UNIVERSITY OF NEW YORK IN PRAGUE

European Business Administration

Observation and Analysis of Freemium Business Model with

Strategic Implication for the Czech Business Market.

by

Philipp Solovyev

2017 PATTISON William

I, Philipp Solovyev, declare that the paper entitled:

Observation and Analysis of Freemium Business Model with Strategic Implication for the

Czech Business Market was written by myself independently, using the sources and information listed in the list of references. I am aware that my work will be published in accordance with § 47b of Act No.

111/1998 Coll., On Higher Education Institutions, as amended, and in accordance with the valid publication guidelines for university graduate theses.

Prohlašuji, že jsem tuto práci vypracoval/a samostatně s použitím uvedené literatury a zdrojů informací. Jsem vědom/a, že moje práce bude zveřejněna v souladu s § 47b zákona č.

111/1998 Sb., o vysokých školách ve znění pozdějších předpisů, a v souladu s platnou

Směrnicí o zveřejňování vysokoškolských závěrečných prací.

In Prague, 19.12.2017 Philipp Solovyev

Table of Contents 1. Introduction 1 1.1. The world before The Fourth Industrial Revolution 1 1.2. Adapting Business Model 2 1.3. The structure of the thesis 5 1.4. Methodology 6 1.5. Personal motivation 7 2. Literature review 9 2.1. Business model of free 9 2.2. It is all about services 10 2.3. Consumer Behavior 11 2.4. Business model canvas 12 2.4.1. Customer segments 13 2.4.2. Value propositions 15 2.4.3. Customer relationships 16 2.4.4. Channels 16 2.4.5. Revenue streams 18 2.4.6. Cost structure 19 2.5. Applicable framework 19 3. Case studies 21 3.1. Dropbox case study 21 3.2. Riot Games 24 3.3. Spotify 29 3.4. Qihoo 360 35 4. Analysis and comparison with literature review 42 4.1. Customer segments 42 4.2. Value propositions 43 4.3. Customer relationships 44 4.4. Channels 45 4.5. Revenue streams 46 4.6. Cost structure 47 4.7. Analysis summary 47 5. Interview 48 5.1. Analysis 49 5.2. Observations 52

6. Conclusion 54 6.1. Best practises 54 6.2. Next steps 56 Bibliography 57

Abstract

This paper explores freemium distribution method within software industry. With claim that disruption in business world is significant, author hypothesizes the following question: “Is it possible to use distribution practices of freemium digital products in order to create a unique and diverse business model applicable for the industries outside of IT?” Firstly, analysis of academic sources is conducted in order to understand what freemium is and how it works.

Then, case studies of established freemium firms are compared with theory. Next, findings are evaluated by comparison with personal interview conducted in freemium pioneer firm,

Avast. By analyzing academic sources, comparing them to case studies and consequently evaluating findings by personally interviewing corporate manager of freemium firm, author presents reader with best practices applicable for future freemium practitioners.

1. Introduction

1.1. The world before The Fourth Industrial Revolution

In the era of the digital world, new technologies play an important role in the business development and maintenance. Truly, it is significant for a successful business to communicate with the customers via various social networks, distribute services and products with mobile applications, and convert prospects into new leads through simple landing page websites. Using such advantageous digital tools is essential for businesses prosperity.

Technological breakthroughs also put emphasis on classic business theories behind the functionality of newly-emerged tools. As an example, Web 2.0 appearance and consequent enhancement of business’ ability to interact with people and gather critical resources from the customers indicated how is feedback, transparency and brand value worthwhile in the business world. Inarguably, only by introducing new alternative ways to how basic websites could be used, business managers’ perception and awareness of stated business tools reshaped and arose drastically.

However, innovation is followed by the disruption that makes once stable practices unusable and require firms to be flexible and adaptable to changes in order to have a sustainable and competitive business. KPMG’s global CEO survey-study (2016) greatly supports that claim in the scope of upcoming The Fourth Industrial Revolution that unimaginably merges digital, physical and biological areas, stating that it is necessary for organizations “to develop incredible agility to stay ahead of the disruption caused by the fourth industrial revolution”.

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As of the competitiveness, KPMG’s study also concluded that “to remain competitive, manufacturers will need to innovate and invest in new technologies, which CEOs believe will have the biggest impact on the growth of their companies over the next three years.” Some older studies also reveal the same tendencies amongst CEOs. IBM (2008) global enterprise study declared that technology is one of the top three CEOs main concerns regarding the possible external impacts on their firms as well as the fact of a drastic gap between required change and current state.

That said, it is crucial for companies to adapt new know-hows and technologies to be able to generate profits. Both studies suggest a number of ways to overcome these issues and both of them point out that business model renovation plays one of the biggest roles in that transformation, but what reasons are behind that?

1.2. Adapting Business Model

A variety of case studies from previous years proved that enhancing firm’s business model in the context of new innovative implementation exponentially strengthens up positioning along competitors on the market as much as it strengthens its core value proposition. One of the most vivid recent examples is Netflix and Blockbuster case, in which the latter was mostly driven out of the market by the first. Back in 1997, Netflix used to have an insignificant market share and overall weak competitive power. The company had rather straightforward value proposition - by request, a customer was able to order any movie he wanted and Netflix would deliver a DVD by mail; however, this core competency is what made Netflix a worldwide brand. Blockbuster neglected even the slightest possibility of such firm to play a role of their competitor, seeing Netflix as a “very small niche business.” (Del Rowe, 2017)

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Regardless of that, Blockbuster had an attempt to replicate and create similar service for their customers, but this experiment in 2005 was too belated in comparison to Netflix that practiced this method for 7 years and by the end of 2007 was already shifting its core competency, making deliveries of movies instantaneous via digital environment. (Del Rowe,

2017) Partially, it was because of the status quo on the market and “mainly because of the resistance of digital transformation” (Del Rowe, 2017), Blockbuster could not adapt and has gone forever. Now, Netflix is the most recognizable streaming cinema service, which once

“embraced digital transformation and succeeded while Blockbuster fought it and failed.” (Del

Rowe, 2017)

Not only Innovation of business model can add to initial value proposition of the product or service but it also expands its ability to capture the value. One famous example of that might be seen in Apple’s combination of iTunes and iPod. By creating a software solution (iTunes) for comfortable music purchase and introducing it together with iPod, Apple achieved certain advantages from the perspective of business model: “the company built a groundbreaking business model that combined hardware, software, and service.” (Johnson, Christensen, &

Kagermann, 2008) As a consequence, this greatly-tied combination of shiny hardware and innovative software granted firm the ability to consistently extract value from customers for a long period of time. At the time of release, the combination itself was only repeatable with the devices from the same manufacturer, meaning that a person could only access his iTunes library from an iOS-powered device only. And since communicating the value to the customer was never an issue for Apple, such approach made firm’s “...market capitalization catapult from around #1 billion in early 2003 to over $150 billion by late 2007.” (Johnson,

Christensen, & Kagermann, 2008)

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The authors of the Harvard Business Review article on the reinvention of business model draw a great comparison between stated above Apple’s model and so-called “razor and blade” model, pointing out that in the essence, first model is a reversed version of the latter.

(Johnson, Christensen, & Kagermann, 2008) The definition of “razor and blade” model sheds light on that connection: “[firm] offers a durable product (i.e., the ‘razor’) at a low price

(even at a loss) and more than makes up for the initial subsidy by charging a high price for the consumable complement (i.e., the ‘blades’) over the lifetime of the durable product.”

(Dhebar, 2016) However, in Apple’s model complementary product and durable product are switched over as Apple charges a high price for the hardware product (e.g. iPod) and makes access to additional digital content relatively cheap. (e.g. iTunes music) This example shows that such model can work the other way around, charging a high price for the initial product and asking for lower payments for the complementary product.

However, let us return to “razor and blade” model. As it has been noted above in the definition, the main product should be distributed “at a low price (even at a loss).” (Dhebar,

2016) This part of the definition provoked the author to ask the question - what if a company chose to distribute such product for no price, for free?

After a brief research session, the author of this thesis realized that the hypothesized question has a definite and concrete answer. Such practice exists and thrives in the software industry with prevalence in mobile applications market where it works precisely as bequeathed by

“razor and blade” model. As it has been reflected in the global report of 2014 by an investment bank for mobile apps and games, “free downloads and in-app purchases are dominating revenue (>90%)” with the best performing applications from the games category.

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(Digi-Capital, 2014) It seems that distributors of mobile applications took over the best practices of “razor and blade” model and applied those to their products.

However, in the digital world such charging policy has a name - it is called freemium, the word created by the combination of free and premium. (Wilson, 2006) It has been a recognizable buzzword even for the businesses outside of the digital environment. As previously argued, roots of this word are tied to one of the oldest defined business models.

Sequentially, author’s curiosity drove him to look deeper into the freemium and analyze it.

1.3. The structure of the thesis

With that said, the purpose of this research paper is to define freemium as an applicable framework for businesses, even those that are not correlated with the software industry. By the end of the research, it is expected to discover a freemium business model or at least define best practices in order for a business to interlace with freemium. Ultimate questions of the research are following: is it possible to use distribution practices of freemium digital products in order to create a unique and diverse business model applicable to the industries outside of

IT? If not, what are the best applicable practices and concrete values businesses can gain

(apart from the profit from the complementary product) by using freemium distribution? In order to find the answer for the stated hypothesis, it is required to mention the ways the research will be conducted.

As there is not much of research done on freemium, in order for a reader to fully understand what this phenomenon is the Chapter Two will deal with the comparison of definitions from various sources. For the sake of this particular research, it will be decided which definition

(or definitions) will be used for the following case studies analysis chapter. Also, this section

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will state what are the requirements for freemium to work, detailed freemium features and benefits.

In Chapter Three, a number of case studies will be looked upon. There, successful and unsuccessful implementations of the freemium within the company’s product or service will be analyzed. The comparison will highlight the best practices of these firms and things to avoid in order not to repeat occurred mistakes.

The fourth chapter will present the findings and the feedback on the previous secondary research. In order to do that, after the gained insight from the previous chapter, an interview with questions specified from the previous part of the research will be presented. The findings of the secondary research will be discussed during the interview sessions. This should confirm or disprove findings from the secondary research.

Finally, the output of this work will be presented. The conclusions will be drawn in form of stated observations, results, or a guide based on the research findings.

1.4. Methodology

As freemium itself is relatively new opposed to classic business theories, to make a comprehensive research it is required to access sources outside of academic scope. With that said, Chapter Two of this paper will include such things as blog posts, technology journals, conferences, and various statements of freemium practitioners which would help to get the

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deepest insight possible. Academic papers, empirical analysis and business books available regarding the topic will accompany this information.

The Chapter Three of the thesis will be based on analysis of quantitative data, namely interviews. “For both exploratory analysis and for gaining deeper and different insights”

(Lehmann et al., 1998), qualitative research will include a personal interview with vice president from one of the leading corporation in the software industry, Avast. This company has high proficiency in usage of freemium model, with practices dating from 2001. ("Avast

Milestones", 2017) The interviewee, Mr Hugo Sellert, is an experienced customer analytic and practitioner of freemium with more than 6 years of experience in monetization mechanics of freemium. Thanks to his insight and knowledge, the author hopes to answer most of the questions and uncertainties achieved through the secondary research. The transcript of the interview could be found in the appendix.

1.5. Personal motivation

The author of this paper has a belief that freemium phenomenon could be valued as technological breakthrough and used within the established business model or as a completely new separate model. This feeling was endorsed during author’s the internship in the company that creates a variety of custom merchandize for logistics firms. Manager of the firm would gladly give away a couple of those products to a potential customer without any fee. In most of the cases, those customers were consequently converted into paying customers, adding value to overall revenue.

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The author’s interest in freemium is also supported by the fact that one of his main hobbies consists of following IT trends as well as recognition of new practices in the IT industry. As previously been proved, technology plays an important role within the business world; thus, the author is more than passionate to find correlations between his interests and knowledge gained through the course of studies and hopefully defining practices worth of a value for businesses.

The nature of freemium is inspirational – spending resources on creation of something of a value and distributing it freely afterwards kept the author, as an unaware user, sceptical each time he stumbled upon the software of this kind. The author is driven to understand what tangible and intangible benefits companies can gain out of such bargains.

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2. Literature review

Academic literature provides researchers with relatively scarce analysis on the freemium topic. Because of that, it is required to state that some sources will be used from non- academic literature; nevertheless, this part will compare definitions, discuss and identify what concrete features freemium implication brings to the business. Also, based on empirical studies it will be classified what are the requirements for firm, service or product in order to use freemium.

2.1. Business model of free

In order to stay in its particular scope and to find the best freemium interpretation, let us address the definition of the business model itself. According to Essentials of Strategic

Management by Hunger & Wheelen (2011), a company operates business model as a

“...method for making money in the current business environment”, with the clarification that

“It includes key structural and operational characteristics of a firm - how it earns revenue and makes a profit.”

The combination of words free and premium was first proposed by Jarid Lurkin and embraced by Fred Wilson (2006) in his personal blog with the following blog-post explanation: “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.” The name was successfully adopted and perceived as a term in academic circles.

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McGrath (2010) characterizes freemium as a business model in which company gives its core product away and creates revenue through rather extension of the initial product or creation of complementary good for it. That goes in line with the previously stated business model definition as well as it summarizes other versions of analyzed academic writings. (Pujol,

2010; Anderson, 2009; Kumar, 2004) This definition will be further used as a benchmark to determinate and choose freemium case studies.

It is needed to emphasize the fact that the initial product is required to be accessible to all customer segments, meaning that the free value proposition of the service should always remain free. That claim is supported by the discussion over the initial definition from Fred

Wilson’s (2006) blog, “...make sure that whatever the customer gets day one for free, they are always going to get for free. Nothing is more irritating to a potential customer than a ‘bait and switch’ or a retrade of the value proposition.”

2.2. It is all about services

As mentioned earlier, the concept of giving things away is not something new. However, in case of digital products main good plays a role of distribution platform, whereas subsidiary good or service is what customers are aiming for. (Reime, 2011) Vivid examples might include music streaming from Spotify app or file sharing & storage from Drobox app - in both cases, the software plays a role of simple wrapper for the actual service. Thus, an adaptation of freemium in the software industry became common practice - in fact, it is the most widely used model by Internet startups and mobile app developers. (Kumar, 2014)

Looking at the worldwide perspective, The Copenhagen Institute for Future Studies, which principally discusses the phenomenon of free goods stated in their Anarconomy report (2009)

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that “we are witnessing a huge growth in the volume of free products on the internet, created by networks using almost anarchic principles. This development will increasingly challenge traditional, commercial companies”. As it can be deducted from the name of the report, the authors claim that this tendency occurs to be anarchic but at the same time functioning economy (Copenhagen Institute for Futures Studies, 2009). Interestingly enough, the authors also mention that free-structure creates a pressure for traditional businesses. What might be a reason for that?

2.3. Consumer Behavior

The success of freemium can be explained by addressing the consumers’ psychology and the incentives they are driven by. Experienced in the provision of free and premium services, the

CEO of MyLife.com Jeff Tinsley explains the willingness of consumers to use a free product by saying the following:

"By offering some unrestricted access, you are giving users a taste of what you have to offer, and they can decide to upgrade at a later date. At MyLife, we've found that once they use the service, there is an opportunity to convert the user to paid services over time." (Martin, 2012)

This goes in line with the discussion of zero price and behavioral economics in Chris

Anderson’s (2009) book on free pricing techniques, which reflects that consumers tend to associate the price of a product or service with consideration of the cost. Because freemium business model diminishes barriers for users’ direct access and interaction with the software, it allows adopters to critically evaluate a product using their own experience as a basis.

(Bowman & Ambrosini, 2000; Priem, 2007) This also makes consumers lurk through the

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options until they find the best-priced solution, even though “the amount saved doesn’t cover the time spent gathering information and making the decision.” (Reime 2011)

2.4. Business model canvas

For further analysis of freemium key elements, it is required to choose a specific framework.

Therefore, features of freemium will be assessed within business model canvas (BMC) in the next section to analyze and structure gained information from secondary research as a comparison matrix. The matrix will be applied to later sections of case studies and interview analysis.

The creators of business model canvas, Alexander Osterwalder and Yves Pigneur (2010) define their offspring as an easily understandable, graphically appealing and yet powerful template, which should be used as an analysis tool for existing or drafted business models. It is built with “nine basic building blocks that show the logic of how a company intends to make money”. (Osterwalder et al., 2010) (figure 1).

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Figure 1: Business model canvas (Osterwalder et al., 2010)

The following paragraphs will present each of building blocks. The name of the block will be followed by the definition of Alexander Osterwalder and Yves Pigneur (2010). Then, the stated definition will be compared with academic sources on the freemium topic and classic business theories. In order to create a framework that would fit with any case study, discussed blocks will not include Key Activities, Key Resources and Key Partners since these are too specific and would vary from firm to firm. Nevertheless, aspects of those blocks will be mentioned within the consequent comparison of case studies with the literature review.

2.4.1. Customer segments

“The customer segments building block defines the different groups of people or organization an enterprise aims to reach and serve.” (Osterwalder et al., 2010)

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This block is crucial for efficiency and effectiveness of business reachability and understandability about potential customers. This can be explained by the fact that consumers of different markets have different needs, wants, demographic and psychographic traits. As

Kotler and Armstrong (2014) recapitulate, “[Customer segmentation] can help companies identify and better understand key customer segments, reach them more efficiently, and tailor market offerings and messages to their specific needs.” If a company is successful in the definition of its targeted audience, it will be able to minimize the costs of production, narrow down communication channels and create a superior value proposition in accordance with customer’s needs.

BMC authors also define sub-categories of customer segments - amongst those, freemium fits in so-called segmented type of customer segmentation, which “offers slightly different Value

Proposition” (Osterwalder et al., 2010) for each segment. This accurately describes the relationship between free and premium users – the first group is offered value of a free service whereas those who pay get initial free value and additionally added extra features.

In the freemium model, it is crucial to specify and distinct free users from willing to pay users. It is decisive to communicate appropriate value for each segment in order to create the best fit and make conversion more likely to happen. Looking at segmentation from the other perspective, it is also essential not to spend resources to persuade a free customer with no conversion intention. Thus, customer segmentation plays a big role in the whole model.

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2.4.2. Value propositions

“The Value Propositions Building Block describes the bundle of products and services that create value for a specific Customer Segment.” (Osterwalder et al., 2010)

The whole process of marketing a service or product is constructed around the notion of the value proposition. In their Principles of Marketing, Kotler and Armstrong (2014) propose marketers to ask the following question, “How can we serve [targeted] customers best?”; they also define the value proposition as a “Set of benefits or values [which brand] promises to deliver to consumers to satisfy their needs.” Hence, the proposition of value is crucial in order to consequently capture value from customers.

One of the most recent academic works that used empirical analysis to evaluate the correlation between the quality of service provided by free product and the conversion rate to premium concluded that “the effect of perceived quality of a freemium service on premium purchases is mediated by use of freemium” and summarized by saying that “increasing the quality of a freemium service has surprisingly little effect on the demand for additional premium services directly.” (Hamari, Hanner & Koivisto, 2017)

In terms of the value proposition, the main goal of a freemium practitioner is to make a vivid differentiation of free value and added premium. Free version is supposed to perform a role of interactive commercial - however, there must be a good communication of added premium value to base service. As Wagner, Benlian and Hess (2014) stated in their study on freemium conversion, “...it is important for provider to increase the perceived price-value ratio, for

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example, by adding new features and exclusive content”, which should theoretically “result in higher willingness to pay for the premium product.” Thus, it is needed to accurately communicate what additional value customer would she get by purchasing premium offer.

2.4.3. Customer relationships

“The Customer Relationships Building Block describes the types of relationships a company establishes with specific Customer Segments.” (Osterwalder et al., 2010)

This building block highly depends on the users’ perception of a company. As it was stated above, the software itself works as a wrap for the actual service. Comparatively to real products, software is the equivalent of the retail product package. Christine Birkner (2011) in her journal article discusses the importance of the packaging in retail: “...packaging is critical to communicating the true equity of the brand” since it is the “first point of contact with consumers.” Because freemium allows users to interact with service instantly, the first experience is crucial in the establishment of positive relationships between the firm and their customer. Software needs to be remarkably constructed, starting with delivery of value relative to segment and finishing with the responsive user interface. That way, critical mass required for the launch of network effect could be gathered rapidly.

2.4.4. Channels

“The Channels Building Block describes how a company communicates with and reaches its

Customer Segments to deliver a Value Proposition.” (Osterwalder et al., 2010)

In classic definition by Kotler and Armstrong (2014), the distribution channel is “a set of interdependent organizations that help make a product or service available for use or

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consumption by the consumer or business user.” In line with freemium and classic definitions, it can be observed that there are various mediums that play the role of promotion nodes.

As mentioned above, vast majority of base users consists of non-paying users that are held in hope of later conversion. However, at the same time, they contribute to the model as promoters and distributors of freemium service. Eric Seufert (2014) in his book about

Freemium Economics describes that concept by saying that “Non-paying users … can also serve as product ambassadors, recruiting through social or physical channels the future highly engaged users who contribute to the product’s revenue streams.” Thus, non-paying users also should be perceived as a separate channel that communicates a value proposition to similar customers or potential premium users.

As a result of digitization and viral nature of the Internet, social media websites contribute to freemium channel block as a source for user base expansion and conversion. Because freemium service is easily accessible, “Social media adds more value to freemium content and allows that content ‘to scale faster’.” (Martin, 2012) Therefore, socials have a positive effect in terms of faster user base acquisition. This user base can be perceived by freemium adopters as the critical mass that can provoke network externality effect later on.

Network externality effect that is defined by Shapiro & Varian (1999) as an effect, which increases the value of a product or service under circumstances when the number of new users of this product or service also increases. The simplest example of network externality effect includes the appearance of first stationary telephones - as the number of new telephone users grew, the reachability (i.e. value) of the telephone within constantly extending network

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grew as well. This effect is crucial for the development of freemium product because practically, big masses of free users also attract the attention of willing to pay customers through word of mouth or referral programs.

2.4.5. Revenue streams

“The Revenue Streams Building Block represents the cash a company generates from each

Customer Segment (costs must be subtracted from revenues to create earnings).”

(Osterwalder et al., 2010)

When using freemium, a company has to spread profits among free users in order to cover incurred expenses. That is given by the fact that free user base prevails over premium users.

(Anderson, 2009) This aspect is further analyzed in the study conducted by members of

Information Management Institute by Wagner, Benlian and Hess (2014) - they claim that “the main concept of freemium is that the paying premium users finance the non-paying users” with a remark that in most cases “freemium providers have to finance their free users, which the payments of the premium users alone do not usually cover.” To generate additional revenues, freemium practitioners are inclined to offer advertising space on their platform and sell customers’ data. (Seufert, 2014)

As stated previously, because premium offer also creates additional value, producer gains ability to charge those customers, who are willing to pay for extra features; that means that initial price (zero) raises in line with the proposed additional value. In academic literature, such aspect is called versioning - different pricing based on quality discrimination. (Varian,

1997) Initially, that method was used to make “Consumers with high willingness to pay choose one version, while consumers with lower willingness to pay choose a different

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version.” (Varian, 1997) That pricing tactic could be used for Revenue Streams block to adjust monetizing mechanism of premium customers or Customer Segmentation block to narrow down or try out new segment’s willingness to pay.

2.4.6. Cost structure

“The Cost Structure describes all costs incurred to operate a business model.” (Osterwalder et al., 2010)

There is a logical pitfall that freemium practitioners tend not to recognize. The marginal cost of producing a copy of a digital product after successful development is zero, however, it does not necessarily mean that service’s maintenance costs will be zero as well. As it has been discussed previously, the software itself plays a role of the service wrapper. For instance, in order for Dropbox to provide their main service for users who downloaded freely distributed Dropbox app, they are required to maintain the servers i.e. the actual space on hard drives. Therefore, although the production cost of next application is inarguably low or nothing, in order to have a valid and working service company is required to invest in the physical space now occupied by free users. Thus, free software developers should constantly spend resources on free software updates, service maintenance and adjustments of premium offerings.

2.5. Applicable framework

The previous section has assessed most corresponding with freemium canvas blocks and has drawn a number of things that should be taken into consideration for the analysis of freemium firms. Firstly, it has been mentioned that firm uses freemium model if one of the products of the firm is freely distributed with the possibility of premial extension. Secondly, based on

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observations from the secondary research in the section above, the following table will be

used as a benchmark for evaluation of freemium appliance within the company or product.

Table 1. Applicable freemium framework based on information gathered via secondary research and analysis. Building blocks Summarized freemium characteristics

Customer segments Distinct segmentation between free & premium members. Value Propositions Free base offer and value added premium with clear communication of differences. Customer Relationships Smooth user experience via responsive and appealing software interface. Channels Non-paying users and social medias. Revenue Streams Advertisement, customers' data and conversion. Cost Structure Development and updates of software, service maintenance.

At the end of research, framework will be transformed in a checklist for successful

application of freemium by a firm. After conducting analysis of distinctions and similarities

between secondary research and real life business which use freemium, framework will be

updated and discussed in an interview with Mr. Hugo Sellert. As Anderson (2009) states in

his book, “people are making lots of money and charging nothing”. Let us take a look on the

examples of most successful and less successful case studies of freemium application in

software business.

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3. Case studies

In the previous chapter, it was stated and defined what freemium means and what characteristics it includes. The following chapter is going to check facts, assumptions, and claims that are in line with the real world practices. To do that, the following paragraphs will firstly present some successful and less successful freemium products and services, using findings from academic case studies and public information available at the time about discussed companies. This will be followed with the comparison of case studies’ key points and framework established earlier in the literature review section. This will show the validity or weaknesses of framework’s observations. In the end of this chapter, correlations with theory and practices in the updated version of framework table will be presented.

3.1. Dropbox case study

As of the present time, Dropbox is the biggest player on the cloud market with 8 million business-customers, $1 billion annual revenue run rate and total 500 million users. (Dropbox,

2017; Solomon, 2017; CloudRail, 2017; "Celebrating Half a Billion Users", 2017) In its early days, Dropbox emerged from the idea of being an “…easy-to-use, accessible remote storage” after one of its founders forgot his USB drive on the bus trip (Teixeira & Watkins, 2013). In early 2007, when Dropbox was firstly entering cloud solutions market, directors rapidly gained competitive advantage and outcompete other small businesses by doing something they were the best at, which was providing fastest backup and retrieval service amongst competitors (Teixeira & Watkins, 2013), once again precisely proving Michael Porter’s

(1996) teachings on business strategy, “...nurture [core] competencies in race to stay ahead of rivals”.

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The company preserved this attitude through the course of years and along with simplicity of use and independence of additional software. This approach has granted winning competitive advantage to Dropbox over similar services from such Internet giants as Google, Microsoft and Apple that fought for the share in relatively new and popular market of 2013. (Teixeira &

Watkins, 2013) To prove the point, let us consider the following: in order to use cloud storage from Microsoft or Google, a customer is required to create a unified account, which then grants access to a number of services, amongst which there is remote storage. Because of this forced-bundling strategy, users are unable to choose only cloud storage service even if they have desire to. As it has been greatly pointed out by Teixeira & Watkins (2013), a growing number of newly registered users does not have to necessarily represent portion of users that are particularly interested in the regular utilization of that particular cloud service. With that in mind, consider the Figure 2.

Figure 2. US Usage of Major Cloud Media Services Commented [1]: Source here?

After conducted survey amongst US cloud users in 2013 it has been reflected that the biggest share of cloud-storage is held by Apple. However, because of the reasons pointed out early,

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this conclusion is relatively skewed and does not represent users purely utilizing cloud storage. Apple bundles iTunes and iCloud together with their devices, meaning that represented 27% include also a big volume of users, who simply bought an iPhone or Mac.

On the other hand, next most popular service after Dropbox was Amazon, which in comparison to Dropbox is focused on cloud drive service. Keeping in mind bundling policies of Dropbox competitors, it could be certainly said that as of 2013 Dropbox was able to outcompete similar cloud solution services.

However, the company had to generate revenues in order to stay on float; this was achieved after pairing great service with even greater marketing strategy, the combination of

Dropbox’s core competencies and freemium. Conversion rates at Dropbox are low, as of

2014 “only an estimated 1.6 to 4.0% of its users provided any revenue to the company”.

(Teixeira & Watkins, 2013) Because the performance of the firm’s service was created to be qualitative and convenient, the freemium incorporation as a distribution tool was a great choice. During initial strategy formation, the CEO of Dropbox Andrew Houston recognized a profit potential within enterprise customer segment and therefore chose to target it. (Teixeira

& Watkins, 2013) As he stated in his interview, in order to cut through the red tape, avoid unnecessary bureaucracy and simply communicate the value of his product directly to the customer, ”[We] decided to target Dropbox to individual users” with the main goal to “get people using it inside companies.” (Dhanani, 2011) More than that, directors also added an incentive-driven referential program to the recipe, so that “satisfied users [would] spread the word”, get additional free cloud space and consequently make their employees use Dropbox's cloud service, further expanding clientele of the firm (Teixeira & Watkins, 2013). As it is reflected in figure 3, during only 3 years this strategy harvested over 200 million new users.

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Figure 3: Dropbox users growth (Constine, 2012) Commented [2]: Same, source? Precisely, that strategy allowed the company to outpace competition and gain insight data about their customers that they used in order to create more value for customers. After expanding its consumers’ base, the firm “began to directly target corporate customers.”

(Bilton, 2013) Because of their previous experience with customers of the same segment, the company was successful to provide beneficial versions for business teams in terms of discounted price and features, which were meant for teams. (Viswanathan, 2013) In

“Dropbox for Business” version they bundled unlimited storage, control panel for managing employees’ files and single sign-in option, which enabled any team member to access all stored files of the particular business. (Bilton, 2013)

3.2. Riot Games

The next case study analyzes a PC gaming industry company called Riot Games. Over the ten years of company’s existence, it has developed only one PC game called League of Legends

(LoL). Yet, over the course of its existence the game turned out to be one of the biggest electronic sports (eSports) brands ever created with “7.5 million Number of concurrent LoL players, during peak hours each day”. It also had $1.6 billion estimated revenue in 2015 and one of the most popular eSports worldwide events, World Championship which in 2017 had

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over 60 million unique viewers. (Xing, 2017; Helm, 2017; Gaudiosi, 2016) Riot Games is not publicly traded since it has been fully acquired by Chinese digital holding conglomerate

Tencent. (Moser, 2017)

The game’s genre is defined as multiplayer online battle arena (MOBA) with high emphasis on team play. Each game starts with summoners (players) picking a character from free available champions (playable characters) of the week or purchased previously characters by players themselves. After that, two teams with 5 people in each team are summoned to the

Summoner’s Rift arena. In order to win the game players are required to destroy opponent’s

Nexus (base). However, that one objective requires players to create a strong coordination within a short period of time. This is crucial because of the game’s fast-paced environment and other risks implied over other strategic elements of the game.

The game itself is distributed as a free-to-play installable package. After installation, a user is provided with the game’s launcher interface. There, such things as new updates about the game, summoners’ chat rooms, players’ statistics, a queue button, and a shop are presented.

Items sold in the shop have no direct impact on the gameplay or have any influence on the course of the game. Those items include rather cosmetic visual enhancements for a particular character (i.e.so-called “champion skins”), champions not yet purchased, keys and chests with random champions or skins. These items are sold for two currencies: one is so-called

Blue Essence (BE), the internal game currencies gained by the end of every won or lost game

(in corresponding proportion) and the second one is so-called Riot Points (RP) that can be obtained only via real payments. Notably skins, chests, and keys are only purchasable with

RP (real money) and the rest of items are available for both BE and RP.

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Since it is a recognized eSports brand, as any other competitive game it has a League of

Legends Championship Series (LCS), which is being played during the year. There, professional teams from different regions are competing for a spot in the biggest eSport event, League of Legends World Championship. The last Worlds in 2017 included total prize pool of $4,170,000 and overall peak of 106,210,010 viewers ("2017 World Championship detailed stats", 2017). The events are sponsored by such notorious companies as T-Mobile,

Acer, Coca-Cola, BMW, and other well-known brands.

However, not only prize pool is subsidized by partnerships, it also consists of money raised from the championship promotional skin offers that also brought big revenue for the company. Consider the following fact: 25% of sales revenue gathered from Championship

Zed skin (figure 4) in 2016 went to the prize pool, contributing $2,015 million to Worlds

Championship of 2016 and making the overall prize equal to $4,145 million. (Kennedy &

Rozelle, 2016) After brief calculation, it can be deduced that the remaining 75% equal to

$6,045 million. That way, Riot saves money on tournaments’ prize and also makes a huge profit by enjoying the rest 75% from the skin sale.

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Figure 4: Championship Zed skin

The tendency of buying practically unnecessary additional in-game items has been striving amongst players. Although there is no official data available on how much of Riot’s revenue comes from in-game microtransactions, according to a poll of over 60,000 game players

(figure 5) it can be deduced that on average, all together those people spent over 30 million dollars with largest contributions between $749 and $1000. ("How much money have you spent on League of Legends?", 2017) Because there are other valuable parameters not considered in the poll (i.e. for how long a person played the game, what is the approximate weekly game time player spends on game, etc.), this data does not particularly reflect any concrete fact; however, it proves the point that players see additional value in sold skins and are willing to pay for the premium content.

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Figure 5: How Much Money Have You Spent on League of Legends? ("How much money have you spent on League of Legends?", 2017)

The game is being constantly updated on monthly basis with various improvements, balances or changes in game mechanics - these updates are called patches. Additionally, patches also introduce new content to players such as skins for old champions, new champions and skins for them, discounted bundles, (e.g. newly released champion with skin) and promotional game modes for certain skins. These changes are also crucial for in-game experience as if one tactical element of the game would be slightly modified by the patch, it can have an impact on the other game aspects and consequently alter the whole game experience for players.

Because of that, patches tend to keep the game in constantly refreshed state, as well as present players with new obstacles or advancements for the win. By this reason summoners are constantly challenged to adjust to the game’s changes and search for new ways to win the

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game - even the game’s community itself refers to this phenomenon as META (Most

Effective Tactic Available).

The community built around Riot’s game actively participates in discussions regarding new improvements and content; likewise, it simply enjoys watching pro players and entertainers play LoL with commentaries. To prove the point, one of the famous discussions’ site on the

Internet named Reddit.com hosts a forum dedicated to LoL. It has over 1 million subscribers and 20 thousand daily active users with threads opening each hour on average.

("r/leagueoflegends", 2017) The community also enjoys interactions with the game’s influencers via online video streaming services such as YouTube and Twitch - there, gamers are able to see and hear a player via the stream as well as directly communicate with him or her via chat messages and do donations. For instance, the most popular Twitch streamer and

LoL pro-player with nickname “imaqtpie” has streamed over 102 days of net time and has 20 thousand average viewers during a stream day. ("Channel Details for imaqtpie", 2017) All that proves that the game’s fans are desperate for the content and additional material around their beloved game, whether it is a discussion of the particular game’s aspect on the forum or just observing and chatting with the pro player idol on the stream.

3.3. Spotify

Being one of the most popular and well-known online music streaming services, Spotify started as an alternative service to pirated music. Founded in 2006, a Swedish company had a goal in mind to make music accessible under a couple of clicks - any time, any place, legally and without any restrictions. Daniel Ek, the founder of the company came up with that ideology after an attempt to get pirated music. Because of no entrance barriers and peer-to-

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peer technology used by illegally shared music files, he was able to discover an enormous amount of new music on famous Swedish torrent tracker The Pirate Bay, which at a time became a shocking discovery. However, Ek realized that the illegality of music meant no financial support from listeners of this files. That seemed to be an issue for Daniel Ek as he wanted to give musicians some credit. Thus, he created an idea of accessible and legal substitute for pirated music known today as Spotify; during one of his interviews he precisely summarized that his “...idea was to create something that would generate revenue for the music industry and that would work on any terminal, that would be like water.” (Beuth, 2011)

It would be fair to acknowledge that great burden of service’s success lies in change of consumers’ preferences affected by digitalization. According to report of International

Federation of the Phonographic Industry (2011), between 2004 and 2010 there has been an enormous growth of 1000% in the digital music market and downturn 31% in revenues of global recorded music due to the rise of illegal Internet services and the introduction of peer- to-peer clients, such as BitTorrent. Thus, Spotify founders responded to market’s demand by introducing a profitable solution for artists and legal alternative for the music enthusiasts that prefer to support their favorite artists.

The main goal of Spotify was not only to create a replacement for pirated music and compensate musicians but also to make a superior to piracy version of enjoyable listening experience of free music. The company took the best out of pirated music in terms of distribution: it adopted decentralized sharing method by implementing a peer-to-peer network, in which every participant stores a tiny piece of information that once pulled together creates a whole file. That way, additional downloads assure further file availability for other nodes within the network. On top of that Spotify added such services as music

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discovery, which suggests a user similar tracks to his or her preferences, an ability to create and share playlists with other users, add liked tracks to users’ personal library. Spotify works using same technologies and practices of pirated music, but opposed to pirated music it brings additional value and benefits – not only it provides listeners with easily accessible music but it also gives more services related to it, shifting simple music consumption to a new level.

Thanks to peer-to-peer, Spotify achieved most fluid user experience it possibly could. The delivery speed of music into one’s device is simply great - “Spotify functions as an application downloaded to the user’s hard drive rather than as an online service, and it draws on the hard drives of all users.” (Bissonnette & Brunelle, 2015) Precisely, all that is required from a user to start using the service is to download the application on his or her device, register an account and simply enjoy 30 million legal tracks on demand. (Bissonnette &

Brunelle, 2015) In HBR case study about Spotify, Bissonnette & Brunelle (2015) explained the reasons and the ways that factor is crucial for overall perception of the service, stating that “When consumers click on a song, it plays immediately, […] within 200 milliseconds, or the time it takes for the human brain to perceive the slightest delay”. This creates unique user experience because consumers feel “…as if they owned all the music in the world on their computer hard drive.” (Bissonnette & Brunelle, 2015)

As in every freemium model, Spotify provides users with a choice between free and premium subscriptions. On-demand music streaming service comes in two versions: forever free with occasional ads in between songs (approximately every 15 minutes) and the premium version with higher audio quality, no ads, and the ability to play offline music. As of 2017, Spotify

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has 140 million monthly active users of which 60 million using the premium version of the service. (Dredge, 2017; Russell, 2017)

It would be fair to mention that from the company’s foundation in 2006, Spotify is yet not profitable – however, the main revenue stream of the firm consists of subscriptions purchased by 42% of premium customers mentioned in the previous paragraph. In the first half of 2017, estimated operating losses of the firm composed of “anywhere from 100 million to 200 million euros” (Hu, 2017). However, in between 2016 and 2017 the company reported 40% growth in subscriptions and according to the company’s consolidated statement of operations, it “... generated €2.64bn from premium subscriptions in 2016, and €295m from advertising –

89.9% and 10.1% of its overall revenues respectively.” (Dredge, 2017) In his article on company’s profitability, Stuart Dredge (2013) summarized outlined strategy by stating the following, “As the company reaches more users, the proportion of them who will pay to access the service will grow, revenue will climb and the amounts paid to music rights holders will increase proportionally.” Although it is not clear when or if this tactic will make the company profitable, one thing can be said with certainty - stated percentage growth in customers’ conversion rate proves that their willingness to pay is high due to transparent and weighted premium value of service with eminent quality of free subscription, both of which were described previously.

The combination of freemium and great execution of free service gives Spotify its competitive advantage over similar services in the digital music market. As a freemium firm, company has no access barriers to its core service which is its wide repertoire of 30 million tracks is what distinguishes it from competitors; as it is greatly compared in case study by

Bissonnette & Brunelle (2015), “...unlike platforms such as iTunes, where you have to pay to

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listen to a whole song, there are no barriers of cost or access to the music experience of

Spotify’s free offer.” The company was able to manage that by negotiating terms and conditions with musicians and labels, which in turn made such distribution possible from a legal perspective: “With services like iTunes, people acquire ownership of a piece of music, while with Spotify, people acquire access to a song, a bit like renting it.” (Bissonnette &

Brunelle, 2015)

One of the ways the company promotes the service and encourages further conversion is promotion via social media. Their social media marketing goes in line with ideology on the ways music should be perceived and consumed. The most notable platforms Spotify uses are

Facebook and Twitter. During LeWeb conference in 2011, Daniel Ek pointed out that,

“Facebook is the largest distribution platform in the world today. What Facebook enables is content sharing. Mark Zuckerberg realized that Facebook’s value lies in interactions between people. And music is one of the most social things there is.” (Beuth, 2011) In September of the same year, Spotify and Facebook integrated their services - that enabled users of both platforms to share songs and playlists with their friends just by simply clicking “Log in with

Facebook” button. (Bissonnette & Brunelle, 2015) Two months after integration, “Spotify announced that users who link their Spotify account to their Facebook account are three times more likely to become paying subscribers.” (Bissonnette & Brunelle, 2015)

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Apart from having a great conversion, social media play a role of promotional channel and data gathering tool. Spotify users are constantly encouraged to create and share their playlist based on time of the year, holidays or any other special occasions. In fact, the company creates and promotes special days of their own. Consider the screenshot (figure 6) taken from their official Twitter account, the hashtag #NewMusicFriday present users with a playlist which opens up after clicking on the post. A user interacts with the playlist and thus generates data for analysis that creates even more feedback for the company to analyze. Each Friday the company makes such posts and thus encourages further user engagement and promotion of artists featured in particular playlist. Commented [3]: Пикчу тут отсорсь, мб в ворде получится, у меня тут ломается формат

Figure 6: Twitter. Screenshot of Spotify promotional Friday playlist post

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3.4. Qihoo 360

Qihoo 360 Technology Company is a Chinese Internet firm, which specializes in the production of digital products for consumers’ comfortable utilization of the Internet service.

The firm has developed three main products: an antivirus for personal computers and smartphones, a mobile app market and an Internet browser. As a result of freemium implementation during initial strategy formation, the company achieved a unique position on the market of Internet-based solutions by creating the biggest open platform in China. That approach helped the company to operate business outside the rules dictated by harsh competition and monetize significant customer base gained via free products.

In order to enter the market, the company had to face unpleasant and unethical environment formed by governmental regulations and near-monopolistic state of the industry. Back in

1996, when the Internet was firstly brought to masses in China, the government recognized a political danger in innovative communication medium. As a precautionary measure against possible hoax caused by new technology, central government implemented surveillance projects (namely Golden Shield and Great Firewall of China) in order to track the usage of internal and external Internet consumption and gain control over the domestic Internet.

(Melvin & Nair, 2015) These projects successfully “isolated the Chinese Internet market from much of the Internet world—YouTube, Facebook, and Twitter were all blocked in 2009 and Google shut down its servers in China in 2010, declaring that it no longer wanted to abide by the censorship rules.” (Melvin & Nair, 2015) Albeit all possible restrictions, in 2014

Chinese Internet user base counted 632 million people with a 14.42 million increase from the previous year. (Melvin & Nair, 2015)

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Given the circumstances, monopolistic nature of Chinese Internet industry has been inevitable. Indeed, the market had small players but compared to 4 biggest corporations prevailing in the industry the gap in terms of available resources for operations is drastic.

Search engine market is dominated by Baidu with 76.05% market share as of 2017; it is also the world's second largest search engine. (Hunt, 2017) Alibaba, “Chinese eBay” dominates e- commerce by targeting B2C and B2B customers. The scale of the company’s operations is humongous, in 2014 it created and promoted anti-Valentine’s Day, occasion which company called “Single’s Day” on 11th of November. During the “celebration” and special offers,

Alibaba recorded sales of $9.3 with more than 278 million packages to be delivered, which lead “...some courrier companies to require workers to put in 21-hour days” (Doyle, 2014).

Tencent, the company cited for the acquisition of the Riot Games from previous case study also demonstrates dominance on the entertainments market, which includes PC and mobile video games, music and films. In 2014 “Tencent signed an agreement with Sony Music

Entertainment to become the exclusive manager in China for the online distribution of Sony’s music library; it also brokered deals with Warner Music and HBO.” (Melvin & Nair, 2015)

Lastly, the fourth big player is Qihoo 360, but how could it achieve a success in such a monopolistic environment?

The company’s management saw an opportunity in yet not occupied niche of the market.

Demand for security rose in line with new Internet consumers each year, as CEO of the company Zhou Hongyi stated in his interview with Frank Nazikian (2012), “I realized when more and more people spent more and more time on the Internet and in cyberspace, the need for security will be a very fundamental need, so the security service should be an infrastructure service as important as search, email, or instant message.” And so the first

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company’s product, PC antivirus 360 Safeguard entered the market as freely distributed software.

The software was introduced as a freemium product, but company abandoned differentiation of free and premium users because of the given market condition. The company chose a free strategy in order to get instant advantage over other competitive services available on the market because they acknowledged the fact that consumers had no willingness to pay for the digital product. The software of the same nature presented on the market was fee-based and

“the overwhelming majority of Chinese Internet users opted not to pay for such services, most users went online without any protection.” (Melvin & Nair, 2015) The company’s solution came into the right place at the right time; it had an innovative user interface and accessibility via the cloud - paired with free distribution, these characteristics defined its competitive success.

After gaining the customer base and brand recognition, the company released its second product, 360 Secure Browser. In 2014, the software was amongst top 3 most used browsers in

China, according to CNZZ (figure 7).

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Figure 7: China Web Browser Market Share by Total Reach in August 2014

Because of established brand value and similar to antivirus value proposition, the company expected to simply convert users from the previous product into a new browser. The assumption was successful and browser gained 45% of the market share with next biggest rival in face of Microsoft’s 30%. On the paper, the product aimed, “to serve as an entrance for Internet users who want to get great Internet experiences with zero security concerns.”

("Qihoo 360 More than Doubles in U.S. Debut", 2011).

However, on the practise product’s market position allowed the company to influence users’ behavior in a way that the company was able to monetize free customers by selling generated traffic to other companies and providing its software as an advertising platform for other firms of the Internet industry. To create sellable traffic, Qihoo 360 implemented a 360

Personal Start-Up Page within its browser, as Qihoo’s CFO Alex Xu describes it: “It is a one-

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stop starting point for users’ entire online experience.” When a user opened the browser, he or she would be greeted with the start-up page and be immediately exposed to web- suggestions featured by third parties that paid for the placement there: “No matter where you go, you can find that link and you can click it. You don’t even need to touch the keyboard to finish the whole [conversion] process.” (Melvin & Nair, 2015) The company also integrated its competitors’ WeChat, the biggest social media platform in China with 980 million active monthly users as of 2017. (Schaefer, 2015) It also actively encourages consumer to use the application, in fact “...very first default screens that appear after the browser is launched for the first time urge users to install 360’s WeChat browser plugin.” (figure 8). (Schaefer, 2015)

Figure 8: WeChat browser plugin

The company's management recognized that monetization strategy applied in web browser worked really well; because of that, they preserved that strategy with a number of consequently developed valuable products for their customer base. The CFO of the company standardized the practice by saying that “The first two layers are really about gathering users, generating influence on behavior, and then the third layer is

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where we achieve monetization.” (Melvin & Nair, 2015) Among next company’s products that utilized this idea are search engine and mobile application market.

The introduction of search engine supposed to be better monetization version of browser start-up page due to the more advertisement space provided by unlimited keywords. (Melvin

& Nair, 2015) As for mobile application market, because any developer could use it as distribution platform and reach Qihoo’s users it gained popularity; even there, the company applied three layers’ rule: if the application had any micro transactions presented, the company would take the small fee of ⅓ from each in-app purchase and the rest transferred to developer (Melvin & Nair, 2015). The three-step approach proved to be sufficient monetization system for the company.

The success of the company’s products could also be found in constant learning and dedication to their users, as CEO of Qihoo 360 says in his interview, “In the beginning, forget how to make money—focus on how to create a valuable service for every consumer.” (Frank

Nazikian, 2012) Understanding user’s value and delivery of the best possible user experience is a big part of the company’s ideology. As a result of behavioral data analysis the firm was able to adjust and create features in line with facts about their consumers. Qihoo found that it is problematic for a Chinese person to use English keyboard, in reality, “Even if you want to type Chinese characters using pinyin pronunciation, it takes multiple keystrokes to enter a single character.” (Melvin & Nair, 2015) Thus, by implementing start up page with relevant suggestions into its browser company enabled users to avoid keyboard during Internet surfing. This approach applies even deeper, the company assesses the smallest details in user interface, as the company’s CFO explains, ““...if people for whatever reason, prefer the button in the upper right corner of this particular product and we put it there but other developers put it in the upper left hand corner—this creates a huge difference in terms of user

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interaction with the product. These kinds of details are very important.” (Melvin & Nair,

2015).

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4. Analysis and comparison with literature review

This section will outline main success factors of the firms discussed in case studies and evaluate freemium contribution to those achievements. Following the pattern of literature review, next paragraphs will similarly present each building block and briefly state observations from freemium framework table outlined in secondary research. Then, the validity of academic freemium characteristics will be compared with relevant key points from case studies.

4.1. Customer segments

In the freemium model, customers are divided in two categories: paying and non-paying users. There is a minor difference in value proposition which distincts two targets of the same segment.

Except for Qihoo 360, all other companies covered in case studies have free and premium users. Also, Riot and Dropbox have a distinctive proposition of additional to free service. By purchasing or referencing to a friend, free Dropbox user gets extra space to store more files whereas Riot gives player ability to renew the look of his or her favorite champion via skin purchase. Notably, in both cases the core service remains untouched: neither upload of files into cloud or gameplay affected by the added value. On the other hand, with Spotify’s premium offer user gets following: ad free music experience, ability to download music to cache and listen offline, higher quality music up to 320 bitrate (sound quality measure), and

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remote control of Spotify applications installed on other devices. Bundled together, these features have such immense influence on the music experience that the difference between free and premium offerings is rather modest. This aspect will be discussed deeper in the next building block.

4.2. Value propositions

In theory, vivid perception of value added to free service should increase customer’s willingness to pay for premium offer. That is achieved by adjustments of the offer and constant communication of the updated offers. Freemium companies are required to enhance core service with more features to distinctly communicate the added value in order to entice customers and provoke conversion.

As it has been stated in the previous block, of all covered case studies Spotify is the only company which provides premium users with the array of added values within one premium offer. Also, amongst these companies it has the biggest conversion rate of 42% which indicates users high willingness to pay for premium. That notion stands out and will be further discussed in the interview section in order to see if there is a parallel between bundled features in one premium offer and consumers willingness to pay.

Notably, in Riot case study company was able to use appeal to emotion in order to provoke conversion as it has been exemplified with promotional Championship Zed skin sale. The company exploited strong relationship between game players and professional teams. The company gave players ability to support pro teams by contributing to Worlds Finals’ prize

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pool 25% from skin sale. Given the volume of cheering for the teams users, Riot was able to create new value for their customer base. In response, company captured value in terms of high profits from skin sales and consolidation of brand loyalty. By doing that, the company was able to find a different way to affect users’ willingness to pay.

4.3. Customer relationships

In order for a company to create strong long lasting relationship with new users, it should entice customers with relevant value of free service which should be evident from the first interaction. That can be achieved by addressing complete user experience: look and responsiveness of the software, its usability and unchanging free service.

Previously stated Riot’s monetization example via promotional skin sale for Worlds

Championship event wouldn’t be possible without having strong bond with its players. Riot was able to achieve this relationship by constantly providing updates for the game which mainly focuses on gameplay adjustments but also bring new buyable items. This approach keeps the game in a fresh state which contributes to positive user experience by both paying and non-paying players.

Qihoo’s product development process greatly proves the significance of customer perception of the company. As it has been previewed in case study, company is dedicated to constant improvement of user experience by addressing customers’ values and needs. The essence of discussed products was designed to solve users’ problems (i.e. inability to use pinyin layout

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on the English keyboard layout) and make overall user interface maximally appealing for the target audience.

Spotify and Dropbox also present an aspect not mentioned in literature review which is retention of customers. Regardless of users’ category, the switching cost to alternative software in both services is high due to its core characteristics and features. In case of

Dropbox, bulk move of data is rather an unpleasant process. Albeit service itself provides users with ‘download all files’ button, a user is required to have stable and fast Internet connection in order to have uninterrupted and quick download, not to mention required free space for all files from the cloud. In contrast, Spotify’s unrestricted access to full music track and impossibility of playlists export are the things which hold consumers from switching to alternative services. This aspect will be addressed during the interview session.

4.4. Channels

According to the analyzed literature, using freemium companies communicate its value proposition mainly via two channels - previously acquired free users and social media platforms. Both these channels are crucial for the launch of network externalities effect.

Dropbox was affected by indirect network externality which emerged via free users.A great example of indirect network externality is provided by Clements (2004): “A DVD player becomes more valuable as the variety of available DVDs increases, and this variety increases as the total number of DVD users increases”. Precisely, combination of referential bonus space and no-barriered entrance drove the value of the service up for both existing and new customers. It also expanded the platform itself, which in turn made it possible for Dropbox to

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offer even more free storage for new coming users. Success of the referral strategy without utilization of free users as a channel otherwise would not be possible.

As shown in both Riot and Spotify case studies, companies utilize social media channels in order to communicate the value of their service to new and regular users. Spotify’s integration with Facebook resulted in incremented conversion rate and Riot’s indirect content creation by game appraisers created a viral promotion over various social media channels

(Twitch, Youtube). To some extent, social mediums exposed both companies to network externalities effect via social networking aspect.

4.5. Revenue streams

It is said that a company is required to cover the costs of providing service to non-paying users by coming up with monetization techniques. Methods extracted from literature review include providing third parties with advertisement space within service, converting free users to paying customers and selling analytical data about customers.

Spotify, Riot and Dropbox cover costs of their free user base in a different manner. Spotify uses profits gained through premium conversions to subsidize costs of free users and provides its platform as highly customized targeting option for advertisers. Riot’s revenue comes from microtransactions within game and sponsorships of eSport events. Dropbox finances free users by extracting a portion of profits from Dropbox for Business subscriptions and conversions of free users.

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Qihoo 360’s approach to its free customer base differentiates with the rest of covered companies. Their main revenue stream is based on utilization of free customers. Dedication to user experience allowed the company to transfer their user base from antivirus to web browser from which company earned revenues by selling traffic generated by users to

Internet companies.

4.6. Cost structure

Freemium require companies to notice the costs incurred of service maintenance since marginal costs associated with software itself (i.e. service wrapper) are zero.

All of the presented freemium case studies indicate constant development and adjustments of their services. Riot finances development for its game updates on monthly basis as well as servers maintenance. Spotify’s main goal is to provide free music worldwide, thus apart of servers maintenance, the company has to pay for music licensing in order to expand its repertoire. Straightforwardly, Dropbox has to pay for physical space occupied by its users.

4.7. Analysis summary

Comparison of case studies and literature review showed that observations drawn from academic writings are applicable and mostly in line with real world business implications.

Also, two absent in literature review features were additionally discovered. First contributes to Value proposition block with the observation that a number of additional values added into one premium offer have positive impact on consumers willingness to pay. Second contributes to Customer relationships block with the suggestion that by making free value non transferable or replicable, customers retention rate should be high since users are ‘locked’ in

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particular feature of the service. Next section will compare stated findings and applicable framework with the interview.

Table 2. Updated version of applicable freemium framework with additional characteristics added after comparison of literature review and case studies.

Building blocks Summarized freemium characteristics

Customer segments Distinct segmentation between free & premium members.

Value Propositions Free base offer and premium offer of bundled features with clear communication of differences.

Customer Relationships Smooth user experience via responsive and appealing software interface, non transferable or replicable free offering.

Channels Non-paying users and social medias.

Revenue Streams Advertisement, customers' data and conversion.

Cost Structure Development and updates of software, service maintenance.

5. Interview

Mr. Hugo Sellert, Vice President of Avast was generous to provide author of this research with insights about how firm operates within freemium. Since this company is one of the earliest and most successful freemium adopters, gained information from such source is excellent for finalization of applicable framework. The interview was conducted in Avast’s incredible headquarters in Prague. The conversation was had rather informal scope with more general questions. With that approach, author gained the most ambient perception of

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freemium in firm and gained the confirmation to most observations without focusing on each specific element during interview. Next paragraphs will present reader with commentaries of interviewee on observations from previous section. The interview questions could be found in appendix.

5.1. Analysis

The interview started with Mr. Sellerts interesting comparison of freemium with a conversion funnel. He stated that all users start on the top of the funnel as free users. Over time, as company gets to know these users better, it proposes relevant to user added value in form of premium subscriptions thereof dragging user down the conversion funnel. That funnel utilizes number of techniques for successful conversion.

During discussion about artificially downgraded free offer, interviewee emphasized the main finding of the research - that ism freemium service has to have qualitative and relevant free value proposition. Mr. Sellert also stated, that “if you artificially make your free product not very good you are not going to get the distribution which you potentially could get from a freemium products, because consumers will learn overtime that your actual service it's not really good, thus assuming that premium offering is not worth it.” Therefore, there must be enough value in order to entice users and gain strong initial customer base.

Based on interview, assumption that multiple values formed in one premium offering correlates with higher conversion rate turned to be false. Moreover, interviewee claimed that communication of differences is not “as important as the context and the approach to sell premium offer”. According to Mr. Sellert, high conversion rate does happen with the right context: “It’s not only about what you sell, but the time at which you sell and how you

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actually enable user to go from the potential interest into something more; how to very quickly convince them, that they actually gonna par with x-amount of dollars and actually pull their credit card from the wallet.” He further states that team he leads creates a resonative messages based on all the information company has on that particular user. That includes data which would help to “reach people at the right time, with the right offer, price point, and value proposition.”

On the other hand, that claim goes in line with characteristic outlined in customer relationship block about user experience and responsive software interface. Interviewee stated that software gives company additional way how it can interact with user. Via software’s interface user is exposed to premium offers and is more likely to interact with those directly. Simply put “if user finds some premium feature he thinks, ‘Oh, what is that? That looks really interesting!’, he clicks and prompt asks him to pay for it.” By stating that simple example,

Mr. Sellert represented how crucial is user interface in terms of value communication within platform. Moreover, user interface directly contributes to conversion process: “When you have our free product installed and for some reason you consider to buy it, everything happens within the application - no need to open the browser page, no distraction involved.

Reducing friction for those free users that actually spurr an interest in converting by capturing the attention.”

Interview also briefly touched subject of freemium use by other firms. Discussing costs incurred with free users, interviewee unintentionally proven one of the observations regarding

‘lock up’ effect on customers, he stated that in case of Dropbox, “once you got people hooked

I think their retention rate is a lot higher than something like antivirus since it is much harder to move all the user files from cloud than uninstall a piece of software.” He also pointed out

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that user experience is crucial as a whole, apart of user interface he also added full localization (translations, local payment systems, customer service).

Discussing whether Avast’s competitor, Kaspersky Antivirus will be able to succeed in its implementation of freemium model, Mr. Sellert stated that competitor will firstly need to gain critical mass of free users in order to “open up top layer of the conversion funnel”. He also added that, that it requires gain of things as “SEO rankings (which comes with people’s interest in what you have) and recommenders influence (word of mouth) which comes from having a good reputation.” That point goes in line with channels block confirming usefulness of free users as a promotional medium.

From the interview, it is evident that company puts a lot emphasize on conversion. Mr. Sellert stated that since Avast is funded by investors, the targets are quite aggressive: “For us it is a lot about finding ways to convert free installs into paying customers then show that we provide enough value to retain them and cross sell them other adjacent services & products.”

That approach greatly resonates with other alternative financing methods covered in previous chapters.

Mr. Sellert said that Avast uses number of monetization techniques, which are applicable during customers’ way down conversion funnel. This monetization engine addresses questions: “How to innate acceptance for people to pay for product?” These techniques are presented within platform and include things as trials of the premium product (with or without pre-insertion of credit card) or prompts asking user to choose whether they want to stay on free product or give upgraded version a try. Interviewee noted that “...because we are

51

protecting users both on the device and while browsing the internet, we are able to collect quite a lot of data and distinct when user’s likelyhood to pay for a product is high”. This

‘shopping mode’ gives company ability to time offers instead of “shooting messages randomly.” As a mechanism outside of software, Mr. Sellert mentioned offers based on occasions: “Seasonal offers work well too - Black Friday, Cyber Monday. The system is complex and includes other techniques, in the nutshell - from very friendly and soft to quite aggressive and annoying, finding the balance in customer's’ brand perception and valuing other trade-offs.”

5.2. Observations

The comparison with previous chapter and conducted interview mainly proven the validity of observations outlined in first freemium framework. However, one of the proposed updates in chapter three contradicts with interview observation.

Mr. Sellert described the importance of value communication context, saying that “...what

Avast has done really well is not focusing too much on the features but actually the context in which those features are proposed, to make it relevant with the state of mind of the consumer.” Given his experience and credibility, value proposition block will be adjusted accordingly. Notably, this notion requires deeper research which will be proposed in conclusion.

The second proposed update goes in line with observation from case study. Interviewee accurately stated, that customer’s retention rate is much higher if the switching cost to alternative service is high.

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After taking into account all observations from current and previous chapters, final version of framework will be presented in conclusion and used to answer ultimate questions of the thesis.

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6. Conclusion

First part of the work briefly discusses relevance of disruption, innovation and digitalization in business context. Basing of that discussion, it has been hypothesized that freemium can potentially be a disruptive business model of its own. First question of this thesis work was following: “Is it possible to use distribution practices of freemium digital products in order to create a unique and diverse business model applicable for the industries outside of IT?” To evaluate validity of hypothesis, research aimed to firstly extract available information about freemium from secondary research (mainly academic sources), compare it with case studies and adjust findings by interviewing an experienced corporate freemium practitioner. By the end of research it became clear that freemium is wide topic which needs further in-depth research. To answer stated question - it is not possible to narrow freemium down to one concrete business model and apply it to any business.

However, taking into consideration a possibility of such outcome, author proposed second question aswell: “What are the best applicable practices and concrete values businesses can gain (apart from the profit from the complementary product) by using freemium distribution?"

6.1. Best practises

This section will briefly summarize observations from the research and state what things should be fulfilled in order to use freemium based of framework created through research (Table 3).

Table 3. Final version of applicable freemium framework after secondary and primary researches.

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Building blocks Summarized freemium characteristics

Customer segments Distinct segmentation between free & premium members.

Value Propositions Free base offer and premium offer with clear communication of differences within right context (timing).

Customer Relationships Smooth user experience via responsive and appealing software interface, non transferable or replicable free offering.

Channels Non-paying users and social medias.

Revenue Streams Advertisement, customers' data and conversion.

Cost Structure Development and updates of software, service maintenance.

Firstly, there should be a definite segmentation of free users and premium users. This base can be further manipulated into various purposes, ranging from word-of-mouth promotion to different monetization techniques.

Next, the value proposition needs to be balanced, with constant availability of free service for both segments. Also, if company’s main revenue consists of premium conversion, then communicating added value of premium within right context is a good tactic for conversion rate maximization.

To make maximally appealing service for the customer, user experience within the application should be supreme. That applies on user interface, responsiveness of application and customer support. Also, in order to keep customer retention rate high firm encouraged to make unreplicable features within free offer.

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Promotion should be done mostly via free user base since it has potential to tackle network externality effect, which can consequently turn into viral growth. This effect also creates user communities which attract newcomers via word-of-mouth and social media.

6.2. Next steps

For the consequent research, it would be valuable to conduct a focus group with customers of freemium companies discussed in case studies. Dropbox, Riot and Spotify users would be asked questions in order to evaluate how clear companies communicate differences between free and premium values to the customer. The result of that research could contribute to finding whether number of features bundled in one premium offer has an impact on consumers’ willingness to pay.

Also, the next research step might involve interviews directly with members of the companies from case studies. This is preferable step which could remove accidental bias incurred in secondary research, mainly in case studies section since information will be gathered from primary source.

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