Lock in and switch: Asymmetric information and new product diffusion
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Many new web-based services are introduced as free services. Depending on the seller’s business model, some remain free in the long run, while others switch to pay mode at some point in time. I characterize the relation between buyers and a new service seller when the former are uncertain about the latter’s business model and need to incur a one-time sunk cost before enjoying the new service. I derive a natural signaling equilibrium where the seller plays a “lock-in-and-switch” strategy, while buyers play a “wait-and-see” strategy. Specifically, a high-cost seller starts by pricing at zero and waits for a sufficient number of consumers to adopt the new service, at which point the seller switches to pay mode. In this gradual separation equilibrium, the signal is given not by the price level (which always starts at zero) but rather by the duration of the introductory offer. Finally, I show the equilibrium entails diffusion even though consumers are identical and equally aware of the new service’s existence.
KeywordsDiffusion Asymmetric information
JEL ClassificationD11 D21 D82 L11 L12
The author thanks Jim Anton, Kyle Bagwell, Yuxin Chen, Judy Chevalier, Tülin Erdem, Mike Katz, Alessandro Lizzeri, Barry Nalebuff, Roy Radner, and seminar participants at NYU and ECARES for useful comments and suggestions with reference to a previous (and substantially different) version of this paper. The usual disclaimer applies, especially considering the differences between this and previous drafts of the paper. The author is also grateful to the Editor and to two referees for helpful comments and suggestions. A previous draft under the same title was circulated as NYU Stern WP EC-07-11.
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