Optimal Pricing of Information Goods under the Freemium Strategy in the Presence of Piracy and Network Effects

Abstract

Information goods providers adopt the freemium model to increase their user base and maximize their profits. However, a serious piracy problem cannibalizes the demand for legal goods and deeply harms firms’ interests. We investigate the optimal pricing of information goods under the freemium strategy in the presence of piracy and network effects. In this paper, we consider consumers’ perception change to determine the market structure by a two-stage model. In this model, consumers are heterogeneous in their goods quality preference, and they update their quality perception after using some or all functionality. We provide important insights into pricing decisions in all market structures under piracy for firms that adopt the freemium model. The results show that a portion of consumers who use free version will become paying consumers under some conditions. This finding explains why providing a free version is usually effective because it can not only expand the user base but also help the firm obtain more paying consumers. The results also show that some pirates will buy the premium version in the second stage in certain conditions, which confirms that pirated goods can be regarded as sampling goods to some extent. Finally, the premium version’s optimal price and the firm’s optimal profit increase in the network effects and piracy cost in the presence of piracy.