The Twofold Effect of Customer Retention in Freemium Settings

Abstract

The main tradeoff in designing freemium services is how much of the product to offer for free. At the heart of such a tradeoff is the balancing act of providing a valuable free product in order to acquire and engage consumers, while making the free product limited enough to entice some consumers to pay for the service. We argue that customer retention plays an important role in balancing this tradeoff, due to customer retention’s twofold effect in freemium services—it not only generates additional revenues from the advertising side but can also increase user’s monetization in the future—firms are often myopic in their retention efforts by not recognizing that by limiting the free product, the firm is not only risking monetary losses from the advertising side but is also suffering monetary losses from the premium side. We leverage a large-scale field experiment run in a mobile game context, where game difficulty was exogenously manipulated among customers at risk of churning. As expected, giving customers an easier game significantly decreases purchases in the specific round played. However, lowering the game difficulty not only increases short-term play and subsequent retention, but also increases customer spending from premium services both in the short- and in the long-run. We find substantial heterogeneity in the effect of reducing game difficulty, where customers who are more prone to making progress in the games exhibit stronger effects and customers who previously spent money on the game exhibit the strongest effect on in-app purchases. We leverage these insights to recommend personalized freemium product design strategies and show how the focal firm can further increase revenues from both advertising and premium services.