David Skok contributes to the Wall Street Journal: Do the (Freemium) MathFebruary 27, 2013
Wall Street Journal
by David Skok
Guest mentor David Skok general partner at Matrix Partners: If you’re an app developer, you are likely dealing with a variety of important choices: Should I make my app free or paid? And if I make it free, how will I ever make money?
Will users ever convert to paying? How much should I charge?
Freemium vs. Paid. For mobile-app developers, let’s start by looking at the question “Will I make more money with a freemium approach than with a paid app?”
Like many of today’s marketing questions, some important insights can be gained by looking at the conversion rates at each step in your funnel. Imagine we have the opportunity to test both approaches in parallel.
We start with 1,000 people who see the app in the app store.
10% of the viewers decide to install the app. (100 users)
50% of the installations are for engaged users. (50 users)
6% of the engaged users convert to paying. (3 users)
They each pay $1. We make $3.
Paid App Math:
0.2% of viewers decide to install the app. (2 users)
They each pay $1. We make $2.
See what other startup mentors have to say about making money on apps.
In this example, the math shows us that the freemium approach is going to make us more money than the paid app. But the outcome depends on the assumptions we make for conversion rates, monetization and the number of users the app ultimately attracts. Use your own intuition to help you make an informed decision.
Modelling the funnel like this also highlights the key factors to focus on: Getting more viewers to see the app in the app store. A quick look at the top-grossing apps in the iTunes store shows that paid apps have given way to free apps with in-app monetization.
The Appeal of Freemium. There are several things that make freemium a highly attractive way to acquire customers. Because it’s a much easier decision for a prospective user to try out a piece of software that is free, you will typically get far more users for your app. (As a counterpoint, you should watch out to make sure that you are attracting the right kind of users. Sometimes, the customers you want will be put off by free, with the thought that the product can’t be “serious enough” if it’s being given away.)
Once you have a user, you have the chance to build a trusted relationship with them. This helps make them feel more comfortable parting with their money at the point in time when they decide to move to paid.
Freemium apps allow you to extract more payments from the user over time. A great example is Zynga ZNGA +4.46%’s popular game Farmville, where users continue to buy virtual goods like crops, tractors, etc.
If you are able to break through to very large numbers of users, this becomes a truly powerful marketing advantage. There is a tipping point that can be reached where word of mouth takes off. It allows you to appear bigger than your competitor, even if they have greater revenue than you. You become the market leader, which is a self-reinforcing phenomenon.
Press, analysts, bloggers and other influencers talk about market leaders more frequently. If you achieve this coveted status, you’ll end up with third parties writing software around your APIs, which adds functionality.
One of the most powerful ways to acquire customers is through viral adoption. Most of the top apps in our lives (Facebook, Skype, GMail, Dropbox and YouTube to name a few) got there through viral adoption. This works best when the application has specific viral features (Skype works best if the person you want to talk to is also using Skype).
What is clear is that if you want viral adoption, you must have a free application. If something costs even as little as $1, the friction introduced will kill your viral coefficient.
To make the freemium approach work, you need to solve not just one, but two challenges.
Make a free application that is compelling enough to engage users.
Come up with a reason that is compelling enough to make these users pay.
For startups, it’s hard enough to solve the first challenge. Finding a second compelling feature makes the problem much harder.
Certain freemium apps (Dropbox) have sidestepped the problem of needing to come up with additional premium features by using a simple capacity limit — two gigabytes for Dropbox. Storage is free, and you pay once you go over the limit.
There are two common mistakes made with the Freemium model.
In an effort to keep the paid version compelling, important features are removed from the free version, resulting in a loss of users who no longer find the app compelling.
The free version is so good that users feel no reason to upgrade.
This reinforces the need to come up with two highly compelling features: One to get them using the free product, and another to get them to pay.
Let’s take a look at some of the ways in which freemium apps have managed to monetize their users.
Upgrade to a paid app with premium features
Content subscription (New York Times)
App subscription (Dropbox, Evernote)
Virtual Goods (Games like Clash of Clans)
Other features (Calling minutes for Skype, Text+)
Other forms of subscription (Text+ sells a subscription to get a phone number)
Transaction fees (e.g. Uber)
Sales of physical products (e.g. Fitbit, Nike running shoes, etc.)
This is not an exhaustive list, but it’s a good starting point if you’re considering a freemium strategy.
If you’re still stuck trying to figure out which approach to take, my advice is to model your funnel with both approaches.