Nonlinear Pricing of Information Goods

This paper analyzes optimal pricing for information goods under incomplete information, when both unlimited-usage (fixed-fee) pricing and usage-based pricing are feasible. For a general set of customer characteristics, it is shown that in the presence of contract administration costs, offering fixed-fee pricing in addition to a non-linear usage-based pricing scheme is always profitimproving, and there may be markets in which a pure fixed-fee is optimal. Moreover, it is proved that the optimal usage-based pricing schedule is independent of the value of the fixedfee. These results imply that the optimal pricing strategy is never fully revealing. A procedure for determining the optimal combination of fixed-fee and non-linear usage-based contracts is presented. Applying these general results to specific business contexts suggests a number of operational guidelines for designing pricing schedules, and managerial insights for setting pricing policy. For instance, in nascent information markets, firms are most likely to profit from low fixed-fee penetration pricing, but as these markets mature, the optimal pricing mix should expand to include a wider range of usage-based pricing options. The effects of changes in product value and administration costs on the adoption levels of different pricing schemes, optimal quantity discounts, firm profitability and total welfare are analyzed. Strategic pricing responses to changes in market characteristics are described, and the implications of the paper’s results for bundling and vertical differentiation of information goods are discussed. ∗I thank Roy Radner for a number of helpful discussions and comments, and Bing Jing and Ravi Mantena for helpful comments on an earlier draft of this paper. All errors remain mine.