Freemium strategies dominate software product markets, with many, if not most, apps attracting new users with a free version, then requiring payment for more advanced features. The strategy is successful in attracting users, but there is very little empirical evidence showing its impact on a company’s bottom line. New research published in the Strategic management review in November changes that, with data suggesting that this oft-used tactic has its limitations for generating revenue, especially for companies lagging in their market category.
“Freemium strategies often appear as a natural way to exploit a network effect“, says Kevin J. Boudreau, associate professor of entrepreneurship and innovation at Northeastern University and one of the study’s authors. “By offering a free version, companies may be able to increase the size of their user base. But for a business to use the freemium model to increase revenue, it needs to make enough money network advantage in tilting the market.”
Boudreau, along with co-author Lars Bo Jeppesen of Copenhagen Business School and corresponding author Milan Miric of the University of Southern California, created a empirical study using Apple’s launch of Game Center in 2010 and its effect on 485 game application market categories. Like nearly every app category, gaming apps already existed in centralized marketplaces, with the leaders capturing 40% of all app category revenue and the second-tier subscribers only 17%.
The new Game Center introduced powerful network effects to the market with multiplayer and interactive features. To better compete with network effects, many apps moved to a freemium model with their next product update, 70 days later. The researchers used this window, combined with 70 days before Game Center hits the market, to study the performance of freemium strategies. Their analysis included public data on more than 1.4 million mobile apps and proprietary data from a marketing analytics firm to rank apps and identify market leaders and followers.
“While a 140-day sample might seem like a short time in conventional industries, application markets are particularly dynamic,” says Jeppesen, professor of innovation. management. “On average, a market category would experience dozens of direction changes in that short period of time.”
The authors used Apple’s daily list of the top 500 apps sold and downloaded to gauge revenue, using an established method that incorporates revenue ranking, price and download ranking. They found that using freemium strategies in markets with strong network effects widened the already large earnings gap between leaders and followers by 55%. The leaders gained ground and the second-tier supporters lost ground.
“Our results show that freemium strategies can lead to dramatically different outcomes for market leaders and followers in markets with strong network effects,” says Miric, assistant professor of data science and operations. “Network effects had no impact on paid-only products, but significantly amplified leader benefits when freemium strategies are used.”
The study data suggests that freemium models and network effects are not always mutually beneficial, as many software vendors believe. Companies that don’t dominate their market end up suffering when both are at stake, and the Marlet itself suffers as competition and innovation end up diminishing.
Kevin J. Boudreau et al, Competing on freemium: Digital competition with network effects, Strategic management review (2021). DOI: 10.1002/smj.3366
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