Optimal free trial strategy of software in the digital environment

The software industry has gone through a radical transformation in the past decade in the way products are distributed to consumers. The new digital distribution environment has made it easier and cost efficient to offer free trials of digital products, which in turn provided an excellent environment to build the user base quickly. This paper considers a software firm's decision to offer a free version with limited functionality in a competitive software market. We provide a duopoly model of software firms in which a dominant firm determines the relative quality of the free version in order to maximise its profit under network externality. When network externality is sufficiently large, it is optimal for the high-quality dominant firm to offer a limited functionality (i.e., lower quality) free version. The freeware's optimal quality level should be high enough to entice lower-end customers to adopt it, but it also needs to be low enough to benefit from the expanded network by the lower-quality competitor in the market. The high-quality firm's optimal profit and freeware's quality increase as the network externality increases. In addition, when usage cost is sufficiently small, it is the high-quality firm's best interest to keep the quality of its free version below that of the low-quality competitor so that the freeware does not drive the low-quality firm out of the market.