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whatsapp used this pricing strategy to win and you can too
WhatsApp Used This Pricing Strategy to Win and You Can Too
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Seven years ago, First Round Partner Josh Kopelman wrote a seminal blog post on
the importance of free services in consumer-facing business models. He argued th
at most entrepreneurs misunderstand how subscription pricing works and assume th
at as price goes down demand goes up in equal measure. Instead, he suggested tha
t price affects demand to a point, but the relationship is far from linear there
is a gap between free and any other price. This gap is known as The Penny Gap.
Years after the post was written, WhatsApp used a novel approach to solving the
Penny Gap while creating one of the fastest growing mobile networks on the plane
t. And while WhatsApp built an incredible product that solved a real need, their
understanding of the Penny Gap may have been their shrewdest product move of al
l. In this article, we explain why, and how this knowledge can help your company
and apps succeed.
Minding The Penny Gap
Kopelman pointed out that while lower prices generally create higher demand, the
re is a unique phenomenon that occurs between free ($0.00) and paid ($0.01). Mos
t entrepreneurs assume that the cheaper a service is, the more people there will
be who are willing to pay for it. But that doesnt account for the massive gap be
tween unpaid and paid products, or the power that dynamic holds for growing a co
nsumer business.
The Penny Gap, according to Kopelman, can be understood as follows:
Author: Sean Ellis and Morgan Brown, Qualaroo
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The truth is, scaling from $5 to $50 million is not the toughest part of a new ve
nture it s getting your users to pay you anything at all.
To support this claim, Kopelman pointed to breakout hits of the time. When compa
red to their legal, paid competitors, free music sharing services Napster and Ka
zaa werent just incrementally better they were exponentially bigger, suggesting t
hat the relationship between price and demand is more complicated.
He went on to assert that sometimes offering your product or service for free is
actually cheaper for consumer businesses. Acquiring customers for a paid produc
t with a low conversion rate can be expensive, while monetizing free users throu
gh ads is relatively easy. In the world of mobile, this lesson may be more impor
tant than ever.
The Mobile Penny Gap
In the years since Kopelman coined the Penny Gap, this reality has been compound
ed and magnified in the mobile space thanks to App Store distribution and the ma
ssive number of users on platforms like iOS and Android.
A quick look at revenue for top grossing iOS games highlights the effect of the
Penny Gap. On Think Gamings list of the highest grossing games, out of the top 50
games, only one Minecraft is a pay upfront app. The rest? Free with in-app purc
hases. Out of the 100 highest grossing, only five use pay upfront models. The nu
mbers are similar for Android apps, with just two pay upfront games out of the 1
20 highest grossing games on the Google Play store.
In what he refers to as An App Store Experiment, Stuart K. Hall observed the pow
er of free when he built a very basic 7 Minute Workout App. After letting the ap
p run as paid for a few weeks (he sent out press releases with promo codes and a
dded iPad support, with minimal effect on downloads), Hall decided to make the a
pp free to see what would happen. Within three days, the apps downloads had grown
to an average of 72,000 per day, or around 2,500 times what they had been for t
he paid app. It became the #1 fitness iPad app in 68 countries and the #1 fitnes
s iPhone app in 49 countries.
The apps revenue was also impacted by the shift from paid to free. When Hall swit
ched the app to free, he added in-app purchases by way of a pro upgrade that provi
ded workout tracking and customization. The switch led to a 300% increase in ove
rall revenue, even though 97% of users didnt pay anything to use the app. Halls ex
periment highlights the real power of the Penny Gap.
Free in Winner-Takes-All Markets
The examples Kopelman used in his original post werent just any old consumer busi
nesses. Both Napster and Kazaa were driven by the network effect. And when it co
mes to businesses built on network effects such as LinkedIn, Twitter, and Yelp t
heir value is only as great as the size and quality of the network. Any business
fighting the early challenges of Metcalfes Law knows how important it is to quic
kly build out their network to create value.
Notably, making things free removes some of the friction that comes with establi
shing the value of a network. Network businesses are fighting for a winner takes
all end game where the dominant network is so valuable that users dont want to lea
ve because other alternatives dont offer the same value.
ny also looking to expand in emerging markets, the value of this move is clear.
The challenge now is that the mobile market has grown so big that there is no lo
nger one true winner. Apps like Line are growing even faster and winning in coun
tries where WhatsApp has been unable to make a dent. As this trend continues, it
will be interesting to see if WhatsApp rises to the occasion or loses its user
lock-in, becoming the mobile messaging version of Friendster in the process.
If youd like to read more case studies like this on fast-growing tech companies,
check out our book Startup Growth Engines. Its a collection of deep dives into ho
w the smartest companies in the world are growing today, including LinkedIn, Sna
pchat, Square, Evernote and more. You can also find more tips on GrowthHackers.
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