Optimality analysis of freemium with usage limitation strategy

In this dissertation, the focus is on the freemium paradigm for a digital product that imposes a usage limit on free users and allows unlimited usage for paying users. The research methodology involves the formulation of a two-period analytical model of a freemium business that incorporates responses of users who are heterogenous in both the valuation of marginal usage and the inconvenience of insufficient usage. Analyzing the user utility model reveals two possible usage limiting freemium strategies to emerge, where each freemium strategy uncovered is found to be distinct in market coverage style: one attempts to aggressively acquire the whole market and one is more selective at the initial stage. The optimal strategic decisions for both variants of freemium strategies are derived and then benchmarked against a conventional subscription strategy to identify the dominance criteria of each strategy. The degree to which insufficient usage inconveniences free users and the proportion of high valuation users are found to determine critically whether a strategy would dominate others. Notably, the need to alleviate users’ inconvenience would drive the firm to compensate with a higher free usage limit and thus weighs against the performance of freemium strategies. In such circumstances, a more aggressive freemium variant that needs to maintain high free usage and high price is found to be underperforming unlike a more conservative variant that offers modest free usage and lower price. The proportion of high valuation users then determines the optimal strategy between a conservative freemium variant and a conventional strategy, where the latter is shown to outperform if the proportion of high valuation users is very polarizing. Additionally, our freemium model adds to the discussion regarding the appropriate level of conversion rate given the firm’s market by showing that a lower conversion rate should be expected when the firm amasses users aggressively with a freemium strategy.