Recently, a growing number of media platforms have allowed users to pay for a premium version of their service that removes ads. A classic example is YouTube, which launched YouTube Red that is a paid service with no ads. This is puzzling because these platforms historically rely on advertising revenues to grow.
In this research we develop a game theory model to rationalize this strategic move. We argue that this practice is a special type of price discrimination. On the consumer side, the versioning strategy allows different consumers self-select into different offers, with some choosing the standard version with more ads while others opting for the premium version with less ads. At the same time, this consumer segmentation facilitates the segmentation on the advertiser market: the media platforms can now let advertisers choose different ad packages with different prices and audience reaches. In essence, price discrimination on one side can strengthen the incentive to discriminate on the other. This form of price discrimination is termed two-sided price discrimination.
Managerial insight: The theory explains why it makes sense for traditional ad-only platforms like YouTube, Facebook, Instagram, Spotify, iQiyi to adopt the versioning strategy by allowing consumers to pay for less ads. It also explains why it is also reasonable for subscription-only platforms such as Netflix to venture into the versioning strategy by introducing a basic version with ads. At the same time, the theory provides insight into whether it makes sense for the platforms to completely remove ads for their premium users (VIP customers), which has been under heated debate in recent years.