Want to edit your selfies, track your sleep, chart your baby’s development, or build a virtual world on your phone? There are apps for all of those things – and most are free. But new Maryland Smith research has a message for app developers: Don’t rule out introducing a paid app just because it seems like the industry is swamped by free ones.
Yes, most apps are free. And most fail. “They fail because they just couldn’t generate enough money to sustain,” says Jie Zhang, who worked with fellow Smith marketing professor Michel Wedel and their former Smith PhD student Seoungwoo Lee, now an assistant professor at Tulane University, on the research, featured in the Journal of Marketing.
Zhang cautions app developers: “Just because so many apps are offered in a free version doesn’t mean that’s the best way for all apps to enter the market. Don’t shy away from offering the paid version if the right factors align.”
Zhang, Wedel and Lee tracked about 580 top apps for 13 months to analyze app developers’ versioning decisions and monetization strategies. They used a sophisticated economic model to determine whether an app maker should offer free or paid versions of their app, both at the same time, or eliminate one of the versions.
“Fundamentally, it depends on the app’s ability to monetize from different sources,” Zhang says.
Developers make money when users download a paid version on an app. For free apps, they can make money by selling advertising that consumers see while using the app. For both versions, they can also generate revenues by charging real money for virtual items that people can use within the app, such as additional weapons, sparkly gems or stamina in a video game.
“Developers have to think about, at any given point in time, how much money they can make from each of the sources,” Zhang says. “But the even bigger consideration is what is the future revenue stream.”
To attract advertisers, app developers need to have a sizable customer base, which takes time to build. Likewise, relying on in-app purchases as a revenue source depends on having a lot of users making the often small purchases.
So why not just offer both paid and free versions of an app?
“There are complex interplays between the paid and free versions of apps,” Zhang says. “It’s not always synergy.”
The researchers find, over time, as either version of an app becomes more popular, a developer can expect more new users to download it in the future, thanks to word-of-mouth and social influence among current users. But they also find a contemporaneous cannibalization effect – that is, if paid and free versions of an app are available simultaneously, a user is unlikely to download both, especially if they have to pay for one.
“What we found is that the versioning decision depends on the lifetime stage of an app,” Zhang says. “The optimal launch decision is not necessarily the best decision throughout the rest of the life of an app.”
At launch, many apps would be better off by offering only a paid version, they find. This applied to about 40% of apps in their sample, with the caveat that the researchers’ sample included larger, more successful apps. “Offering a paid version in an early stage can help generate sales revenue quickly to help offset the development and marketing costs of an app and fund the development of future upgrades and launching a free version,” Zhang says.
Then, over time, many developers do best by adding a free version of the app so that at some point, both versions are available.
However, when both versions of the app are available, as time went on, the researchers found that the presence of a paid version could lead to a significant reduction in the free version’s customer base, which would have negative consequences for the app maker’s bottom line.
“We suspect the paid version siphons away the most devoted users, who tend to be more engaged with the app,” Zhang says. That can result in a reduction in the in-app purchase rate among free users.
“For apps that see a clear trend of this, at some point, it actually makes sense to eliminate the paid version,” Zhang says. The researchers found that the average optimal time to do so was about 1.5 years after launch for apps in their sample.
The “it depends” strategy also kicks in across app categories, Zhang says. For utility apps that help users do something, such as tracking behaviors, paid versions tend to be more attractive all along. “They don’t necessarily attract the biggest customer base, they’re not really conducive for selling in-app advertising, and they also usually don’t have a whole lot of virtual goodies to sell. But people are more willing to pay to download because these apps help them get things done.”
In contrast, entertainment apps – like those that stream music, videos or games – are very strong in their ability to generate advertising revenue and sell in-app items. “We found that most of those apps would be better off just offering the free version alone throughout their lifetime,” Zhang says.
For app developers, the researchers say the most important takeaway from their findings is to constantly monitor your revenue streams and future potential along the stages of an app’s lifetime, and don’t remain tied to one strategy.
For many, the researchers say this is the optimal strategy:
“Use paid apps initially to help fund your business. Once the free app has been propped up, and strong enough to make money, monitor the impact of both versions, especially being mindful of the potential negative impact of the paid version on the free version when the free version has been introduced. There is a point where perhaps it’s not worth keeping the paid version anymore.”
Read the research, “Managing the Versioning Decision over an App’s Lifetime,” in the Journal of Marketing.
Read "When to Release Free and Paid Apps for Maximal Revenue," on the American Marketing Association website.
Media Relations Manager