Using Samples to Decrease Uncertainty When Pricing Experience Information Goods

We develop a model for pricing experience information goods that exhibit initial uncertainty in the marketplace. We show how a combination of heterogeneous consumer valuations of the good and an increasing, but concave, word-of-mouth effect that decreases uncertainty results in an inverted U-shaped willingness-to-pay function for the buyers. With a fixed-price strategy the uncertainty in the market may prevent any sales from occurring, however, initial adoption may occur for well-known producers of the good due to lower uncertainty. This is contrasted with a variable-price strategy where the seller may initially price higher for well-known producers, but may need to price lower for unknown producers of the good. In addition to the word-of-mouth effect, the seller is able to reduce uncertainty by providing a free sample of the good. We show how the sample decreases uncertainty leading to a greater likelihood of initial adoption, but a stand-alone value from the sample may cannibalize sales of the good. While a variable-price strategy captures more consumer surplus, allowing the consumers to retain much of this surplus under a fixed-price strategy may be necessary due to competition from a pirate market. However, if the seller controls the format standard it can make up the difference by selling a complementary hardware device. On the other hand, in a virtual environment a variable-price strategy allows the seller to take advantage of the long tail effect by selling a large number of niche products.