Do you still believe freemium has not run its course?

Let me start by reiterating my past objections about giving Apps away for free in the hope of getting attention now and monetization later. Call it by whatever portmanteau you wish – freemium etc. or use the justification that free is free marketing. It does not matter if customers are not hiring your App for a job they are willing to pay for and you do not take the time and effort to understand customer jobs and position your App for the right job.

The App economy tempts us all with billion customers – small percentage of a large number is still a large number. But trying to target billion customers is what SurveyGizmo CEO described as shotgun approach to marketing.

And guess what? You are not the only one with the same shotgun – the App ecosystem has made the same shotgun available to everyone. There are many just like you and their App just like yours with the same hope of converting the same 1-2% of users into paying customers.

With hundreds of thousands of games, productivity tools and other apps already on the market, and thousands more launched every week, many startups are finding that their ideas aren’t so unique after all. (source)

With all these thousands of look alike Apps, the small percentage of large number becomes small fraction of the small percentage of a large number. Which I assure you is a really small number.

The odds of striking gold in the apps business are quite long. While there are more than 800,000 mobile apps available in Apple Inc.’s App Store, only 80 of them generated more than $1 million in revenue during the fourth quarter, according to research firm Distimo

That is the chances of an App making $4 million a year is 1 in 10,000. And there is no point in trying to do expected value math here because the winner takes it all.

And it turns out Free is not even close to free marketing or to be precise marketing is not free even for free Apps. If you want any thing close to decent installs (let alone frequent usage) it takes considerable marketing resources.

In this environment, well-heeled companies with big marketing budgets hold sway.

It gets worse than Free – you end up paying users to install and tell others about the App as the App maker Mouthee found out

Mouthee ran promotions—giving out free iTunes gift cards or other gifts to users who signed up their friends—which would bring a spike in downloads, but the boost would taper off after a week or so,

Let us recap the App situation

  1. There are hundreds if not thousands with App just like yours
  2. They are free as well
  3. Free isn’t free marketing and marketing isn’t free
  4. Building passionate user base is a myth and the chances a newbie App maker without marketing resources will make it into Top 250 is less than 2%
  5. Chances your freemium App will make $4 Million a year is 1 in 10,000

Finally even when you gain millions of installs, your users can stay on free version longer than your startup can stay solvent,

There are so many startups that die with a whimper

Do you still believe freemium has not run its course?

Cast aside these fads and start with the business first principles to go from plan to profit.

Start with the customers, not your App. The App could be new but the customer needs are not. Whether it is a “bits” product with zero marginal cost or “atoms” product with non-zero marginal cost, customer needs come first. In fact, it is not a product until you have identified a set of customers whose needs you meet and who want to pay you for that value.

Make your choice. Successful strategy involves making choices. You cannot treat billion users as customers. Getting 90 percent of customers to take free Hershey’s chocolates with the hope that they will pay more for extras or will upgrade later is not a strategy.

Get your fair share of the value created. Charging for the product is still the simplest of all business models. Product and platform innovation do not mean business model innovation like freemium (which should never be called a business model). If your product adds compelling value to customers, charging for it is simply getting your fair share of the value created. You do not have to be ashamed of making a profit.

How do you go from plan to profit?

How Discounting Affects Product Value Perception?

It is fair to say everyone loves a discount. There is data to support the claim from years of Black Friday discounting that not only makes customers skip sleep and stand in cold weather for hours but also generates considerable revenue for the retailers. Then there are the group buying discounts made popular by GroupOn.

At the individual customer level, previous research done on customer preference for discounting point to both rational economic and emotional reasons.  Kahneman and Tversky showed, customers prefer discounts even if they saved lower amount in absolute terms.

Thaler in his work on Mental Accounting and Consumer  choice provide evidence of emotional (non-financial) reasons for why we may be motivated by discounts.

So we all value deals for rational and irrational reasons. But how much do we value the product after the initial buying decision? More specifically, since we do not know the absolute values, how much relative value do we place on a product bought on a discount vs. an identical and substitutable product bought without the discount?

There are three distinct possibilities.

Hypothesis 1: If we treat our customers as rational (ignoring the contradiction), once they bought the product at whatever price, the costs are sunk. How much relative value consumers get from each product should depend only on its own merits and independent of initial discount. At the very least, the choice between the two should be no different from  a random choice.

Hypothesis 2: If we treat our customers consistent with their previous action of seeking discounts for non-financial reasons, we should expect them to value the product bought at a discount higher than that of the one bought at full price.  This hypothesis is further reinforced by endowment effect and cognitive dissonance (I must really value this product, otherwise I would not have stood in line for it).

Hypothesis 3: Customers value the full price product more than the one bought at discount (remember the preconditions – identical and substitutable products).

So I conducted an experiment. The data and analysis show that  the last scenario, Hypothesis 3, is more likely than the other two.

The experiment was designed to get customers to reveal their preference by asking them to give away one of the two identical products of same price:

  1. One they bought at full price
  2. Other they bought at 50% discount

As it turns out, customers are more likely to keep for themselves the full priced product and happily give away half-priced identical product.  So while discounting may bring in customers, it may hurt by depressing the relative value of the product to the customers.

What does this mean to you as a marketer?

  1. Think again before running 50% deals on any group buying site or allowing your product to be bundled and sold at a discount by other channels.
  2. Attracted by large user base from giving away your product for free? Consider loss in perceived value to the customer.
  3. Know the customer’s end use of the product. If they are predominantly buying it for their own use, discounting most likely will not help improve lifetime value of the customer.  If they are buying it for others, discounting helps.

Want more actionable insights? Talk to me.

Further readings:

Kahneman and Tversky – Choices, Values and Frames, American Psychologist,  1984

Thaler – Mental Accounting and Consumer Choice, Marketing Science 1985

Note on the Experimental Method:

I relied on convenient sampling and applied Bayesian hypothesis testing. Compared to conventional, run of the mill hypothesis testing, say testing for statistical significance at 95% confidence level using Chi-square test for this case, Bayesian Hypothesis testing allows to test multiple hypothesis at the same time and help state the results in terms of probabilities instead of as absolute truths.

Results are subject to sampling errors, and do not take into account segmentation differences. This is also stated preference study and not a revealed preference study.

Let Us Do Expected Value Math on $0 Price

Once again the power of $0 price is in the news. This time in The Wall Street Journal, featuring research published in Journal of Consumer Research. It is the previously famous Hershey’s experiment from Dan Ariely’s work,

“In one of their experiments, participants were offered a choice between a cheaper lower quality chocolate (Hershey’s) and a more expensive higher quality one (Ferrero Rocher). The price of the chocolates was manipulated between subjects in the following manner: two cents & 27 cents, one cent & 26 cents, and zero & 25 cents. Results showed that whereas there was roughly an even split between the two chocolates in the first two conditions, 90% chose Hershey’s when it was free, indicating a discontinuity in the cost-benefit evaluations. In other words, consumers over-reacted to the free chocolate.”

As it had been said before, “something magical happens at $0 price”.   So a strong case is made for giving your product away for free regardless of the experimental conditions and its applicability to your particular scenario. You are told that Free is Free marketing. But no one bothered to do the math for you on what is the expected value of free. Let us do just that here.

Let us assume the costs are all sunk since you already bought the chocolates. From the text in bold above you can see that:

  1. When the price was 1 cent for Hershey’s and 26 cents for Rocher,  the choice was even, that is 50%. So the expected value of the customer is  (0.5 * 1 + 0.5 * 26) =  13.5 cents
  2. When the price was 0 cent for Hershey’s and 25 cents for Rocher, the choice was 90% Hershey’s and 10% Rocher. So the expected value is (0.9*0+0.1*25) = 2.5 cent

So which option would you choose? One that has an expected value per customer of 13.5 cents or 2.5 cents.

If you believe the free customers generate other revenue, then each one has to make up additional 12.2 cents from whatever means it is.

Just by giving up the 1 cent on the price you could lose much more than 1 cent. In this case, you lost  11 cents and left with the hope that you will somehow make up for it.

What does this say about the wildly famous Freemium model? The Freemium model is about having a free version to get users and hope that they will convert over to paid premium version. Simple calculation from Hershey experiment shows presenting a free version is much worse than presenting a low priced version alongside premium version.

Isn’t it time you do some hard math and reject fads and pseudo economics of social media gurus?

See also:

1. Opportunity cost of $0 price.

2. Dan Ariely cautioning on the dangers of $0 price.

Free to Fee – Kraft Charging For Its Magazine

Kraft Foods has a magazine called  Food & Family that is basically a recipe book that pushes brands owned by Kraft in all its recipes. The print version of the magazine, published quarterly, used to be free to its subscribers. Not anymore.Kraft decided to charge its subscribers $13.98 for an year. Not all customers are amused. The reader comments in discussion boards hosted at KraftFoods.com ask why Kraft is charging for what is a book of advertisements for its brands. Here is one example:

How can you charge for what is nothing more than an advertisement for Kraft products? As a free magazine, I liked looking at the ideas for using your products in the recipes, but upon receipt of my issue today including the invoice, I promptly tore the invoice in half and threw it in the trash. I don’t know how the idea of paying for a bound advertisement for Kraft came to be, but I will not be doing so.

I have written about Kraft’s effective price management before. I like their current decision to charge for their magazine. I believe they would not have decided to charge for this without the required analysis. I can think there is data that shows pricing for this magazine delivers them incremental profit over the free offering. Here are my reasons:

  1. Cost: Kraft wants to move to move their customers from print version to digital version. This is clear in their messaging and from the bulletin board discussions. Moving customers to digital version does result in savings. While one way is to incent customers to switch to digital version charging for print has its advantages. They are applying prospect theory (like some mobile phone providers did for paperless statements) to nudge customers to move to digital version.
  2. Analytics:  With print magazine it is difficult to track to the impact of Ads and promotions on sales unless they use coupons. There is better traceability and ability to run targeted Ads with digital version. This improves their model of customer margins and make better predictions about profitability.
  3. Sharing in value: If the print magazine adds value to customers and if there exists customer segments that only wants to receive the print version then Kraft should get their fair share of the value added. For example, here is one customer comment:

    This is such a beautiful, and well done magazine. I just love it, and this time was almost better than ever, if possible, with the wonderful calendar included. I was as thrilled as a kid in a toy shop. Thank you Kraft!!! :) We all just pour over it reading and rereading it and looking at the lovely presentations, each of us deciding on what to make first, and there are so many good recipes in it.

The net is I think Kraft’s decision to charge for their magazine makes very good business sense.