end product or low-end product depends on the level of switching cost. If the switching cost is low, the new firm will benefit more from high-end encroachment and vice versa. We also find that it is not always optimal for the new firm to adopt the free entry strategy. In the high-end encroachment, the new firm will be better off providing a product for free if the network intensity is high enough, whereas in the low-end encroachment, the free strategy is dominant only when the network intensity falls within a given threshold.