Conventional wisdom says it’s a mistake to slash prices when you’re already giving away part of your product.
To promote or not to promote? That was the question leaders at a gaming company were debating when Julian Runge arrived as a consultant.
“They’d grown from Facebook gaming to mobile and now were debating how much to rely on sales and price promotions to acquire customers and boost revenue,” says Rungeopen in new window, a former doctoral fellow at Stanford Graduate School of Business who’s now at Northeastern University. “The managers were split between thinking promotions would be super helpful and crucial to use versus actually harming their revenue in the long term.”
The value of price promotions has become a question of great interest as more digital businesses adopt a “freemium” model, where users can opt for a free base version or pay a premium for a full version or feature upgrades. Slack, Tinder, and LinkedIn use a freemium model, as do over half of all apps in the Apple Store.
Yet is it smart to cut prices further when you’re already giving away part of your product for free? If the execs at the gaming business Runge consulted had checked out the existing marketing literature, they might have come away feeling wary of these kinds of promotions. “There are a number of very good papers that lean toward the harmful side of this perspective,” he says. “They say price promotions help you drive spikes in short-term sales, but might actually harm your long-term profitability.”
Promotions may be frowned upon for several reasons. A reduced price can cause consumers to believe the product is worth less, thus lowering their willingness to pay full price. Other consumers may engage in what marketers call deal-seeking — only buying items on sale — or stockpiling discounted items.
Runge cautions that those conclusions emerged largely from research into traditional packaged goods and retail settings stretching back to the 1980s. Along with his collaborators, Jonathan Levav and Harikesh Nairopen in new window, current and former GSB marketing professors, respectively, he believed the promotions-are-bad belief might not apply to freemium models for digital products.
“This is a case where an industry problem became the core of an academic paper,” Levav says. “The question of promotions in freemium settings is of both substantive and theoretical importance, as many companies now use freemium to attract and acquire customers, and the effect of promotions has been debated in the literature for years.”
The authors offered several reasons promotions might not pose problems for digital businesses. “It’s different,” Runge says. “The marginal cost of producing anything in this space is zero. So even if you reduce the price of something, it’s still all profit in the end.” Moreover, many of the barriers to consumption of traditional goods don’t exist in the virtual world. “If you buy chips on sale, you have to go to the store, bring it home, and you still can’t eat five bags of chips at once. But with virtual goods that are commonly offered in freemium settings, you buy something and it’s available to use immediately — for example, in-game currency,” Runge says.
That suggests freemium-model businesses might be able to have their promotions and profits too.
Do Digital Discounts Work?
To test that idea, the researchers and the gaming company ran an experiment placing users of a freemium game randomly into groups receiving certain promotions or none at all over six months. “We’re lucky that Julian has such deep ties to industry,” Levav says. “The industry partner here allowed us to do something unique: run a field experiment rather than analyze secondary data, allowing for direct causal analysis. I wish we could benefit from such partnerships more often.”
Their results showed that promotions increased both conversion rates and revenue significantly with no negative impact. “Promotions are profitable,” the authors conclude.
The mobile game the researchers studied involved building a virtual city by solving graphical puzzles. Free play was possible without ever making an in-app purchase, but users could buy in-game premium items such as session extensions and city decorations using in-game currencies purchased with real money.
More than 160,000 users who downloaded the game in late 2016 or early 2017 were randomly placed into a control group that received no promotions or one of several groups that got discounted bundles of in-game currency on a biweekly schedule.
To understand the potential impacts of timing, the promotions were given to users at different times: immediately upon installing the app, 25 days later, or 50 days later. The researchers were interested in how promotions related to conversion — a user purchasing the discount bundle — and revenue over six months post-download.
The results showed a clear pattern: All promotions led to substantially higher conversion rates than the control group. Across different onset times, promotions increased conversion by 37%. Moreover, the share of users making a premium purchase was closely related to timing, with the highest level observed with immediate promotions.
Revenue, too, was higher for the groups that saw promotions — nearly 24% higher than the control group. There was evidence that players who saw the promotions after a 25-day delay generated the most longer-term revenue. “The sooner you start promoting, the higher conversion will be,” Runge says. “If you start super late, you seem to miss out on the opportunity to reach a lot of users.”
Something for Nothing?
So why do promotions seem to work when customers are already getting a version of the product for free?
Runge sees it largely as a matter of complementarity: “If you buy the upgrade, that increases the utility you get from the free version, or at least from the combination of both, which makes it more valuable, in turn, to buy something again. It’s a kind of beneficial loop.”
Consider a dating app, where users may experience a cyclical increase in benefits from promotions. A user may start with the free version, then purchase a way of getting better matches or connecting with people they find attractive. “That makes the social interaction substantially better,” he says. “So you have incentive to keep using the app because of the paid features, and when you run out of those, you have incentive to buy them again and to keep using them on the free version.”
Digital businesses that use the freemium model can then offer promotions with confidence that the complementarity will boost their bottom line. And they can get strategic about it. “You could, for example, not make all the goods somebody buys available to them immediately, but pace that out to also set an incentive for them to keep using the app,” Runge says.
Still, it’s too soon to throw out past research on the impacts of promotions on traditional consumer goods like potato chips or dish soap. For one, physical goods don’t have the same complementarity as digital goods. Moreover, Runge says, “the big difference is that with virtual goods, there are no physical boundaries. They’re consumable immediately.” So consumers are less likely to engage in deal-seeking or stockpiling.
Then there’s the metaverse. While the current research doesn’t touch on virtual space, its results may be applicable. In a boundaryless online realm, Runge says, “you can be anywhere at any time and consume as much as you want, and promotions are bound to be hyper-effective tools in that setting.”
So, giving away bags of virtual chips might incentivize customers to consume more, with no harm to their waistlines — or your bottom line.