Lots has been written about the ethe “freemium” pricing model, particularly as it relates to web services companies. Essentially, it is a penetration pricing play where the vendors attempts to get widespread adoption at a low price ($0) and upsell some form of premium service to generate profits.
Most recently, Knowledge@Wharton has this article. Its no surprise that “free” impact on has a significant on demand:
Indeed, the appeal of “free” has been shown to be so extraordinary that it bends the demand curve. “The demand you get at a price of zero is many times higher than the demand you get at a very low price,” says Kartik Hosanagar, a Wharton professor of operations and information management who studies pricing and technology. “Suddenly demand shoots up in a nonlinear fashion.” Josh Kopelman, a venture investor and entrepreneur who founded Half.com, has written about what he dubbed “the penny gap.” Even charging one cent for something dramatically lessens the demand [generated at] zero cents.
This article has a very way to address this penny gap (which is described in more detail here):
Then there are two-sided markets, which derive revenue from two sets of customers. In those, “whichever side is more price inelastic [less sensitive to price changes], that’s the side you want to charge more [for],” says Zhang. In the case of “Ladies’ Nights,” he says, establishments may increase overall revenue by letting women in for free to attract more males — who are price inelastic in that their desire to be there will not be greatly affected by entrance price.
In addition to “ladies night” the other example given is Adobe which gives away the Reader for viewing PDFs but charges for software to create them. Not too many businesses have solutions that lend themselves to this type of pricing but its an interesting approach if you do.