I have been reading Chris Anderson’s Free (for free). I’ll post a review when I am finished but I got interested in the notion of freemium. The idea is that you sell two versions of a product. A ‘lite’ one for free and another one with more features for money.
In a sense, this looks like nothing more than third degree price discrimination or as Hal Varian has called it ‘versioning.’ But there is a difference: the low priced product is free which means that people buying that have some consumer surplus. Interestingly, the standard analysis of price discrimination suggests that that should not happen and the price should be higher leaving those consumers with no surplus and also a product with a sub-optimal number of features. We do get the latter but clearly not the former. The implication of this is that the full version of the product will be priced too cheaply to maximise profits. Consequently, there is more to freemium than just versioning and, indeed, it must be that the free pricing option leads to other benefits: the principal one most likely being that it is useful to ‘try before you buy.’ This will maximise profits, however, only if, in expectation, a consumer’s surplus is zero and some consumers regret wasting their time trying the product. I suggest that data from the iTunes App Store will illuminate on this whole issue but someone is going to have to extract that from Apple.