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Marius Niculescu, assistant professor of IT Management
Marius Niculescu, assistant professor of IT Management
D.J. Wu, the Thomas R. Williams Wells-Fargo professor of IT Management
D.J. Wu, the Thomas R. Williams Wells-Fargo professor of IT Management

For Free or Not For Free: Scheller Professors Examine Various Software Business Models

The market for software applications continues to grow exponentially, but some developers may not be hitting it as big as they could, according to researchers at Georgia Tech Scheller College of Business.

With so much competition for consumer awareness of mobile apps and other software, companies need to carefully consider their marketing strategies – including methods for allowing a certain level of free access to the product, says Marius Florin Niculescu, assistant professor of IT Management

“There are hundreds of thousands of apps out there,” he says. “So it’s easy for people to miss one. Companies can help customers assess the quality of software, including performance and functionality, by allowing them to sample the product – or part of it – before committing to a purchase.”

Niculescu collaborated on this research with D.J. Wu, professor of IT Management. Their paper, “Economies of Free under Perpetual Licensing: Implications for the Software Industry,” was recently published in the leading journal Information Systems Research.

Changing Market

In their study, the researchers note that the global software market is expected to reach $356.7 billion by 2015. They discuss the radical shift in how software companies have generated revenue over the past several years with the rise of smart-phone and tablet technology.

Recent reports, for example, show that 86 percent of revenue from the Apple App Store comes from free apps with in-app purchases through which customers can get access to additional functionality or content (for example, purchasing access to extra levels of a game like Angry Birds).

“This approach represents a variant of what is commonly referred to as the 'freemium' business model, under which customers gain access to a certain level or type of consumption for free but have to pay for premium consumption,” Niculescu explains.

As an alternative to creating basic versions of the software that are made available for free to everyone, smaller-scale market “seeding” strategies could be employed, the researchers note.

For instance, the full products could be distributed, or “seeded,” for free to a limited number of customers who could help generate word-of-mouth and effectively jump-start the market – perhaps influential technology bloggers or media figures like Ashton Kutcher with large numbers of social media followers. Or, in the hopes of generating buzz, the complete app could be offered for free for a limited time to consumers who discover the deal online during the promotional-campaign window.

Comparing Strategies

In their study, Niculescu and Wu compare the profitability of “seeding” the full product to a certain number of consumers against offering “feature-limited freemium” versions or selling the software as a bundle without free options (“charge for everything”).

He and Wu found that “seeding” might be the optimal way to go when word-of-mouth is weak and consumers undervalue a product’s functionality or what they might get out of purchasing additional features even when exposed to the basic version.

On the other hand, employing a “feature-limited freemium” approach may work well for products where exposure to some basic functionality can lead customers to increase their valuation of premium features, Niculescu notes.

For example, customers may be willing to pay more for the premium Adobe Acrobat software once they can open PDF files with the free Adobe Reader and understand how much more they could do with the enhanced product, he explains.

“This approach has become the dominant business model for mobile apps, allowing the customers to sample content and interfaces,” Niculescu notes.

But giving away a certain level of free functionality hasn’t worked for every business. The publishing company Flat World Knowledge, for instance, recently did away with the “freemium” versions of its online text books after realizing that few customers found it worth paying a premium to print out versions or access additional study notes for the material that they already could read for free in the cloud, Niculescu explains.

Managerial Significance

“The insights derived from our study are of significant managerial importance, as they help firms determine whether or not to undertake certain investments in development and advertising,” he says.

In their study, Niculescu and Wu explore in-depth how a firm’s choice and implementation of a strategy can be impacted by factors such as the value of basic versus premium features, consumer valuation beliefs about the product based on pre-release advertising, as well as consumers’ ability to learn about the value of the product from direct experience or via word-of-mouth.

As these parameters change (for example, as a result of an increase in advertising dollars), it’s important for firms to figure out how to adjust their strategy, according to the study. “That adjustment can actually be quite complex,” Niculescu says. “Should a firm just alter price, or also switch business models (for example from ‘freemium’ to ‘charge for everything’)? Should it also change how many people are seeded if it were using seeding? There are many variables to consider.”

He adds: “Firms should carefully tune their business models in sync with their pre-release strategy (which leads to consumers’ assessment of value) instead of independently deciding on the two,” Niculescu says. “This is consistent with reality where we see many firms pre-announcing products and talking about their features way before pricing schemes and release configurations are announced. This allows for the latter strategies to be based on updates in consumer beliefs.”

In a software market where customers are increasingly inundated with options, it can be challenging to reach sales goals, Niculescu says. For example, a company that invests $70,000 in an app would need to sell $100,000 worth of copies or in-app content in the Apple App Store just to break even, given that Apple gives developers 70 cents on each dollar of revenue generated.

“There are some gems out there, and some developers have gotten rich,” Niculescu says. “But there’s by no means a guarantee to recover the costs of development. However, going the smart way about commercializing the software can get a developer a few steps closer to that goal.”


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