Unlocking the Power of Freemium

When do freemium apps boost sales of their paid counterparts?

Platform Papers is a monthly blog about platform competition and Big Tech. Blogposts are written by prominent scholars based on their research. The blog is linked to platformpapers.com, an online repository that collects and organizes academic research on platform competition.

This blog is written by Yiting Deng, Anja Lambrecht and Yongdong Liu.

Digital platforms have enabled individuals and businesses to access audience and markets in unprecedented ways. Central to the success in this digital realm is the ability to monetize digital offerings. There are various methods for monetizing digital content, including freemium models, subscription models, pay-per-download or pay-per-view, and advertising.

The freemium business model, a blend of offering a “free” and a “premium” version of a product, has gained considerable traction in the digital space. Well known examples include Dropbox, LinkedIn, Spotify, etc. For mobile apps, freemium apps are those that offer a complimentary version with basic features while providing opportunities to unlock advanced or premium features for a fee. This can be accomplished by providing a separate paid premium version of the app, or more recently, through in-app purchases or subscription plans. Essentially, the free version provides consumers an opportunity to explore the app without incurring any immediate financial cost. The notion of sampling, a fundamental aspect of freemium models, is not exclusive to the digital realm. Well before digitization, merchants would distribute free samples to consumers to allow them to try the product. Similarly, in the software industry it has long been common to offer free trials. These trials typically came in two forms: time-limited trials (providing a free, fully functional version with a limited trial period) or feature-limited trials (offering a free, perpetual “light” version with restricted functionality).

In the context of freemium apps, developers typically opt for feature-limited trials. The free version grants users free access to the app’s core functionalities. For example, a freemium game app might allow users to play a few initial levels for free, while reserving advanced levels for the premium version. While sometimes users can access the premium version as a separate downloadable app, in other instances, these advanced levels can be unlocked through in-app purchases.

Despite the popularity of the freemium business model, a crucial question remains: Does the existence of a free version boost or undermine the sales of its existing paid counterpart? On one hand, the free version provides consumers with the opportunity to try out the product before committing to a purchase, potentially driving up demand for the premium version. However, on the flip side, the free version might cannibalize sales of the paid version. So, does the availability of a free version enhance or undermine the sales of its premium counterpart? How should developers design freemium apps to increase conversion rates?

In a recent paper published in Management Science, we set to answer these questions. We compile a comprehensive and granular data set on mobile game apps from Apple’s App Store and identify apps that offered both a free version and a paid version. In our sample, the majority of freemium apps initially offered a paid version and later introduced a free version. We focus on these apps to analyze how the introduction of the free version affected the paid version’s demand. Interestingly, we find that the introduction of a free version boosts the demand for its paid counterpart, suggesting that such positive effects outweigh any possible cannibalization. It is, however, not immediately clear why the free version of the app increases the sales of the paid version, instead of cannibalizing it. To better understand why this is the case, we explore two possible mechanisms: sampling and app discovery.

Sampling

We first explore whether the free version may benefit the paid version because it allows consumers to sample the paid version before making a purchase. After exploring the free version, if the consumer enjoys the app but wants to gain access to more functions, they would then upgrade to the paid version. In this way, the free version can increase the paid version’s demand through sampling.  

When would the benefits from sampling be most prominent? If, for example, information such as previous ratings indicate that the paid version is of low quality, consumers have such low expectations of product quality that it is not worthwhile incurring the hassle of sampling, and as a consequence, offering a free sample will have little effect on purchases of the paid version. Conversely, if there is information suggesting that the paid version is of very high quality, consumers may prefer to purchase the paid version directly – if they expect that the full and better version justifies its cost, they may consider it not worthwhile to go through the effort of downloading and using an inferior version. The sweet spot therefore lies in the middle: it is only for products where publicly available information, such as ratings, suggests a medium quality level that sampling matters. Indeed, we identify this inverted U-shaped relationship between an app’s average star ratings and whether the free version indeed increases demand for the paid version.

App discovery

With the very large number of available apps, one challenge for apps may be to be noticed by consumers. Statista reports that Google Play had 3.55 million apps and Apple App Store had 1.6 million apps. As a result, it may be difficult for any individual app to be visible to consumers, put differently, it is harder for a consumer to find the “needle in the haystack”. Could the availability of a free counterpart make it easier to find a paid app? We explore our data and compare categories with a smaller or larger number of available apps. Our results show that for a category with more apps, the extra visibility from a second version matters less. This makes sense: if the “haystack” is large, the relative benefit of a second app in helping discoverability is less than if the “haystack” is small. This pattern suggests that indeed the availability of two versions makes it easier to discover the app.

Balancing act: What should be free?                              

The success of a freemium app hinges on striking a balance between free and premium features. App developers must ensure that the free version remains useful and engaging while offering a compelling incentive for users to upgrade. How can developers strike such a balance?

In our data, we observe differences between the paid version and the free version, and analyze which differences are most effective in driving demand of the paid version. There are mainly six dimensions along which the two versions may differ:

• First, the paid version allows users to progress to more game levels than the free version, such as a more complete, advanced, or challenging game experience.

• Second, the paid version offers more modes or themes than the free versions. Although the ability to progress or the difficulty of the game does not change, the user experience can be customized.

• Third, the paid version offers more functions or features (e.g., more powerful weapons, record keeping) than the free version.

• Fourth, the paid version allows for social interactions, whereas the free version does not, such as integration with Game Center, Apple’s social gaming network, or linking to Facebook to post scores and share progress with friends.

• Fifth, the paid version is ad-free, whereas the free version is ad-supported.

• Finally, the paid version might provide better user support, for example, an email contact to address user questions.

We find that the positive impact of introducing a free version is particularly pronounced for apps where the paid version offers distinct additional benefits, such as extra game levels, enhanced functionalities, or a broader scope of social interactions. With such “vertical differentiation”, the free version allows consumers to experience the initial game levels with basic functionality, while the additional levels and/or advanced features provide enough value for consumers to upgrade. Likewise, the opportunity to compete, compare scores and communicate with others provides added value for those who enjoyed the initial version, making a purchase of the full version appealing. When the paid version offers more modes or themes, the free version does not affect the paid version’s demand. Such “horizontal differentiation” only changes the appearance but does not improve the gaming experience to a meaningful degree. Interestingly, if the paid version simply removes ads, an ad-supported free version has a smaller benefit, consistent with the notion that many consumers prefer ads rather than paying for content. Finally, if the paid version only provides more support, then the free version would cannibalize the paid version.

Broader implications

When we initiated the project, most freemium apps existed as two separate versions. However, in today’s landscape, it has become commonplace to have a single app version with integrated in-app purchase functions (an earlier blog covers this model). According to Statista, as of July 2023, nearly 97% apps on Google Play app store and nearly 95% apps on Apple App Store are free to download. This trend is observable in the journeys of many individual apps, such as Fruit Ninja, a popular game released by Halfbrick in 2010. Initially, Fruit Ninja Classic (known as “Fruit Ninja” before 2017) was introduced in April 2010 with a price tag of $1.99. Over time, it transitioned to being free to download with in-app purchases. At the same time, Fruit Ninja (formerly known as “Fruit Ninja Lite” and “Fruit Ninja Free” before 2017) was introduced later in October 2010 and has always been available as a free app.

While our study focused predominantly on apps with separate free and paid versions, its implications are relevant for apps offering in-app purchases and have broader relevance beyond the mobile app market. For digital firms and app developers, the study offers three salient takeaways:

First, it substantiates the effectiveness of a freemium strategy in increasing demand for the paid version of a product. Second, the results indicate that a freemium strategy is most effective for products that prior users evaluated as moderately good. Third, the findings demonstrate that to truly benefit from a freemium strategy, firms need to ensure a sufficiently large difference between the value consumers receive from the free and the paid versions to induce upgrades. In pursuit of this goal, developers should carefully consider which features should be made available for free.

This blog is based on Yiting, Anja and Yongdong’s research, which is published in Management Science and is included in the Platform Papers references dashboard:

Deng, Y., Lambrecht, A., & Liu, Y. (2023). Spillover effects and freemium strategy in the mobile app market. Management Science, 69(9), 5018-5041.

Platform-Paper updates

I am excited about the Platform Leaders Future of Digital Platforms conference later this week at London’s Science Museum. Benoit and Laure from Launchworks asked me to put together a panel on the Future of Platform Research.

In my opening remarks I will document the evolution of platform competition research by pulling some descriptive stats from the platformpapers reference dashboard (for example, mobile app stores are now the most popular empirical context for platform research, replacing video game consoles). It’s an excellent opportunity to start preparations for 2023’s Year In Review post.

My colleage JP Vergne (whose work is included in the references dashboard and who’s written an excellent blog on decentralized platforms and Web 3) and Xu Zhang at the London Business School (whose work will soon be included in the reference dashboard, surely) have kindly agreed to showcase their work at the panel.

I have known Benoit and Laure for some time now and a few months ago I sat down with Benoit for a conversation about network effects. We discussed what network effects are and what firms should take into account when designing their products for network effects. The conversation has been cogently summarized in two separate articles: What are network effects? and The power of network effects. Enjoy!

On top of all of this, several interesting papers have been added to the Platform Papers references dashboard this month. Here are some highlights:

• A paper by Takanori Adachi and colleagues (published in The Journal of Industrial Economics) studies the implications of consumer multihoming in two-sided platforms. Their economic model shows that “the required merger-specific cost reduction is larger if consumers benefit more from multi-homing and that the equilibrium level of platform entry can be insufficient in the presence of consumer multi-homing.” In other words, contrary to popular belief, multihoming does not necessarily alleviate the need for stricter (merger) policy.

• A study by Suzana Varga and colleagues (published in the Journal of Business Venturing) tracks the growth trajectory of Takeaway.com, a successful food-delivery platform, to identify the drivers of ‘platform scaling’—the ability to accommodate growth and add revenues without a commensurate increase in costs. The authors conclude that managers at Takeaway.com “purposefully and repeatedly use and revise a portfolio of decision rules to cultivate indirect and data network effects, which allows them to initially facilitate the growth of their platform and over time support the transition to scaling the platform.”

• A study by Arslan Aziz and Rahul Telang (published in Information Systems Research) looks at the consequences of ratings inflation on platforms. While ratings can reduce search costs, ratings inflation, where the overall average rating increases and the variance in ratings decreases, can dampen the informative value ratings provide. Analyzing data from a quasi-experiment conducted on another food-delivery platform, the authors find that while sales surge following an inflation in restaurant ratings, such inflation decreases user trial and leads to an overall increase in sales concentration among the most popular restaurants.

That’s all for now. See you next month!

Platform Papers is curated and maintained by Joost Rietveld.