Freemium and price discrimination

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.

4 thoughts on “Freemium and price discrimination”

  1. There is a possibility that the implicit costs of, say,  downloading  software and learning how to use it are roughly equal to the utility gained for some portion of the population, so a price of 0 would produce no consumer surplus.
    Presumably members of this population would then face lower implicit costs for the premium version, so some could then face 0 or positive consumer surplus there.


  2. don’t forget the comparison of pirated “try before you buy” versions, the free version is competing with the pirated product with serialz on bittorrent. Most people using software in business will buy the licence but the rest of us mucking around with photoshop etc for a couple of weeks the lite version is just fine.
    Getting someone to download a legit free version (trojan free) is a big plus in general marketing.
    Remember in P2P filesharing, the product is the advert.


  3. Funnily I’ve just this last 30 minutes ponied up $24 aus for the full version of  Allway Sync ‘n’ Go 9.2.21 from
    I was using the free version for a few weeks to sync data with my small Imation 2.5″ portable 350Gig HD and it was so good I used it more than allowable for free. I was happy to get out the credit card and pay and get the activation code in 30 seconds.
    Worked ok this time for them.


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