The freemium business model whereby firms offer paid and free versions of the same offering side-by-side presents an inherent trade-off: spending on the paid version surges under conditions of reduced consumer uncertainty that a legitimate and accessible experience with the free version provides, but the free version also cannibalizes the paid version. Many firms attempt to reconcile this trade-off by differentiating the paid from the free version by providing some content or features exclusively in the paid version. We draw on the optimal distinctiveness literature to theorize the performance implications of such paid-free differentiation. We theorize that greater paid-free differentiation reduces cannibalization concerns at the expense of legitimate representation in such a way that paid-free differentiation follows an inverted U-shaped relationship with freemium performance. We further anticipate that paid-free differentiation is particularly salient for freemium offerings that rely on network effects, while it is less of a concern when the freemium offering is ad-supported. Our hypothesis-testing analyses are based on a sample of 18,935 newly released pairs of related paid and free apps from the iOS App Store. The findings from our analyses mainly inform our understanding of freemium business models, optimal distinctiveness, and platform-based entrepreneurship.
