One of the great pleasures of following the tech world is seeing it rocket makers and doers to the top. Brilliant people guided by powerful intuitions, with little tolerance for theory. Never boring! But theory distrust has a downside, as shown by last week’s mixed reaction to the excellent rant about the game Dungeon Keeper “How In-app Purchases Have Destroyed The Industry.” [Update: Follow up here.] Apparently people are shocked (yes shocked!) to find there’s free software on the internet. Less flippantly freemium pricing, giving an entry level free product away, is a big deal. Not just for gaming. So let’s have another go at the topic using what I’ll call the Minimum Viable Free Product (MVFP). With deep apologies owed to Eric Ries for the play on words on his quite distinct and deservedly influential idea of Minimum Viable Product.
First some quick review. Economists define perfect competition as a market with many buyers and sellers, undifferentiated commodity products, and no barriers to entry. Plus a host of other constraints. Under perfect competition, prices drop to marginal costs and profit drops to zero. And digital goods, by which I mean software, music, movies, ebooks, online “MOOC” classes, newspaper websites, etc., have nearly zero duplication costs. This means the closer the internet brings us to perfect competition, the closer we get to free. This topic has been discussed for a long time of course. See Chris Anderson’s 2008 piece in Wired “Free! Why $0.00 Is the Future of Business“. So one way to think about this is to ask what’s preventing prices from dropping to zero?
Start by recognizing the consumer market is very different than enterprise (business selling to business). In consumer, the end users are the buyers, the products are less differentiated, and there are many more buyers and sellers overall. More from Ben Thompson here. Second, network effects can move us to monopoly behavior. Third, we know customers themselves face large costs when switching to a new product. In fact the “switching costs” of discovering and learning how to use a new product are becoming the single largest cost inflicted on the customer. This means we’ll never hit zero as a pure price point, especially in business. But we can get really close.
What business models sidestep free? At a high level two: bundling and freemium. With subcategories beneath each.
So how to know which model fits your market? Nate Weiner from Pocket (via Phil Libin from Evernote) has a great framework. Pause to read it. First determine whether your product decreases in value over time (food or games), stays flat in value over time (news), or increases in value over time (Evernote, Dropbox). My twist is adding a table underneath Weiner’s diagram, showing more detail on the pricing model to use.
So if your value goes down over time charge lump sum. For food up front. For software as an in app purchase, or becoming less common using an up front nominal fee. Where consumer software also has the option of ads. If your value stays flat or goes up over time, charge a subscription. Again, ads become an option for consumer. The wildcard here of course is bundling/unbundling/rebundling, as Marc Andreessen points out. Stepping back, we have a general framework for analyzing digital goods pricing, where zero marginal cost is eating the world. Think of the above framework as the “default” pricing model. A great starting point, but not definitive for every case.
Bear with me for one more theory and terminology step. As many others have said, I think long term all businesses selling digital goods need some type of free, entry level product. For consumer, it’s because the market demands it, and is ok with bundling ads. But for business, the critical reason you need a freemium product is value grows with usage over time. Virally seeding the market with a free version of your product gives two huge advantages: 1) massive leverage to upsell, 2) barriers against new entrants. Freemium is also the only model built on the bedrock of human switching costs, which can never be competed away. So rather than charge $x for a subscription, have a free version and charge $2x for the full product. Justify this higher rate after free usage has grown the value proposition and switching costs are eliminated. In the end, creating a free version should be thought of as a marketing cost. Pay it. So we get back to my made up term: Minimum Viable Free Product (MVFP). The term is slightly distinct from freemium, since it allows you to talk about the free version of the product (the MVFP) as something different than the business model. Freemium in common usage tends to mean business model, not the product. So it’s a bit awkward to say a company should “go freemium”, when what you really mean is they should keep their current business model intact but add an MVFP to their portfolio. The terminology also emphasizes how the free product should be both minimal and viable. But maybe the world doesn’t need another clunky acronym. In that case I’ll say straight up I think every business selling a digital product (software or media) should embrace freemium. Accurate enough.
Regardless of the terminology, right now even some exceptionally well run and deservedly loved companies, like say Basecamp, don’t provide a free version of their product. They provide a free trial of the full product, which is not the same thing at all. I get it. As a product manager it’s painful to slice up a beautifully designed and wonderfully easy-to-use product just to retrofit a freemium version. Or alternatively give away a usage capped version of the full product for free. But look at your market. Hasn’t this become table stakes? If not now, what about several years from now? Which brings us back to the complaint about in app purchases for games. The solution is not to be naively shocked about in app game purchases, declaring freemium is ruining the world. Rather it’s to artistically work within that market constraint to create something great. If nothing else, make your game’s in app purchase a way to unlock new levels. Which is at least fair and won’t make people angry. In the end what EA did to Dungeon Keeper should be called what it was: crappy design.
Let’s wrap up with the table below. It’s an overview of internet products, showing what changes are needed, if any, to get to a “pure” MVFP. We’re closer than you might think.
Some final comments. One way to think of mp3 music files is as an “in app purchase” to get full control of a particular song. While this won’t go away completely, I think archiving media files on your local device won’t continue to be mainstream behavior. Those files belong on the servers of the people you pay your subscription to. And regarding games, in app purchase isn’t the only way to go. Flappy Bird is (or at this point was) pure ads. And MMO games like World of Warcraft have value which grows with time, so subscriptions can and do work. Another caveat I’ve seen is claiming niche software can charge up front because with fewer buyers/sellers we move away from perfect competition. That’s true for now. But misses the larger shift in norms taking place. Once things work a certain way, people expect everything to work that way. For example what happens when you click on a Wall Street Journal link from twitter and hit a pay wall? Anger! Note: pro tip is copy title into Google search to bypass the paywall. We also need to keep sight of the fact that even though this brutal price competition is horrible for producers, it’s great for customers and society at large. In any case, the point here is once cultural norms get broadly established, everyone has to abide. So eventually even niche software will need an MVFP. As the quality of someone’s shoes reveals more than they intend, so does a companies’ freemium offering.
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References for this post:
- Quite a few people I enjoy and learn a lot from on twitter commented on the Dungeon Keeper rant, which is what precipitated this post. For example John Gruber, Benedict Evans, Hiten Shah, Horace Dediu, Ben Thompson.
- A Dungeon Keeper debunker response to the original is here.
- Naturally the Freemium article from wikipedia is excellent. And free! The term was coined in 2006, but the idea goes back decades. I’m old enough to recall getting free software CDs in the mail in the 1980s/1990s. My recollection is companies spent 5 minutes disabling the File>Save menu and then shipped the CD. Sometimes I feel that level of thoughtlessness is still the norm for companies producing freemium versions today.
- Hard not to mention again Chris Anderson’s 2008 piece in Wired “Free! Why $0.00 Is the Future of Business“.
- Also, another link to Nate Weiner’s post mentioned above which is where I copy/pasted the idea for segmenting products by whether they decline, are flat, or grow with value in time.
- Recent article on the growth of freemium.
- Solid 2011 article on the death of up front purchases for games.
- The excellent Marco Arment is working on a new prodcast app, and has some great pricing commentary I’ve learned a lot from. Start here.
- Marc Andreessen recently posted a flood of tweets on 8 business models for news. To retain your sanity, avoid reading on twitter and go to the tumblr version. What encouraged me is his 8 business models can be mapped into my more plodding framework above without much difficulty. 1. Advertising (check), 2. Subscriptions (check), 3. Premium content (check), 4. Conferences & events (bundling check), 5. Cross-media (think this is really a combo of advertising + bundling, so I’ll claim check), 6. Crowdfunding (charity bundling? ok, check), 7. Bitcoin for micropayments (my opinion is micropayments will never work because it’s the worst of both worlds. Lump Sum. But unpredictable budget destroying lump sum. Parents hated having their kids on a charge by the minute phone/text plan for a reason. So doesn’t fit my model. But since I think it won’t work for the news use case I’m ok with the lack of fit.), 8. Philanthropy (check. bundling with charity).
- Last but not least, this is my 9th post on “Digital Economics”. A term loosely pulling together how zero marginal cost digital goods are impacting everything. More in this same vein here https://praxtime.wordpress.com/category/digital-economics/
Praxtime by Nathan Taylor 
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