Subscription price and advertising space decisions for online content firms with reference effect

https://doi.org/10.1016/j.elerap.2018.05.007Get rights and content

Highlights

  • A joint subscription price and advertising space allocation model with the reference effect is considered.

  • When the viewer’s sensitivity to advertising is relatively small, the provider should adopt a subscription-support model rather than a hybrid business model.

  • The provider should reduce the advertising space when viewers pay more attention to the viewer experience.

  • The provider will overestimate (underestimate) the profit if he overlooks the negative (positive) reference effect.

Abstract

This paper investigates how an online content provider decides the optimal subscription price and the advertising space allocation considering the reference price effect. We consider a hybrid business model in which the provider offers both a subscription service to viewers and an advertising service to advertisers. The viewers consist of subscribers and non-subscribers, and the latter are only permitted to watch a fraction of the content. We develop a new reference price model by incorporating the viewer experience and examine both constant and dynamic scenarios. We find that it is not always optimal for the provider to adopt a hybrid business model. In particular, when the viewer’s sensitivity to advertising is relatively small, the provider should adopt a subscription-support model (i.e., offering paid content only). Moreover, the provider should reduce the advertising space when viewers pay more attention to the viewer experience. Under the dynamic scenario, we examine the impact of the reference effect on the provider’s decisions. We find that the stable value of the subscription price may not be consistent with the stable value of the reference price when the viewer experience is considered. By comparing profits under different scenarios, we find that when the provider neglects the reference effect, he will overestimate (underestimate) the profit if the initial reference price is relatively low (high).

Introduction

With the development of Internet and data technology, online content (also known as information products or digital goods) has become an essential part of people’s daily lives. In the past, viewers have been unwilling to pay for online content; thus, the offering of content for free has been a popular practice for a long time. In recent years, with the surge of various high-quality paid content and convenient electronic payments, more people are gradually getting used to paying for the content they need. A typical example is the development of the online media industry. In the USA, pay-walls, which restrict access to online content via a paid subscription, are widely adopted by many companies, such as the New York Times and the Wall Street Journal. There are many video services firms (e.g., Hulu in the USA, Youku and iQiyi1 in China) providing high volumes of homemade or purchased hit series and films for viewers. To generate more revenues from advertising, some firms may offer a part of the content for free. A study by the Newspaper Association of America (2012) shows that 62% of the publishers employ a metered model, out of which 95% offer up to twenty free articles monthly. For example, the New York Times offers access to ten articles for free on its website each month (Halbheer et al., 2014).

An online content provider acts like a two-sided platform that joins viewers and advertisers. The provider charges subscription fees from viewers and advertising fees from advertisers. Advertisers are more willing to cooperate with the provider when there are more viewers, but the viewers’ experience will be worsened when the space of advertising increases. At present, many websites are adopting the strategy of combining subscription fees and advertising revenues as the business model (Kumar and Sethi, 2009). To attract more advertisers, the content provider may offer some free content to viewers to enhance the click rate. Meanwhile, allocating more space for advertising increases the advertising revenue but reduces the subscription demand. On the other hand, if the provider reduces the advertising space, the provider may suffer some advertising revenue losses but may gain a larger subscription demand on the viewer side. Therefore, it is important for the content provider to jointly determine the subscription price and the advertising space.

The subscription demand is not only influenced by the price but also by the reference price, a fact that has been confirmed by a large number of empirical studies (Kalyanaram and Winer, 1995). The reference price can be considered as a benchmark against which current prices are compared, and prices above the reference price appear to be “high”, whereas prices below the reference price are perceived as “low” (Popescu and Wu, 2007). Hence, viewers perceive a psychological gain when the subscription price is below the reference price; otherwise, they experience a psychological loss. Prior studies show that the reference price is formed by historical prices. In this paper, we assume that the viewer experience, which is closely related to the space allocated for content and advertising, also has an influence on the reference price level. More specifically, a larger space for content (or a smaller space for advertising) makes viewers feel more satisfied and could lead to a higher reference price. Therefore, we develop a new reference price model for online content in this paper.

The main objective of this paper is to examine the joint decisions of subscription price and advertising space, with the consideration of the reference effect. We construct a new reference price model considering the viewer experience and then develop an infinite-horizon model in which a content provider offers both free and paid content to viewers. We first examine the scenario of constant pricing and constant advertising without the reference effect as a baseline, then we examine the scenarios with the reference effect. Under the scenario of constant pricing and constant advertising with the reference effect, the subscription price and the advertising space are both constant, but the reference price changes over time until it reaches a stable value. The difference between the subscription price and the reference price has an influence on the subscription demand. Unlike static scenarios, the provider can dynamically adjust the subscription price under the scenario of dynamic pricing and constant advertising with the reference effect. Then, the optimal solution is obtained by using the optimal control theory. As an extension, a more general scenario in which the provider can dynamically adjust both the subscription price and the advertising space is also investigated. Finally, we use numerical studies to obtain more managerial implications.

The remainder of this paper is organized as follows. A literature review is presented in Section 2. Section 3 introduces the problem settings and presents the basic model. In Section 4, we investigate three scenarios and obtain optimal solutions. In Section 5, we examine the scenario of dynamic pricing and dynamic advertising with the reference effect as an extension. In Section 6, numerical studies are presented to gain more managerial insights. Finally, Section 7 summarizes the main conclusions and points out future research directions.

Section snippets

Literature review

Our work is related to three streams of research: online advertising, online content pricing and the reference effect.

Model description

A monopolistic online content provider offers subscription service to the viewers and advertising service to the advertisers (the provider will be referred to as “he” and a viewer as “she” hereinafter). We assume that all the content is purchased or produced by the provider, so user-generated content is not within our consideration. The provider may offer some content for free (the proportion is w[0,1]) to attract more viewers. A viewer is able to view all the content after paying a

Optimal solutions under different scenarios

In reality, it is often observed that many providers do not frequently change the space of advertising. This may due to the long-term contracts with fixed advertisers, the operations complexity involved in changing the advertising space and to other reasons. Therefore, we focus on the case of constant advertising space, in this section. We first investigate the base scenario, i.e., constant pricing and constant advertising without reference effect, which is denoted by “BS”. Then, we examine two

An extension

In this section, we consider a more general case in which the provider can dynamically adjust both the subscription price and the advertising space.

The optimal control problem for the online content provider is given by (6). Similar to Section 4.3, the optimal control method is adopted to solve the problem. The Hamiltonian is given byHDC=(1-w)(p(t)+ζa(t))[1-ηa(t)-(β+ϕ)p(t)+ϕr(t)]+wζa(t)(1-ηa(t))-υ(1-w)2(1-a(t))2-κa(t)+λ(t)θ[(1-χ)g+χp(t)-(1-χ)ga(t)-r(t)].

According to the maximum principle, the

Numerical studies

In this section, we conduct some numerical examples to gain more managerial insights. The base parameter values are as follows: σ=0.1, w=0.4, β=0.5, η=0.7, ϕ=0.35, θ=0.6, χ=0.75, g=1.2, ζ=0.4, υ=0.9 and κ=0.12.

Because many viewers are accustomed to the free content model offered in the early years, they might be unwilling to pay a great deal of money for the content when the provider starts to charge a fee, which leads to a relative low initial reference price. Hence, they usually have low

Conclusions

In this paper, we investigate the optimal pricing and advertising space strategies, with a consideration of the reference effect, for the online content provider. We examine four scenarios as follows: constant pricing and constant advertising without the reference effect, constant pricing and constant advertising with the reference effect, dynamic pricing and constant advertising with the reference effect, and dynamic pricing and dynamic advertising with the reference effect. The optimal

Acknowledgments

The authors thank the associate editor and two anonymous referees for their valueable comments. The authors gratefully acknowledge the support from the National Natural Science Foundation of China (71771179, 71371139, 71532015, 71528007) the “ShuGuang” project supported by Shanghai Municipal Education Commission and the Shanghai Education Development Foundation (13SG24). The second author gratefully acknowledges the support from Bosch-Tongji University Chair of Global Supply Chain Management.

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