Product Line Extension in Consumer Software Markets in the Presence of Free Alternatives

Hypercompetitive consumer software markets pit incumbents against free alternatives and pirates. Although the extant literature has studied firm level strategic responses to consumer heterogeneity and piracy, there is a lack of understanding of consumer reactions to digital goods choice sets that include firm product extensions such as the introduction of premium or free alternatives. With context-dependent preferences as the theoretical basis, this study systematically examines the impact of piracy controls and product line extensions on welfare in a consumer software market context (i.e., willingness to pay (WTP) and changes in consumer and producer surplus). In two controlled experiments using double-bound-dichotomous-choice WTP elicitation, we investigate how piracy controls and product line extensions impact two different platforms of the same software (PC Adobe applications and mobile Adobe applications) in terms of propensity to pirate and WTP. We show that introducing a premium or free vertical extension has different impacts on consumers’ WTP for the focal product depending on whether it is a low-cost or high-cost market even when controlling for individual differences, such as price fairness perceptions, product feature value, brand perceptions, etc. By contrast, piracy controls reduce piracy rates but have a limited impact on consumer WTP for the focal product in both contexts. By calculating the overall welfare of the market, we show that there is alignment in consumer and producer interests at current and estimated optimal price levels in both high-cost and low-cost markets. However, the introduction of a free product extension leads to a higher surplus in the high-cost market, whereas the introduction of the premium product extension leads to a higher surplus in the low-cost market.