Getting You To Pay in a Freemium World

How Companies Use 'Free' Smarter and Make Us Want To Pay Up

Dec 13, 2018
As Featured In 
Journal of Marketing

You’ve seen the promotional offers. “Try before you buy.” Your first week, your first month or first audiobook is free.

The companies who offer these trial freebies, embracing the so-called freemium business model, do so with the hope that they will convert you into a full-fledged paying customer. And in the digital economy, there are a lot of companies embracing free – Spotify, Dropbox, Hulu and The New York Times are examples.

And what many find is that it’s tough to wean customers away from free, says Maryland Smith’s P.K. Kannan.

“Many companies fail at it,” says Kannan, the dean’s chair in marketing science at the University of Maryland’s Robert H. Smith School of Business. “That’s why it’s essential to understand customer behavior, activate the right triggers and design premium product lines strategically.”

That was the challenge for Kannan’s latest research, published in the Journal of Marketing. They asked the question: If a free version is out there, how can you get customers to justify paying anything?

Kannan and his co-authors say their research maps a strategy. Working with the National Academies Press, an online bookseller, they conducted a field experiment to determine how companies might improve their sales of premium products, even while offering free ones.

The strategy calls for offering not just one premium customer level, but several.

Under the freemium price strategy, companies offer a basic version of a product at no charge, and a premium version with added features for a price. Popular examples include Spotify, which offers its music-streaming service for free with ads and some limited functionality, and charges $9.99 a month for a premium service that’s ad-free and lets listeners play any track they want and listen offline when they want to. Other freemium-based companies, including cloud-storage company Dropbox and entertainment-streaming services Netflix and Hulu, offer 30-day memberships for free, followed by a range of billing and service options.

Similarly, NAP, the bookseller at the center of Kannan’s research project, has traditionally offered free downloadable PDF versions of books, and sold paperback versions.

In their research, Kannan, Smith School PhD candidate Xian Gu and assistant professor of marketing Liye Ma, seek to learn whether more customers would decide to pay for products, rather than choosing the free PDF, if there were more products to choose from. They randomly chose certain titles and added either e-books at a lower price point or hardcover books at a higher price point. And they found that the paperback versions of those titles sold far better.

But how the new product formats are priced made a difference, the researchers say. When the e-book's price was closer to the price of the paperback, customers were more likely to select the paperback version, foregoing the free PDF option.

In other words, if the options are "free" or "not free," people will choose "free." When the options are "free," "less expensive" and "more expensive," the "less expensive" option wins out, as in the case when the hardcover option was added. The seller wins too.

A menu of options is good, but it’s important not to exceed the optimum number of choices. "Too few is bad, but too many is bad as well," Kannan says. That’s because when people are given a wealth of options, "they get analysis paralysis," Kannan explains. "They just don’t know what to do."

And in those cases, many people will make no decision at all – a missed sales opportunity for the company. Among scholars and other experts, analysis paralysis is a deeply researched phenomenon.

Behavioral economists have found, for example, that when employees are offered a chance to sign up for a 401(k) at their place of employment, the sign-up rates are lower when there are multiple investment options. People actually sign up more if there are limited options. Companies have found that a sprawling product line isn’t always worth it. Procter & Gamble’s Olay skin-care line, for example, saw sales sag in 2015 after expanding its brand options.

"People got confused and they stopped buying because they didn’t know what was what," Kannan says. The Cincinnati-based company discontinued one-sixth of its brands to focus on its core products.

"There is a cost involved in the cognitive processing of all this information," Kannan says. "It really has an impact on how you make your choice."

Read more: "Selling the Premium in Freemium" is published in the Journal of Marketing. And "How Companies Can Get the Most Out of a Freemium Business Model" is published in Harvard Business Review. 

About the Author(s)

P. K. Kannan

P. K. Kannan is the Dean's Chair in Marketing Science at the Robert H. Smith School of Business at the University of Maryland. His main research focus is on marketing modeling, applying statistical and econometric methods to marketing data. His current research stream focuses on attribution modeling, media mix modeling, new product/service development and customer relationship management (CRM).

Liye Ma teaches the undergraduate Marketing Research Methods class and the Data Science class in the MS Marketing Analytics program. His research focuses on the dynamic interactions of firms and consumers on Internet, social media, and mobile platforms. His work has been published in various journals including Marketing Science, Journal of Marketing Research, Management Science, and Information Systems Research. He joined the Marketing Department in Fall 2011 after obtaining the Ph.D. degree from the Tepper School of Business at Carnegie Mellon University.

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