In 2012, the Wall Street Journal published an articled titled “When Freemium Fails”. The article remarked that, despite the attractive features of the popular digital business model, many freemium products fail to attract sufficient users, let alone generate revenues. Indeed, it is not uncommon for freemium products to have conversion rates (the share of paying users among a product’s overall user base) between two and five percent. Academic research, including by myself, later substantiated these observations: Freemium products may offer users an attractive entry point into a product, average use rates and customer spending on these products, however, tend to be well below that of traditional paid products.

Still, some of the most popular digital products nowadays are brought to market with a freemium model. Examples include the hit video game Fortnite, the online dating application Tinder, and the file-hosting service Dropbox. Base versions of these products are offered at no cost to consumers, who can pay for optional content and features (such as character upgrades, exposure to romantic partners, or extra storage capacity) via in-app purchases. These examples represent a small group of freemium superstars—freemium products that are among the most-downloaded products in a market, which also generate substantial revenues for their commercializing firms.

This raises the following questions: Which freemium products are more likely to become a superstar? How do these dynamics differ from paid products?

The double-edged sword of social product features

In a recent study, co-authored with Joe Ploog at the UCL School of Management, forthcoming at the Strategic Management Journal, we address these questions by focusing on a common design strategy for freemium products: the inclusion of social product features, such as multiplayer modes in video games, ride-sharing functionality in ride-hailing apps, and virtual collaboration tools in productivity software. Such social features enable interactions among a product’s users, which, when present, enhance the product’s value in use.

Analyzing a large dataset of 9,700 digital PC games released on the Steam platform, we find that freemium products that incorporate many social features (such as online competitive play or local cooperative play) are 49 percentage points more likely than freemium products without any social features to become a superstar when they are released when the platform itself has a larger rather than smaller installed user base. Conversely, when the platform’s installed user base is small, freemium products are 26 percentage points less likely to become a superstar if they incorporate many social features. Notably, we find that these mixed effects do not apply to paid products.

Let’s unpack these findings a bit. Social product features can help freemium products attain widespread diffusion. By their very nature, freemium products enjoy strong social referral. We tend to be more likely to recommend products when they exhibit low risks to adoption (i.e., when they are free). We are also likely to share freemium products because we want to reciprocate to the products’ commercializing firm the benefits we receive for free. Social product features can amplify these tendencies. When the value of a product depends on the number of users, we might be even more likely to recommend a product, in the hope of growing its user base and expanding the social interactions.

That said, a product with many social features likely won’t generate much value if it lacks a large user base. Indeed, a game like Fortnite isn’t much fun if there is no one to play with. Google Sheets doesn’t differentiate itself much from Excel if it isn’t for the ability to collaborate in an online environment. Uber’s Pool functionality won’t help you save (on the environment) if there’s no one to share a ride with. Even worse, absent a large user base, consumers may feel they are missing out on key features if the product strongly relies on social functionality for its value proposition.

This is where the platform’s installed base comes in. The platform’s installed base is a strong indicator of a product’s demand potential, given that products released on a digital platform can only be adopted and used by those users who have first adopted the platform itself. When a product’s demand potential is constrained—because it is released on a platform with a small installed base—it’s less likely that social features will come to fruition. Users may be reluctant to adopt—let alone recommend—these products. To be sure, a freemium product without social features faces an equally constrained demand potential, however, it doesn’t require a large user base to confer its core benefits.

Finally, why, then, did we find that these mixed effects of incorporating social features on becoming a superstar do not apply to paid products? This is mainly because of two reasons: First, users are more likely to make an independent value assessment of paid products that is less reliant on social referral. After all, the decision to adopt a paid product is more consequential given the upfront payment that’s required. Second, users will, on average, spend significantly more time on paid products because they want to “get their money’s worth”. Put differently, users may dip in and out of freemium products because they do not incur any costs to adopt these products in the first place. Combined, these differences suggest that, even when paid products incorporate social features, they will be less reliant on widespread diffusion to create value for users.

In conclusion

Freemium is a challenging business model to get right. Despite many appealing features, many freemium products fail. That said, when freemium products do succeed, they tend to succeed to the point where they become superstars. Such products enjoy disproportionately more users, more usage, and more in-app purchases. Our research on digital PC games shows that freemium products are more likely to succeed by incorporating social features when they are launched on a platform with a large installed base, whereas freemium products without any social features are more likely to succeed when they are launched on a platform with a small installed base.

Author: Joost Rietveld - joost.rietveld@rug.nl

Joost Rietveld is an assistant professor in the department of Strategy & Entrepreneurship at the UCL School of Management of University College London and a Visiting Associate Professor at the Innovation Management & Strategy department at the University of Groningen. His research is at the intersection of technology strategy and innovation management, with particular emphasis on platform competition, the impact of digitization, and demand-side strategies.

References:

Rietveld J, Ploog, JN. On Top of The Game? The Double-Edged Sword of Incorporating Social Features into Freemium Products. Strategic Management Journal, forthcoming.

This blog was first published as a blogpost for the Strategic Management Society