In the dying days of the dotcom boom in 2001, I bought a sailing boat and spent four months sailing around the Mediterranean with my then girlfriend, now wife. As I was preparing for my trip, I travelled to Captain O. M. Watts, a yacht chandlery just off London’s Piccadilly on Dover Street. It was a marvellous shop, full of ropes and fenders, oilskins and sextants, with an amazing blend of the highly practical and the beautiful but useless. In the back was a room full of Admiralty charts, covering the UK and much of the Mediterranean. With 2,500 nautical miles to sail, I had to buy a lot of charts.
While I was exploring the shop, working out which items I actually needed rather than just wanted, I noticed another guy wandering around it. He was short and balding with a pronounced beer belly that hung low over his blue jeans. His T-shirt was black, not very clean and could not have been designed better to emphasize, rather than hide, his gut. He carried a small bottle that was once used for Evian water, but now had a black-brown sludge in the bottom. Every so often, the man would remove the lid from the bottle, shift the quid in his mouth and spit a wad of tobacco juice into the bottle.
If it had been my shop, I would have kicked the man out. The shop owners didn’t, and I ended up standing behind him in the queue. He took out a black American Express card and spent, if memory serves, in the region of £20,000 ($31,000).
You never can tell who your best customers are going to be.
I give masterclasses on how to make money from free-to-play games to companies who are making the transition from a traditional fixed-price model. In the model that most people are familiar with, customers pay upfront for a product. In the case of games, that used to mean paying $60 for a console game or perhaps $5 for a game on early generations of mobile phones. Now the iPhone and Android charts are filled with games that players can download for free and where fewer than 10 per cent of customers typically pay anything at all. Many traditional game makers view the 90 per cent of customers who never pay money directly as evil freeloaders, only a slight step above being evil pirates. This is a big mistake.
The first business model that most people propose when asked how they might make money from the 90 per cent of users who never pay is through advertising. That can come in the form of display advertising, the pop-ups and banners that we are familiar with, or in the form of lead generation, where a game maker gets paid if we follow an advert from their app to sign up for another game, join a gym or watch a sponsored video.
Advertising is a well-understood business, although it requires a different set of skills from those required to build an audience through the creation of high-quality content. The premise of the advertising business is simple. It is a cross-subsidy. Instead of us, the consumers, paying for something, we get it for free or at a discounted rate. To take the example of free-to-air television, the television broadcasters commission and transmit programmes to draw in audiences. Advertisers who want to sell products to those audiences pay the broadcaster to air their advertisements. We get television for free and we pay with our attention. The broadcasters earn our attention with programmes and pay for it by charging advertisers. The advertisers subsidize our free enjoyment. The same model is in place throughout the media, at events, as part of the revenues of many retail stores and elsewhere.
Advertising and lead generation have one very important limitation in a connected, online world. Advertising is a volume game. To make money in advertising you need large numbers of users and to be able to show them a reasonable number of ads. There is a perpetual trade-off between keeping the rates you can charge for your ads high by maintaining a focused, targeted audience versus increasing revenue by increasing the number of users or the amount of ads that you show. Advertising revenues inhabit the world of Mediocristan.
Advertising revenue models are best suited to businesses which have massive scale and preferably some form of distribution monopoly, like television broadcasters.* In an open market like the web or mobile apps, competitive pressures have a habit of driving advertising rates downwards. In many cases, it may be better to consider another value of freeloaders: as potential converts.
Getting real people to pay for a product is a great way of building a business or funding the creation of your art. It can be hard to tell whether a freeloader is going to be a freeloader for ever or, like our sailing friend, is going to convert into one of your best customers. Research from Chinese games firm Papaya suggest that customers who go on to be the biggest spenders – those who spend $100 or more per month – don’t start spending until they have played the game at least eight times.1 In a world where you are trying to build a relationship with your customers and let them spend varying amounts of money, it makes little sense to kick them out unless financial pressures make it essential that you do so.
The concept behind the Curve varies from the freemium model. In most freemium businesses, the product or service is offered free but users are charged for advanced features or functionality. Venture capitalist Fred Wilson, an investor in businesses such as Twitter, Tumblr, Zynga, Etsy, Meetup and Foursquare, describes the model as ‘Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced value added services or an enhanced version of your service to your customer base.’2 The freemium business model has come under fire for creating a huge audience of freeloaders that cannot be sustained by the small proportion of users who do pay. Initial proponents of freemium such as software-as-a-service providers Basecamp and Huddle have moved away from a free offering either by eliminating it entirely or by switching to only targeting large corporations. With conversion rates of only a few per cent for most freemium businesses and often a real cost for supporting the freeloaders, the model didn’t work for many businesses that tried it.
It didn’t work not because too many people paid no money but because the biggest fans couldn’t spend enough money. They could spend only a fixed amount. Freemium became a volume game where companies had only two variables: the number of users of the service and the number who paid. In technical terms, freemium is often implemented as a business model that focuses more on audience size and conversion rate than it does on ARPU (average revenue per user). In a world of the Curve, allowing your biggest fans to spend lots of money is key. In freemium, the revenue you could make from your biggest users is often capped. Subscription businesses face a similar challenge. A fixed subscription caps the amount that your biggest fans are able to pay, forcing you to focus purely on acquiring new subscribers rather than servicing your existing customers so well that they want to spend more money with you.
The Curve adds a third element: variable pricing. It focuses not just on getting lots of users (which is difficult and expensive) and improving your conversion rate (which is hard) but on adding layers of value that allow users to spend ten times, a hundred times or even a thousand times the average. It is about allowing your business or art to thrive in Extremistan, not Mediocristan. It doesn’t require a large volume of users to enable your business to make a profit, although a large volume can equal massive success. Just ask Supercell, maker of Clash of Clans and Hay Day. It doesn’t require the very different skills of making great products or services on the one hand and talking to advertisers on the other, so a strategy that excludes advertising allows you to focus your efforts on satisfying your customers and fans. Instead of the only way to increase your revenues being to increase volume, you can expand either by growing volume, or by raising price, or both.
Tumblr, the microblogging site that allows its users to share photos, short comments and videos, is one of the top ten most visited sites in the US, according to audience measurement company Quantcast. In November 2012, it had 170 million unique users, who viewed 18 billion pages. Yet according to Forbes, the company made only $13 million revenue in 2012.3
In stark contrast stands Venan Entertainment, a developer of mobile games based in Cromwell, Connecticut. In 2011 the company released Book of Heroes, a free role-playing game on iOS and Android mobile devices. The company doesn’t have a huge audience for the game, getting about 100,000 unique players per month, and perhaps 25,000 unique players per day.* The company is on track to make $3 million in 2013.
Venan, with fewer than 200,000 unique users playing Book of Heroes, is making around a quarter of the revenues that Tumblr made in 2012. That’s an audience of just 0.1 per cent of Tumblr’s making 25 per cent of the revenue, through application of the Curve.
Freeloaders are not just sources of revenue. They are also one of the most potent sources of marketing. Marketers have long regarded word-of-mouth recommendation as the most powerful form of promotion, and one of the hardest to achieve. With the advent of social networks, sharing what you enjoy has become even easier.
The viral sensations of ‘Gangnam Style’ and the Harlem Shake happened at unprecedented speed due to the ease of sharing across the globe. Freeloaders are critically important in places like the App Store, where by downloading, using or spending in an app, users can contribute to its chart ranking. To be in the charts you either need to spend lots of money on customer acquisition, or you need your existing customers to love your game so much that they each persuade several of their friends to check it out. In reality you probably need elements of both. We have seen how Electronic Arts and others gamed the App Store so that their products appeared at the top of the charts on Christmas Day when consumers were opening their new iDevices. We also saw how the price war between Sony and Amazon over ebooks in the UK affected the charts when many ebooks were available for a very low price. I picked up a copy of 1,227 QI Facts To Blow Your Socks Off for 20p for my Kindle in February 2013, a discount of 98 per cent from the publisher’s recommended retail price. It was at number 4 in the paid Kindle store, behind Life of Pi by Yann Martel, The Hundred-Year-Old Man Who Climbed Out of the Window and Disappeared by Jonas Jonasson and Safe House by Chris Ewan, all of which were also available for 20p.
The marketing value of users is enormous. We have already seen that in this world of social media, the big are getting bigger and the niche is getting more viable. Free users acting as viral marketing are vital to both elements.
There are some things in life that are unmissable. On TV, the Olympics, Queen Elizabeth II’s Diamond Jubilee and the finales of certain shows have already been mentioned in Chapter 4. In 2012, every woman in my social sphere had to have read Fifty Shades of Grey. In my world of technology-savvy game players it was hard to fit in if you hadn’t seen ‘Gangnam Style’ on YouTube, played The Walking Dead on your iPad or experienced Angry Birds Star Wars.
This is nothing new. Throughout the twentieth century we’ve had shared cultural experiences. The difference is that even in this era of time-shifting and streaming, of personalization and niche content, there are some experiences which we all want to talk about, to share, and to experience either in person or via social media. The big experiences benefit from being talked about. A lot.
So do the small ones. Word of mouth enables niche products to thrive. But word-of-mouth recommendation can be at its most powerful when acting on that recommendation is made as frictionless as possible. Technology is making it ever easier to go from a recommendation to a download or purchase. I can click on a friend’s recommendation on a social site and go straight to a purchase page. The friction is reduced even more if the price of the product is free.
It turns out that ‘free’ is a very different psychological price point to ‘cheap’. Psychologist Dan Ariely demonstrated this irrational behaviour that relates to free products in a famous experiment using Hershey’s Kisses chocolates.4 Ariely set up a table at a large public building. He offered two kinds of chocolates: high-quality Lindt truffles and ordinary Hershey’s Kisses. A large sign above the table read, ‘One chocolate per customer’. Customers could only see the chocolates and their prices once they stepped close to the table.
Lindt chocolates are high-quality Swiss chocolates that Ariely describes as ‘particularly prized, exquisitely creamy and just about irresistible’. They cost Ariel about 30 cents each when he bought them in bulk. Hershey’s Kisses are less special: the company makes 80 million of them every single day. Ariely started the experiment by setting the price of Lindt chocolates at 15 cents and Hershey’s Kisses at 1 cent. ‘We were not surprised to find that our customers acted with a great deal of rationality: they compared the price and quality of the Kiss with the price and quality of the Lindt truffle, and then they made their choice. About 73 per cent of them chose the truffle and 27 per cent chose a Kiss.’
The purpose of the experiment was to see what impact free had on people’s rationality, so Ariely then lowered the price of both chocolates by 1 cent. The Lindt was priced at 14 cents while the Kiss was now free. ‘What a big difference FREE! made. The humble Hershey’s Kiss became a big favourite. Some sixty-nine per cent of our customers (up from 27 per cent before) chose the FREE! Kiss, giving up the opportunity to get the Lindt truffle for a very good price. Meanwhile, the Lindt truffle took a tumble; customers choosing it decreased from 73 to 31 per cent.’
Ariely repeated the experiment in different circumstances and with different conditions. His conclusion is that free is a very powerful motivational price. It gives us an emotional charge that increases the perceived value of what we are getting. More than that, we will often take the free option because it is perceived as being lower risk, as eliminating the possibility of loss. We often ignore the externalities (such as the time taken to download an app, or the limited amount of storage space we have on our iOS devices) because the lure of free is so powerful. Most importantly, Ariely shows that the difference between an app that is free and an app costing 99 cents is much bigger than the difference between $0.99 and $1.99. Even though a dollar is a tiny amount to pay for a game, an amount that most of us wouldn’t flinch from spending on a cup of coffee with barely a thought, it is vastly, unimaginably, infinitely more expensive than free. (Expensive is very important too. That is covered in Chapter 9.)
David Barnard has first-hand experience of this. Barnard is an independent designer of productivity apps that he publishes on the App Store. His business, App Cubby, makes an app for keeping track of your car’s fuel consumption and another, Launch Center Pro, which makes it easy not just to launch apps but to launch actions within those apps, such as ‘Call Home’ or ‘Search Yelp for nearby coffee shops’ from a single shortcut.
On 31 May 2012, Barnard released Timer, a simple-to-use app that improves on the built-in features of the iPhone. He priced it at 99 cents. Over the next three months, he saw nearly 9,000 downloads and $6,000 in revenue, but by August, downloads had slowed to a crawl. Barnard’s development philosophy is that ‘the future of sustainable app development is to give away as much value as possible and empower those who receive more value to pay more for it’.5 So he decided to allow people to have the functionality of Timer for free, but to let people spend more on it if they want to with in-app purchases (IAPs). The IAPs were simply different themes: aesthetic choices which allowed people to customize how the app looked and the sounds it played when the timer was up. They started at 99 cents. The most expensive IAP was the Ultimate bundle, $9.99 for all the themes and sounds both in existence now and that App Cubby might release in the future. None of the IAPs were necessary to use the app.
On the first day that Timer went free, downloads jumped from just twelve copies to 25,000. The app has now been downloaded over 200,000 times, more than twenty times its installed base when it was paid. It has made $8,000 as a free app. More than half of the revenue came from the 672 people who decided to upgrade for the full Ultimate Bundle, choosing to pay $10 for an aesthetic upgrade to an app where the core functionality is available for free.
These results happened despite some challenges. The original paid app was featured by Apple. The free version wasn’t. Barnard says he made a tactical error with the free launch too. He turned the product free without having the in-app purchases in place. He got a spike in downloads but there was nothing for them to buy for a long time. Despite these errors, by going free and letting those freeloaders who wished to spend money do so, he has an audience twenty times bigger than he had before, and a third more revenue. Barnard is a believer in the power of free.
The Curve is not dependent on having a free offering. The heart of the Curve is allowing customers to spend lots of money if they wish to. It doesn’t require a starting point of zero, although that may increase your audience size. Many games companies are experimenting with a paymium business model where customers pay up front to buy the game and are then able to spend more on in-app purchases if they wish. It is not without risk – customers are more forgiving of something they got for free asking for money than something they have paid for upfront – but it does shield a traditional business against making the painful decision to offer its core product for free.
The Curve is a defence against piracy, where many customers can get your products for free. Piracy is not the real long-term threat. That comes when competition from new upstarts or brave incumbents pushes the price of anything that can be shared digitally to zero because the new player has figured out how to let the high spenders subsidize the freeloaders. Smart businesses and artists will start experimenting with ways to enable their biggest fans and best customers to spend lots of money on things they truly value now, before it becomes the only way to survive. They will make their mistakes when they have alternatives, and can survive some of the experiments failing. They will prepare for the moment when it is no longer possible to put a pay barrier between their end users and their product, service or art.
Then they will pick their moment. Different industries are at different stages of development. Games has already made the transition to free voluntarily. Music has done so involuntarily. Movies are still at a premium price point, both in theatres (sustainably) and on DVD (less so). I expect Penguin to charge for the ebook version of The Curve because it is not yet essential that all ebooks be free, although I think that day will come. If customers are still prepared to pay, it may be worth letting them do so, until you figure out how to make more money by allowing them to get the product for free and paying you more money further along the Curve.
Free is a powerful tool for getting users to your product, service or art. It is not that users aren’t prepared to spend money on apps or music or online services. It is that their fear of loss is strong and when companies find a way to let them experience an app or music or a service for free, that fear is eliminated or reduced. That means more users in the ecosystems to be advertised to, to tell their friends or to move along the Curve to become high-spending customers.
They also provide the context within which users spend. The final reason why freeloaders are so important is because they act as gawkers. Gawkers are so critical to understanding the Curve that they have a chapter all to themselves.