Pricing digital products has always been a weird touchy subject. Anyone that’s ever taken a microeconomics class knows you should set price to when marginal revenue equals marginal cost in order maximize profits. However this causes a huge problem for digital goods because the marginal cost of reproducing a digital good is very low; therefore the price of digital products, if left to the marketplace, will tend to be low as well.
As a followup to my post last time on Is Price a Point of Difference, I’d like to elaborate on when it makes sense to give something away for free.
Free versions make sense for two reasons. (1) the low marginal cost of creating another copy means it doesn’t require any additional investment to give this away. (2) Digital products are often “experience” goods where customers don’t know the value until they’ve actually tried it. Free versions provide customers with an easy way to test out a digital product.
But you can’t just give everything away for free all the time, else you won’t have much of a business. It is best to only offer a free version if you are trying to achieve one of the following goals.
1. Building awareness. A lot of game makers provide free demos in order to entice consumers to pay for a full version.
2. Gaining follow-on sales. Many mobile games do this by providing a full version of the product, and selling additional upgrades or services within the game. The idea is that the more people use it, the more interested they’ll be in add-ons. Dropbox and McAfee antivirus are great examples of companies who have executed this well.
3. Network effects. Many digital goods only become valuable once a large number of people are using them, so a free version can be a good way to bring a product’s user base to the tipping point. Facebook is probably the most famous example of a company that has huge network effects. Adobe also did this quite well in the 90’s by giving away a simple version of its Acrobat software to print and view pdfs. Then selling full versions of the program at a premium to anyone who wanted to create, share, and encrypt documents over the web.
4. Gaining competitive advantage. Microsoft gave away its internet browser in order to prevent Netscape from gaining market share over desktops. If you have a portfolio of products and free is something you can sustain, then this might be a valuable tool.