Through the Online Revenue Maze

8 Digital Business Models Decoded

By Contents

Preface: Know Your Options...... 3 Glossary...... 4 Popular Digital Business Models ...... 5 Subscription: Committed Customers ...... 6 Subscription Submodels: Three Flavors ...... 7 Frequent Subscriptions ...... 7 Infrequent Subscriptions ...... 7 ...... 7 Microtransactions: Pull in the Players ...... 8 Start Small but Think Big...... 8 Microtransaction Metrics ...... 8 The High Transaction Costs of Microtransactions...... 8 Microtransaction Submodels: Go Virtual ...... 9 and Offer-Based: Scrambling for Indirect Revenue ...... 10 Direct or Indirect? ...... 10 Indirect Metrics ...... 10 Hybrid: Mix and Match to Boost Revenue ...... 11 Hybrid Metrics...... 11 Choosing the Right Model ...... 12 Attracting Customers with Pricing, Packaging, and Promotions...... 14 Top Subscription Promos...... 14 Top Microtransaction Promos...... 14 Best-Practice Tips ...... 15 Conclusion: Match Billing to Your Model ...... 16

2 Preface: Know Your Options

Spending on digital goods, such as games, apps, and entertainment content, exceeded $57 billion in 2013 1. And that doesn’t even account for spending on digital services . Subscription, freemium, microtransaction, and more—digital businesses must choose from an array of business models . The What does Vindicia right model puts you on the path to success, and the wrong model costs you revenue and limits your know about digital offering’s appeal to key customers . business models? Insight from the Get an A+ in Digital Monetization Experts Business Models 101 Acquiring digital goods and services customers Read on for an overview of the most common requires effort and investment . You don’t want types of online business models, along with 143 million customers to buy once and move on . Instead, the advantages and the key metrics associated credit cards processed you want recurring revenue, whether that’s in with each . A glossary of key terms gets things the form of frequent purchases or subscriptions . started . We also shed light on other factors The recipe for success with digital goods is that affect the selection of business models, simple . Acquire customers and keep them, including pricing, packaging, and promotions . ideally for years . Then, we share insights about how the way you bill customers can affect revenue today—and As the leader in subscription and recurring long into the future . revenue billing for digital goods, Vindicia More than $6 billion in understands how important it is to choose the subscription and recurring right business model . Having processed more revenue payments processed than 143 million credit card transactions and $6 billion in payments, we’ve learned a few things about subscription and recurring revenue business models . The Vindicia team has distilled some of the essential details about different business models into this e-book .

1 IHS, “Global Digital Content Spend Rockets to $57 Billion in 2013,” February 2014

3 Glossary

General Terms Terms Associated with Metrics

Account Updater: A service offered by best- Average Customer Lifetime Value (ACLV): Cost Per Thousand (CPM): The cost for in-class payment processors that provides The product of the customer duration and displaying an advertisement to 1,000 users—a updated customer account information from the the average recurring charge . This is a key yardstick for determining advertising prices . card networks . metric for subscription business models . A Related metrics include Cost Per Click (CPC), $15 monthly charge and an average customer Cost Per Sale (CPS), Cost Per Lead (CPL), and Free to Play (F2P): A gaming-industry term lifetime of 20 months result in an ACLV of $300 . ACPM (App CPM) 2. that describes an experience users can have for free, with the option of later purchasing virtual Average Revenue Per Paying User (ARPPU): Monthly Recurring Revenue (MRR): The goods or currencies that enhance game play or The average revenue from users who make amount of monthly revenue that is highly social interactions . purchases . likely to continue in the future, based on subscription contracts and historical customer Freemium: A free service with the option Average Revenue Per User (ARPU): The retention rates . to upgrade to a paid, premium version with average revenue from active users of a product additional capabilities or convenience . or service .

Microtransaction: A payment of a small Cost Per Acquisition (CPA): The aggregate amount of money, also called a micropayment . acquisition cost per user, regardless of the acquisition channel (advertising, promotions, Real Money Trade (RMT): A mechanism by or affiliates) . which users can convert virtual currencies to real money .

Virtual Currency: A type of money used in place of physical currency (real money) .

Virtual Goods: An item that exists digitally, often only relevant within a game or specific online context . Its value can be functional, social, or emotional . 2 To learn about these metrics and other digital performance metrics, see “Metrics for a Brave New Whirled” by Daniel James, CEO of Three Ring .

4 Popular Digital Business Models

The following sections explore the most popular digital business models in detail . This table highlights the major advantages, disadvantages, and key metrics of a few models and associated submodels:

Model or Submodel Major Advantages Major Disadvantages Key Metrics

Frequent subscriptions Predictable revenue High cost barrier ACLV and MRR

Infrequent subscriptions Long-term and predictable revenue Lower retention with higher cost ACLV and MRR barrier

Freemium No price restrictions and no need Challenging pricing strategy since Percentage of paying for free trials the majority of users do not pay users, ARPU, and ARPPU

Microtransactions Low cost barrier for Low margins since the Percentage of paying purchases majority of users do not pay and users, ARPU, and high payment costs ARPPU

Virtual goods and virtual High acquisition rates and low cost management since Percentage of paying currencies barriers the majority of users do not pay users, ARPU, and ARPPU

Dual currencies High acquisition rates, Potential legal issues with RMT and Percentage of paying reduced conversion friction low percentage of paying users users, ARPU, and ARPPU

Advertising Mass adoption with Dependency on market CPM and CPC users assuming no costs rate for advertising and no direct revenue

Offer-based Mass adoption with users Dependency on market rate for ACPM, CPS, and CPL assuming no costs advertising and no direct revenue

5 Subscription: Committed Customers

Subscriptions are playing an increasingly important role in our lives as more and more companies embrace online delivery . Offers range from PC protection and backup services to streaming media and beyond; most digital goods and services can be procured—and sold—on a subscription basis . Subscription Do’s and Don’ts With subscription, the provider periodically Why Subscription? charges customers for a product or service Subscription models offer four concrete according to a predefined cost and schedule . advantages: The two major variations in the terms are:

• A predictable, regular revenue stream • Duration between charges: The billing • Higher ACLV than that of nonrecurring frequency affects how digital businesses DO business models retain and acquire customers . For instance, Ensure that the customer terms and • Greater customer inertia, as compared to some companies charge monthly and conditions clearly explain the purchase other recurring revenue models others on a quarterly or annual basis . details and options for cancellation . • Potential for upselling and cross-selling • Type of customer access: This factor Include contact information for other products or services affects pricing more directly . For example, customer support . digital businesses that adopt a freemium Subscription models bring a couple of model must balance the features and value key challenges, too . First, you must store between the free and paid versions . your customers’ credit-card information in

compliance with the Payment Card Industry Subscription Metrics Data Security Standard (PCI DSS) . Second, fraud rates can be higher than with other DON’T All subscription models share the same key models, since many fraudsters leverage free trial Provide payment options that metrics, such as ACLV and MRR . To compute offers to verify credit card information . require customers to take additional them, you’ll need to track the average customer steps to enable recurring billing . duration, average ticket price, and, depending Multiple options can drag down on the nuances of your model, the percentages conversion rates . of trial and free-to-premium internal acquisition and trial conversions .

6 Subscription Submodels: Three Flavors

Three submodels apply to the subscription model: frequent subscriptions, infrequent subscriptions, and freemium subscriptions . Vindicia Select: The delayed detection of and reaction to customer Secret to High Retention Frequent Subscriptions dissatisfaction . Finally, infrequent subscriptions yield less data for trend analysis . Every month, companies like yours can Frequent subscriptions charge customers lose as much as 15% of subscribers weekly, monthly, or at least once quarterly . It’s a to failed payment transactions—unless widely accepted submodel for online sites that Freemium they use Vindicia Select . Thanks to offer dating, news, information, music, gaming, patent-pending technology, Vindicia video, and both digital and physical services . Freemium offers comprise a free “membership” Select can recover as much as 30% Customer acquisition often takes place through with limited services, and a pay version of failed payment transactions . A small payment-method-required free trials—a proven available by subscription . These services monthly jump in retention can lead to approach . attract a large base of users and monetize a huge increase in subscriber numbers the most devoted group of users . This model over time . works much like a frequent subscription but Infrequent Subscriptions supports users who choose a free version of Higher Retention Leads to the product . A major benefit is the elimination Infrequent subscriptions are those that charge of free trials; acquiring paying customers Higher Revenue customers once every six months or longer . involves only a conversion step . Many online content sites commonly offer Over two years, a 5% monthly increase a long-term subscription option, such as One challenge with freemium subscriptions in retention can yield a >25% increase annual or even two- and three-year plans . This is the need to update and enhance multiple in the paying subscriber base . submodel offers lower transaction costs and a product lines over time—while always more manageable customer base . maintaining a clear difference in value . In addition, calculating ACLV for freemium On the other hand, the higher prices of subscriptions is problematic because it infrequent subscriptions lead to more depends on the conversion percentage of customer abandonment . Less frequent paying users . customer communication can also lead to Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8

7 Microtransactions: Pull in the Players

The microtransaction model is built around small payments, usually considered to be below $5 . With the microtransaction model, customers can purchase content or services on a piecemeal basis . F2P microtransactions rule the world of apps, with as much as 79% of all app store revenue coming from such payments 3. Start Small but Think Big Microtransaction Metrics In the microtransaction model, customers are One big disadvantage of microtransactions: The key metrics to track for microtransaction not as committed to the products as they are transaction costs take a higher percentage of models are Average Revenue Per User (ARPU) with subscriptions, resulting in less overall each payment . The table below shows how and Average Revenue Per Paying User revenue and generally lower customer retention fees eat up a $5 microtransaction as compared (ARPPU) . Tracking them on a monthly basis rates . On the other hand, the lower entry price to a $20 subscription . gives you an excellent baseline for gauging usually leads to higher acquisition rates than success and marketing effectiveness . As with other models deliver . freemium subscriptions, you should also closely track the conversion percentage of paying users . Metrics can vary widely . A recent study of 10 popular F2P games showed ARPUs of between $4 .51 and $1 .32 per user . The High Transaction Costs of Microtransactions

Average Percent of Interchange Percent of Ticket Price Gateway Cost Interchange Transaction Fee Total Cost Purchase Price

$20 .00 $0 .15 1 .7% $0 .15 $0 .64 3 .2%

$5 .00 $0 .15 1 .7% $0 .15 $0 .39 7 .8%

Subscription may have revenue advantages as compared to microtransactions for many digital businesses.

3 Distimo Publication, “How the Most Successful Apps Monetize Globally,” February 2014 4 Superdata, “Comparing MMO ARPU for Major Free-to-Play Titles,” April 2014

8 Microtransaction Submodels: Go Virtual

Two microtransaction submodels have evolved from the simple model described in the prior section: virtual goods—usually accompanied by virtual currencies—and dual currencies . Microtransaction Virtual Goods and Virtual Currencies Dual Currencies Do’s and Don’ts Primarily relevant to gaming and virtual A current trend for F2P gaming and virtual worlds, virtual goods are used in many worlds is a dual-currency submodel, in which ways, from enabling players (customers) to you grant customers two currency types . The personalize their appearance to enhancing their first type is purchased . The second is earned experience . Most virtual goods fall into one by using the product—playing the game or of two categories: those that enhance game spending time in the community . Customers DO play (functional) and those that customize who can afford the credit purchases and want Offer incentives for large credit appearance (social) . Virtual goods business to advance rapidly can buy credits and move purchases, since transaction costs models usually leverage virtual currencies as a ahead, while those who don’t buy credits can represent a higher percentage at lower form of aggregation—typically to entice players earn them and achieve the same results as their price points . For example, if $1 buys to buy more credit, goods, and products . paying peers . 100 credits, offer a bonus promotion of 600 credits for $5 .

DON’T Price carelessly . Figuring out the correct pricing for virtual goods requires just as much effort as it does for real goods . With careful price testing, virtual goods can significantly boost revenue .

9 Advertising and Offer-Based: Scrambling for Indirect Revenue

The advertising model and its variant, the offer-based model, enable customers to “pay” by visiting sites, using products, clicking links, taking surveys, or signing up for other online products and services . Though straightforward and the least burdensome for end users, both models depend almost entirely on the market rates for advertisements and lead generation .

Many digital businesses have found that Direct or Indirect? customers who purchase additional currency Indirect Metrics tend not to fill out advertising offers, preferring Adopting an indirect model is very simple . For Both advertising and offer-based models rely to pay directly through the offer provider . Since the users, the product or service is free . By on the rate at which advertisers pay to display the major benefit of offer providers is connecting browsing advertisements or signing up for offers ads or to acquire leads . Advertising rates are advertisers with consumers, transaction rates from other companies, users can enjoy the defined by CPM (cost per mille; mille means on direct payments are suboptimal . product or service without making a purchase . thousand in Latin), which refers to the number of unique page views . Online products, games, A bigger obstacle to revenue growth relates to The virtual-currency submodel often and services can charge higher rates, but they ownership of customer data . Typically, digital accompanies offer-based models . That is, usually attract fewer daily average unique users businesses host an offer page on their sites users are granted a certain amount of currency (DAUs) than online content sites . and are then paid for successful transactions— in exchange for signing up . Most digital without passing on critical customer businesses do not rely solely on offer-based Opinions vary on the metric for determining information . That makes direct communications models, however . Instead, they build a hybrid prices for offer-based systems . According with customers about promotions or new system (see Hybrid Models on page 13) to to ZenithOptimedia, CPMs are rising, and product capabilities nearly impossible . entice purchases from users who don’t want to premium video commands the highest rates . see ads or accept offers . Zenith reports that premium video placements are commanding $10 .40 in 2014, but general display CPM averages are only about $1 .90 5.

5 Adexchanger, “2014 Forecasts: Global Ad Dollars Surge, Driven by Mobile, Social,” December 2013

10 Hybrid: Mix and Match to Boost Revenue

Many digital businesses blend various aspects of multiple business models . Subscriptions generate steady revenue, but many users don’t want to commit to a subscription . Virtual goods and virtual currencies let users pay as much as they want—but that amount is often zero .

In many cases, combining models makes The biggest challenges of hybrid models are sense . The most common type of hybrid implementation and execution . Any combination combines advertising or offer-based systems of models must complement the value offered with either virtual goods or subscriptions . For without sacrificing the customer experience . example, a software provider might supplement its freemium subscriptions with advertisements for nonpaying users . Or a game company might Hybrid Metrics charge a subscription fee but also sell virtual Tracking metrics is a significant challenge for goods to capture extra revenue . companies with hybrid business models . You must watch the metrics that measure the Advantages of hybrids include: success of each underlying model and consider the effect each model has on the customer • Casual and infrequent users can use the experience . See the metrics described in the service without purchasing, and spend prior sections of this ebook for more information incrementally if they choose to do so— on relevant metrics . essentially setting their own prices . • The most dedicated users are free to purchase as much as they want, with no spending limits . • Layering advertising for nonsubscribers adds revenue and might entice users to upgrade to a paid subscription .

11 Choosing the Right Model

A trademark of successful companies is continuous innovation . Many digital goods companies go through several business models before zeroing in on the one that works best for their products and customers .

This section takes a look at how two fictional digital goods providers evaluate their business-model options and choose the ones that best fit their needs .

Cirruserv draws three conclusions from • Customers will be able to share links and Inside the Numbers this data, along with other user and files for additional fees . Scenario: Cirruserv conversion data: • Cirruserv will raise the monthly pricing to $12 .95 for Standard and $39 .95 for Cirruserv is a software-as-a-service (SaaS) • The product catalog, price points, and Professional, an increase that is projected provider that offers monthly subscriptions to market penetration are not optimally to result in customer attrition of about 20 storage and backup services . Its four offerings structured to maximize overall revenue . percent . However, from an analysis of are Storage Standard, Storage Professional, • The lack of a free trial is turning away some its customer and product survey results, Backup Standard, and Backup Professional . potential users . Also, many who do join Cirruserv projects a monthly ARPU of In an effort to boost revenue, Cirruserv is leave after only a few months, hindering $2 .50, which would more than make up for considering launching a free product . the accuracy of the customer-duration and the lost revenue . ACLV metrics . Financial Data and Conclusions • Each product tier features a large Assuming that Cirruserv attracts 30,000 concentration of “power users” and freemium customers in addition to its 12,000 Here is a snapshot of Cirruserv’s current key “infrequent users,” suggesting a need for subscribers (the original 15,000 minus the 20 financial data: pricing optimization . percent attrition), Cirruserv’s first-year annual revenue increase with a 3 percent upsell • The total number of subscribers is 15,000 . Going Freemium conversion rate from freemium to Standard will • The average customer duration is 15 be $3 .5 million, a 50 percent jump . Cirruserv Cirruserv decides to supplement its current months for Standard and 12 months for may also be able to retain customers for longer product lineup with a freemium offer . The terms Professional . periods with an offer of a free period . Overall, are simple: • The current blended ACLV is $181 across its blended subscriber ACLV would increase by all products, with a split of 85 percent almost 60 percent, to $284 . Standard and 15 percent Professional . • Customers will be offered 1 GB of storage • The MRR is just under $200,000, for an space for free, and charged a small amount annual total of $2 4. million . for each additional 500 MB they consume .

12 Choosing the Right Model

Inside the Numbers Scenario: Kixco Kixco is a new online game company founded by a superstar design team . The company plans to release a new game in six to nine months on its website and the major social networks . The executive team has worked primarily with monthly subscription models and wants to evaluate virtual goods, virtual currencies, and subscriptions as alternatives . To compute the related metrics, Kixco assumed Before deciding on the dual-currency Weighing Business Models a 12-month run rate and calculated the microtransaction model, Kixco considered a averages . Here are the projections: straight subscription model at $4 .95 per month . To determine the right business model for With 100,000 subscribers (again, averaged its target demographic audience, Kixco • DAUs: 100,000 users per day in the first across the first 12 months), the monthly revenue reviewed gaming industry trends and market year and a growth rate of at least 40 would amount to just under $6 million—only half research reports and interviewed potential percent, for a $16 .6 million revenue in the of the revenue projected in the dual-currency customers . The company chose dual-currency second year . microtransaction model . microtransactions as its primary model . • ARPU: About $0 .25 per month, for an annual ARPU of $3 . Kixco plans to offer two types of virtual goods: • Number of subscribers: Half a percent of all those that will enhance game play (functional) the subscribers will upgrade to the premium and those that customize game characters subscription at $14 .95 per month . That (social) . Also, Kixco expects that a subset of equates to a total of 15,000 subscribers dedicated players would pay more for access and $200,000+ revenue per month . to special content and features . To meet • Monthly revenue: Just shy of $1 million, for their needs, the company will offer a monthly an annual total of $11 .8 million . subscription that provides special zones, • Growth: Assuming the company can goods, and designations . increase its DAUs in the second year by 40 percent, it will generate an annual revenue of $16 .6 million .

13 Attracting Customers with Pricing, Packaging, and Promotions

To grow your business, you must continually acquire new customers . While experimenting to find the business model that best meets your needs, you should also assess your product pricing, its presentation, and promotional incentives . One Promo or Ten? Test All Your Ideas with Remember that promotions can also help determine optimal pricing . Similar to in-store Top Microtransaction Vindicia CashBox coupons, online promotions are a viable means Promos to temporarily test multiple price points . • Exclusive content: To target specific Here are the most common types of promotions customer groups, you can offer unique or by business model: special digital goods . You may be surprised by the types • Multipliers: These are bonuses that of promos your customers love, so reward purchases of virtual currencies, it makes sense to try several . Some Top Subscription downloads, etc . marketers find that their ability to try Promos • Referrals: Freemium and F2P sites with different offers is hampered by their microtransactions can offer similar referral payment processing system . It can • Free trials: The trial duration can range awards as subscription-based offerings . take days or weeks to get a single offer from a few days to a full month, depending into the system . Not Vindicia CashBox . on subscription duration, average usage, Vindicia CashBox supports frequent, and customer demographics . iterative offer creation, making it easier • Referrals: Granting upgrades for for you to find the best promos for referrals can be effective in acquiring new your product . customers, especially in a freemium model . • Discounts: Offer customers a price break—such as six months for the price of three—if they subscribe today .

14 Best-Practice Tips

The business models that turn digital goods and services into revenue vary substantially . Picking the right model for your business depends on your industry, customer demographics, product or service, and risk tolerance . Beyond Business Models Regardless of your model, keep in mind these four best-practice tips: As a subscription and recurring • Iterate quickly and decisively: Rapid • Gain insight into your customer base revenue payment platform provider, iteration involves reacting promptly to new and purchase patterns: Understand your Vindicia has learned quite a bit about or evolving market trends and to obvious customers’ needs and the motivations online business practices and digital signs that your strategy is not delivering the behind them . Regardless of your company’s goods . Read all our ebooks for more desired results . Regardless of whether an size, always stay in touch and engage in insights into the practices that can help iteration is aimed at staying ahead of the close dialog with your customers . you win and retain customers . business or recovering from unsuccessful • Add value to your products or services: strategies, closely track results to enable Keep usability in mind and continue to Download additional titles from rapid course corrections . add features, capabilities, and content to Vindicia: • Identify and monitor metrics: Always keep your customers excited about your make this task a high priority . Determine offerings . Targeted promotions and perks Digital Age/Digital Goods: the important and controllable metrics can help drive excitement, but your core Nine Essentials for Acquiring that apply to your business and put the products must constantly improve . Subscription and Recurring processes and infrastructure in place to Revenue Customers track them effectively . You can then make sound decisions and capitalize on them . Thank You for Subscribing: Communicating to Win and Keep Customers

15 Conclusion: Match Billing to Your Model

Do the calculations outlined in this ebook for yourself . They can help you refine your business model . Experiment with models and take a hard look at the expected returns for different submodels . For instance, you may find that adding an annual subscription or even shifting users to monthly billing could lead to surprising increases in ACLV . Innovating with your products and your business model is smart . But trying to take a DIY approach with transaction processing—not smart .

Done well, transaction processing will support your preferred business model perfectly without forcing you into the weeds of PCI compliance . And done with Vindicia, a subscription and recurring payments innovator, transaction processing can add as much as 5% revenue uplift . That’s more revenue for the same level of effort from your team .

Contact Vindicia to learn more about how we help companies that rely on subscription and recurring revenue win more customers and keep them longer .

16 Copyright © 2014 Vindicia, Inc . All rights reserved . Vindicia, the Vindicia logo, Vindicia CashBox and the designated trademarks herein are trademarks of Vindicia, Inc . in the U .S . and/or other countries . All other brands or product names are the trademarks or registered trademarks of their respective holders .