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Winning the Freemium-to-Premium Product Wars

Xian Gu, P.K. Kannan and Liye Ma

Listen to the authors present their findings (source: December 2018 JM Webinar)

It’s hard to resist the allure of free. One key reason user adoption of the Internet has soared globally is the rise of the “freemium” business model – where users get to use a basic product or service for free, but must pay for a premium version with additional features.

When done right, the freemium business model can help drive massive traffic to companies’ websites, offer a “try before you buy” experience that overcomes user resistance to paying, and convert free users to paying customers. Dropbox is a master of this model. The company has 500 million registered users who receive two gigabytes of free storage. Once they exceed that capacity, however, customers are offered the option to upgrade to one terabyte for a monthly or annual subscription fee. With this model, Dropbox generated $1 billion in revenue in 2017 from 11 million paying individual and business users and continues to grow its user base.

Obviously, someone pays the price for free products. When companies can’t convert enough users to paying customers, they suffer, something we’ve witnessed with media companies such as The Guardian, New York Times, Washington Post, and others. Other companies may even fail. So how can companies better position themselves to succeed in the freemium wars?

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Past research demonstrated that new, high-quality product extensions can cause customers to elevate their perception of the brand overall and be more willing to pay for premium alternatives. The Wall Street Journal famously proved this strategy by expanding digital content, adding new paper sections such as Mansion, and introducing events, which created a membership experience that has quadrupled prices in less than a decade, ending the paper’s previous reliance on heavy discounting.

However, freemium products often subvert this strategy because customers perceive the benefits of the free product to be higher than what a cost-benefit model would predict, preferring it disproportionately to other offerings because of the zero-price effect. Simply put, when customers anchor on free, it can be hard to dislodge them. Thus, companies need to understand customer behavior and activate the right triggers, in addition to extending product lines, if they are to drive sales of their premium offerings.

Our research published in the Journal of Marketing assessed the sales of scholarly content by the National Academies Press (NAP), which offers free online PDFs of its book titles, but charges a price for paperback versions. We conducted a randomized field experiment of customer downloads and purchases on NAP’s website between January and August 2016. We tested three different offerings: 1) the control version, with the free PDF and premium paperback; 2) the PDF, premium paperback, and a new premium e-book; 3) and the PDF, premium paperback, and premium hardback.

Key findings include:

  • Extending the premium product line led to a positive impact on the sales of the existing premium option, the paperback.
  • When customers are offered a new premium product that is higher-quality and higher-priced, such as the hardback, the compromise effect kicks in, and they choose the paperback. Adding the hardback increased the paperback revenue by 8.9%.
  • When customers are offered a lower-quality, similarly priced product, such as the e-book, the attraction effect kicks in, and they choose the paperback. Adding the e-book increased the paperback revenue by 21.5%. The positive impact on paperback sales was stronger for titles that were more popular or lower in price.
  • Marketers who are introducing a lower-quality, lower-priced premium product that is higher-quality than the free product should consider whether it will cannibalize the existing premium product. If so, they should determine whether it will increase overall revenues with higher sales, or negatively affect revenues by causing mass migration away from the initial offering.​

Marketers can use our findings to strategize how to extend their product lines—from which products to offer to which prices to set—to motivate zero-price-loving users to pay for premium goods. Any company that uses the freemium model, including online media sites, cloud services, or digital services, can use this research to drive product revenues and create a more sustainable business.

Read the full article.

Read the authors recent HBR article based on this research.

From: Xian Gu, P.K. Kannan, and Liye Ma, “Selling the Premium in Freemium,” Journal of Marketing, 82 (November).​

Go to the Journal of Marketing​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​

Xian Gu is a doctoral candidate, Robert H. Smith School of Business, University of Maryland.

P.K. Kannan is Dean’s Chair in Marketing Science, Robert H. Smith School of Business, University of Maryland.

Liye Ma is Associate Professor, Robert H. Smith School of Business, University of Maryland.