Nested Network Effects in Online Free Games with Accessory Selling ☆

We analyze the innovative business model of free online games in which game players do not pay subscription fees and the firms generate their revenue by selling accessories—namely, virtual items within the games. The online game market is modeled as a nested network, with the segment of accessorized buyers embedded within that of game players. Both segments exhibit local network effects within the segments, and they impose crossed network effects on each other. We demonstrate that offering free games emerges as the revenue-maximizing strategy when the positive network effect of the game is high and the negative network effect of the accessory is low. We distinguish between two major types of accessories—namely, weaponries and decoratives—via their network effects. The weaponries impose a threat on the game players and subsequently confine the growth of the game; this negative effect is absent for the decoratives, which can thus be priced higher. We also generalize our findings related to online games to cope with other types of network-based free services, ranging from social networks to various kinds of information intermediaries.