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Analysis of Freemium Business Model Considering Network Externalities and Consumer Uncertainty

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Abstract

An emerging business model increasingly used by companies in the online software market is to provide both a free basic version and a paid premium version for a service or a product to customers. Such a setting is often called freemium model. The existence of the free version can reduce the customer uncertainty regarding the evaluation of the commercial software and make use of network effect to improve the firm’s profit. However, the freemium model may also have the cannibalization effect which can hurt the profit. Hence, the firm needs to determine the optimal content for the free version and the optimal price for the premium version to maximize its profit. In this paper, first, we obtain the optimal decisions of the freemium model and their properties. Second, we compare the freemium model with the traditional charge-for-everything model that all content of the product need to be charged in terms of the profit, customer welfare, and social welfare. The results show that when customer underestimates the value of the software significantly and the true value of the software is high enough, the freemium model can generate higher profit, higher customer welfare, and higher social welfare. Otherwise, the freemium model may not deliver the desired results.

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Acknowledgments

The authors are grateful to the editor and the anonymous referees for their constructive comments which significantly improved the study. This work is supported by the Key International Collaboration Project of the National Nature Science Foundation of China (No. 71210003, Research on Electronic Business Based on the Users’ Behavior) and the National Natural Science Foundation of China under granted No. 91646115, 71371191.

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Authors and Affiliations

  1. School of Business, Central South University, Changsha, 410083, China

    Wuhua Chen & Wenjie Bi

  2. School of Management, Zhejiang University, Hangzhou, 310058, China

    Zhongsheng Hua

  3. Department of Decision Sciences, Western Washington University, Bellingham, WA98225, USA

    Zhe George Zhang

  4. Beedie School of Business, Simon Fraser University, Burnaby, BC, V5A 1S6, Canada

    Zhe George Zhang

Authors
  1. Wuhua Chen
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  2. Zhongsheng Hua
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  3. Zhe George Zhang
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  4. Wenjie Bi
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Corresponding author

Correspondence to Wuhua Chen.

Additional information

Wuhua Chen currently is a lecturer in School of Business, Central South University. He got his Ph.D. degree in management science and engineering from University of Science and Technology of China, Hefei, China, in 2016. He visited Beedie School of Business, Simon Fraser University for one year. His research interests include healthcare operations management, business model, revenue management. His publications have appeared in Production and Operations Management, Journal of the Operational Research Society, Computers & Industrial Engineering, etc.

Zhongsheng Hua currently is a Professor in the School of Management, Zhejiang University, Hangzhou, China. He received the Ph.D. degree in computer science from the University of Science and Technology of China, Hefei, China, in 2000. His current research interests include service science, production and operations management, and supply chain management. Prof. Hua’s publications have appeared in Production and Operations Management, Journal of Operations Management, Marketing Science, IIE Transactions, etc.

Zhe George Zhang currently is a professor in the Department of Decision Sciences, College of Business and Economics at Western Washington University, USA. He is also an adjunct professor in management science at Simon Fraser University, Canada. Prof. Zhang received the Ph.D. degree in operations research from the University of Waterloo in 1993. Professor Zhang’s research interests include queueing theory and applications, stochastic dynamic programming, probability models in reliability, and supply chain management issues in manufacturing and service organizations. His publications have appeared in journals such as Management Science, Operations Research, Manufacturing & Service Operations Management, Interfaces, Production and Operations Management, Queueing Systems, Journal of Applied Probability, IIE Transactions, IEEE Transactions, Naval Research Logistics, etc.

Wenjie Bi currently is a Professor in School of Business, Central South University. He received the Ph.D. degree in management science and engineering from the Central South University, Changsha, China, in 2008. He visited School of Business, University of Toronto for more than one year. Prof. Bi’s current research interests include behavioral decision theory and methods, big data analysis, behavioral operations management and revenue management. His publications have appeared in International Journal of Production Research, IEEE Transaction on Industrial Informatics, Knowledge-based Systems, Information Economics and Policy, Journal of Industrial and Management Optimization, etc.

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Chen, W., Hua, Z., Zhang, Z.G. et al. Analysis of Freemium Business Model Considering Network Externalities and Consumer Uncertainty. J. Syst. Sci. Syst. Eng. 27, 78–105 (2018). https://doi.org/10.1007/s11518-017-5342-8

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  • DOI: https://doi.org/10.1007/s11518-017-5342-8

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