Which Comes First? Active Users? Or Profit?

Deciding how much to charge for your product is a crucial go-to-market decision. There are a lot of factors you have to consider. Some companies have risen to fame and glory with products that are essentially free — or at least, that’s how we think of them.

Consider Instagram. The social media app has always been “free,” but over the last few years, a robust ad-serving model has quietly crept into both the main feed and the Stories feature. The true value of Instagram, like its parent company Facebook, is in its users and all their data — which is why Facebook purchased the app in 2012 for an estimated $1 billion, one of the smartest tech acquisitions ever. With a current valuation of over $100 billion, this is a 100x increase in value. In the final quarter of 2018, thanks in large part to the Instagram acquisition, Facebook Inc. reported advertising revenue at $16.6 billion. Thirty percent growth over the prior year was attributed largely to Instagram feed and Stories ads, as well as Facebook mobile ads.

You might consider Facebook and Instagram to be “free,” but advertisers would beg to differ. As they say, if you’re not paying for a product, most of the time, you’re the product.

Still, the user-data model leaned on by Facebook and Instagram is the subject of intense debate these days. It works for Facebook because the company has been very strategic in spending lots of time and money on R&D to constantly add features to their core product, so the experience creates an elegant balance between being dynamic and predictable for users. This type of model can be risky to replicate. For most companies, focusing on active users is just a starter tactic; eventually, they charge.

Coming up with a pricing model is the conundrum. Here are the top five types of pricing models apps and other digital products typically use. They fall into two categories: Rent and Own.

Own the Product

1. One-time download fee

Users pay a nominal fee to purchase most apps — maybe 99 cents or $1.99. In 2018, Apple reported that the average price of a mobile app was $1.02. This might sound like a ridiculously low amount to charge for a product that probably cost you anywhere from $80 to $250K to make (at least according to Appster, although estimates from other sources come in much higher). But with enough users, the charges can really add up.

Keep in mind, of course, that revenue should not be your only incentive if you decide to charge for your app or other digital product. Apps with a price tag attached also have a higher perceived value. By charging for your product, you’re implying that it’s worth it.

This model used to be prevalent, but we’re seeing it less and less often today — unfortunate, because it’s a good model from the consumer point of view. With all the services available to “rent” today (more on this down below), monthly subscription fees can really add up.

2. Free

Why would you go through all the effort (and expense) of making a digital product like a mobile app and then give it away for free? In addition to the Instagram/Facebook model of data aggregation described earlier, there are several reasons.

1. Retail apps like Amazon, Etsy, Walmart, eBay, and Target (these happen to be the top five) make up an enormous category of “free” apps designed to make their makers money.
2. Other retail-focused apps are given away for free to engender brand loyalty or augment the present of a physical store. For instance, the Starbucks app builds even more loyalty among customers by helping them collect reward points and even order coffee ahead of time to skip the line.
3. Service companies like insurance companies and cellular providers offer complimentary mobile apps to give their customers an expedited, elevated experience. Today, having a mobile app is an expected way of transacting with customers — not a perk, but a mandate.

Rent the Product

3. Subscription / Membership

The subscription model automatically charges users monthly or annually to renew their membership. Often, there are several types of memberships — a basic one and upgrades.

Apps that charge a subscription generally start with a free trial to put users’ minds at ease about whether they really want this product. Apple Music is a great example. After a 3-month trial, there are several paid subscription types, including ones for individuals, students, and families.

Makers love the subscription model because it helps them circumvent an age-old problem known as the “first-sale doctrine,” which essentially legally enables a consumer to resell a product they’ve bought, even if the product is copyrighted. According to this law, a user could ostensibly purchase an app and then pass it along.

But as rampant as it seems to be today, this model is less desirable for consumers. With every other app out there charging a subscription fee, the monthly totals can really rack up.

4. Pay-per use

Rather than a recurring subscription rate, users pay for some type of use of the product. This category has a lot of variety. There are pay-per-transaction models like AirBnB, eBay, and PayPal. There are pay-per-user models like Slack. And there are pay-per-API-call models like Pixlee.

For most digital product startups, what we’ve seen work well is a go-to-market strategy that involves a combination of focus on acquiring users and charging for the service from the start.

When it makes sense to use this model, it’s probably our favorite because it serves both the consumer and the business well.

For the business, the upside looks like this: While you’re working to engender customer loyalty over time, the customer is paying for each transaction. This helps cover the cost of down-the-road upgrades and revisions to the product. On the other hand, when a customer pays a one-time fee, and can then use the app forever, your monetary compensation may end up wildly skewed toward the consumer.

For the consumer, the satisfaction of receiving something in exchange for every payment made can be incentive enough to appreciate this type of business model. It makes sense that AirBnB or eBay collect a fee each time a transaction is made; the consumer does not question the logic of this method.

Free, Until You Rent

Then there’s the freemium model, which is free to own…. or you can pay to rent.

5. Freemium (free, but you can pay to upgrade)

A basic version of the product is free. You download it, you own it. But you have the option to upgrade to a subscription model — ”rent” — for more features. This is one of the most prevalent ways companies charge for products today. In fact, according to Forbes, 76% of all U.S. Apple App Store revenue comes from “in-app purchases,” including upgrades to paid models once a user has downloaded the Freemium version.

Dropbox is a great example of a freemium product. The cloud-storage solution has a free starter package to give users a taste of the product, with all features unlocked. Once users are hooked on the product and reliant on the storage capabilities, Dropbox offers a paid upgrade for more space and enhanced features, which users are generally happy to pay for.

LinkedIn, Hulu, and Trello also went the freemium route. This can be a “best of both worlds” scenario for product makers because it allows you to build a big user base and still make money. To make this model work requires a savvy understanding of which features should be free and which ones users will willingly pay for.

There are some variations in these five models, and perhaps some crossover, too. But as you begin to assess the optimal pricing model for your product, this is a good place to start.

The model you use to charge (or not) for your product is a critical step in your product marketing and in establishing the right user base. Adoption hinges in part on pricing model, and making the wrong decision could kill your product’s user goals.

Want to keep going? Read our book Got Ideas? How to Turn Your Ideas into Products People Want to Use, which takes novice product-makers through the journey of creating great, user-friendly digital products from the thin air of their imaginations. Available in hardcover, paperback, ebook, and audiobook, it’s a hands-on, practical manual for aspiring entrepreneurs and intrapreneurs.