259 / 2024-04-23 21:30:18

Signaling through free demos: Theory and empirical evidence

Free demos; Signaling; Digital platform; Digital content

In the digital platform, firms often provide consumers with free demos for digital content. The key questions we ask are how free demos signal product quality information and the platform's role in the signaling games. We build an analytical model based on the signaling theory and use a rich dataset that contains 7415 games released on the Steam platform from 1997 to 2019 to examine the results. Our results indicate that: (1) The platform has incentives to help improve the signaling effects of free demos. If the demo quality can signal, the platform would obtain higher profits and set a lower cost per download (CPD) to encourage firms to continue conveying more information through demo quality. (2) When the demo quality cannot signal, the platform would maintain the signaling effects of free demos by charging firms a higher CPD, similar to an exhausting advertisement expenditure. (3) The platform faces a trade-off between the CPD and sales commissions. When the perceived value of a high-quality product is much greater than the low-quality product, the platform prioritizes charging a higher CPD to ensure the signaling effects of free demos while decreasing sales commissions to ensure the firms’ engagement. (4) In empirical results, high-quality firms are more likely to offer demos, and demos cannot signal product quality if the demo quality stays low. Our paper provides helpful suggestions for the platform’s strategic management and the firms’ strategic choice in free demos.