The new season of Game of Thrones will air on April 6th. As a big fan of the show, I am looking forward to watching the next story of John Snow and Daenerys, actually I wonder how big Daenerys’ dragons will become. The internet service industry is another version of Game of Thrones, which is driven by a few big players and small innovators that grow their own differentiators as Daenerys raises three dragons for the next battle.
Actually, we often see that a few leading companies are dominant players the entire industry with the exception of the internet service industry. However, there is one big difference between internet services and others. The cost structure of internet services is almost zero when it compares to other services that root on trade of a service or physical product. That’s why WhatsApp was acquired at $19 billion with less than 100 employees. There is no critical factor of a cost structure apart from expenses for marketing activities.
So, why do we care about this difference?
The basic equation of the success for an internet service is N (number of users) x F (frequency) x D (duration). It means how many people visit a service, how often they use it and how long they stay there. While most people are obsessed with the first part, the number of users, the other two parts are still important to get sufficient sustainability in the long term.
To increase frequency and duration, a service or an application lowers its pricing barrier by adopting two or three level pricing strategy such as freemium. I will not talk about how important trigger or motivator to use the service is for the first or second phase of service growth. This pricing strategy sets it apart from other services and other industries. In the case of Evernote, they provide a memo service up to 40MB per month free of charge. If a user needs more features and storage, it is possible to upgrade to the premium service, which charges $5 per month. Most people do not feel any inconvenience to use the free basic service. That is one of the reasons why a lot of users have tried this service without any consideration of price. Users only needed to tolerate the small banner on the left bottom side of Evernote. Even, Evernote recently eliminated this small banner from the free version.
When I saw the banner, I wondered how much they earn from an advertisement of the small banner and how many people convert to the premium version. Here is an answer to this question by Phil Libin, the CEO of Evernote.
“We have about 80 million users globally, and that’s a combined number for free and paid. Our conversion rate increases linearly with cohort age, so the longer you use Evernote, the more likely you are to convert to premium. The idea is that we want you to use Evernote forever. Once you’re using it, we want you to keep using it, and it’s more important that you stay than you pay us. We want the engagement. The longer you use it, the higher the perceived value gets. And the higher the perceived value, the more willing you’re willing to pay. It’s up to us to make something that you want to pay for. The percentage of people who pay in the first month is like one half of one percent. But if they use it for a year, that goes up to seven percent. In the second year, it goes up to 11 percent. Our oldest cohort, the people who have been with us five years or so, it goes up to 25 percent.”
From an interview with AllThingsD (12/26/2013)
This answer demonstrates what makes people habituated to a service and pay for it. This freemium strategy is not explained with only multi-layer pricing strategy, which tries to maximize the revenue by meeting the different willingness-to-pay of diverse consumer or user groups. The most important impact from freemium is not leveling of price but the formation of habit. By converting the one time trial to regular behavior, a service can see the success that increases frequency or duration of the service.