Many digital distribution platforms such as the iOS App Store and Steam have allowed content producers to operate the freemium business model. In this model, consumers can download a barebones version of a game or app for free, but then have to pay for additional features such as downloadable content or enhanced functionality. The freemium business model removes consumers’ barriers to adoption and allows consumers to more flexibly pay the exact amount of money they are willing to spend. Not surprisingly, the freemium model has taken off in the last few years: in 2016, 76% of all apps on the iOS App Store and more than 11% of the games released on Steam operated the freemium business model. We do, however, know very little about how the choice of this business model affects consumers’ willingness to spend time and money on digital content.
Freemium Study
In a paper forthcoming in the Strategic Entrepreneurship Journal I conducted two studies to get at an answer to this question. In the first study I performed an experiment where I partnered with Dutch video game developer Two Tribes to present their popular game Toki Tori to a group of 246 students. Half of the students were presented the game as a paid game and the other half of randomly selected students were presented the game as a freemium game. After seeing a teaser, some artwork, and a description of the game, students were then asked about their willingness to pay for the game, their willingness to spend time on the game, and their willingness to pay for downloadable content. In the second study I analyzed a sample of 343 games released on Steam in 2014 to see how games’ business models –whether they are freemium or paid- was correlated with the cumulative revenues for these games as well as with the average time individual players spent on these games.
I found surprisingly consistent evidence across both studies. In particular, what I found was that consumers are less willing to spend time on freemium games, they are overall less willing to pay for freemium games, and they are less willing to spend money on downloadable extras for freemium games. In both the experiment and the Steam data I found that gamers spend approximately 30% less time playing a game if it is freemium. I also found in both studies that gamers have a roughly 85% lower willingness to pay for freemium games. Furthermore, in the experiment I also found that gamers are less likely to buy downloadable extras, such as a new game world or a level editor, and spend less money on downloadable extras for freemium games. I found that gamers were 18% less likely to choose a downloadable option and spend 71% less money on downloadable content for Toki Tori if it was a freemium game. Lastly, I also found that consumers are more likely to buy downloadable extras and spend money on such items when there is greater variety in the number of items available.
While certainly not without limitations, what this suggests is that content producers operating the freemium business model, on average, create less value for consumers and also capture less value from their products. It further suggests that content producers are well-positioned by offering premium products that then offer a wide variety of paid extras in the form of added functionality or content.
Sunk Costs
The mechanisms underlying these findings harken back to tried and true theories of consumer behavior in behavioral economics. Designated Nobel Laureate Richard Thaler introduced the “sunk cost effect” in 1980 in which he showed that consumers irrationally attach greater value to products and experiences that they have already paid for. In later work, he further showed that people are more likely to make additional investments when they already have some skin in the game. This explains why consumers are more willing to spend time and money on premium products than on freemium products. Thaler built his theory on yet another seminal theory in behavioral economics, namely “prospect theory” written in 1979 by Daniel Kahneman and Amos Tversky (the former also won a Nobel Prize in economics, in 2002). One of the findings in prospect theory is that consumers have diminishing marginal utility – we are willing to pay progressively less for additional experiences of the same kind. This puts freemium products at double jeopardy: not only are consumers less inclined to spend money on a freemium product, by charging them later in the consumption experience they also perceive less benefits due to their diminishing marginal utility. One way producers can overcome this issue is by offering paid extras earlier, rather than later, in the consumption experience of a product.
I believe my paper takes an important step in better understanding how the choice of business model affects the way consumers interact with a firm’s products. That said, clearly a lot of work remains to be done, especially when it comes to freemium games and apps. For one, because of freemium’s low barriers to adoption we often see that some immensely popular freemium games have tremendous user bases (see many of Valve’s games on Steam). Freemium therefore seems an excellent business model for products that rely on network externalities (such as Skype) or products seeking to build additional income from advertisements – although studies also show that consumers perceive ads as a nuisance. An important question then becomes which freemium games manage to lift off, and why? Other research could be done to better understand how to best design price menus for freemium games. While my research shows that offering greater variety helps, there likely exist boundaries to this relationship, and surely the order or pacing with which extras are offered should also matter.
Read the full paper: Rietveld, J., Creating and Capturing Value from Freemium Business Models: A Demand Side Perspective, Strategic Entrepreneurship Journal, Forthcoming
For more, read the press release on the RSM Discovery blog.
Tags: business models, digital distribution, freemium, research, study Posted by