Creating and capturing value from freemium business models: A demand‐side perspective

• Published date: 01 June 2018
• DOI: http://doi.org/10.1002/sej.1279
• Date: 01 June 2018
• Author: Joost Rietveld

RESEARCH ARTICLE

Creating and capturing value from freemium

business models: A demand-side perspective

Joost Rietveld

Strategic Management and Entrepreneurship,

Rotterdam School of Management, Erasmus

University, Rotterdam, The Netherlands

Correspondence

Joost Rietveld, Rotterdam School of

Management, Erasmus University,

Burgemeester Oudlaan 50, Mandeville

(T) Building, Room 7-41, 3062 PA Rotterdam,

The Netherlands.

Email: rietveld@rsm.nl

Research Summary: While it has long been recognized that the

business model can be a source of performance heterogeneity, less

is known about how the business model affects consumers' per-

ceptions about a firm's products and services. By taking a demand-

side perspective, I argue that business models create and capture

value when the elements that compose a business model improve

how consumers perceive a firm's products and better enable het-

erogeneous consumers to act on their willingness-to-pay. I develop

theory on how the freemium business model competes with the

premium business model and test hypotheses in the market for

digital PC games. Results show that freemium games are played

less and generate less revenues and that greater variety in games'

menus of paid items is associated with higher revenues.

Managerial Summary: Freemium business models are increasingly

prevalent in the digital economy, yet very little is known about

how freemium affects consumers' perceptions of value and their

willingness-to-pay. In this article, I study how the freemium busi-

ness model competes with the premium business model in the

market for digital PC games. Results show that freemium games

are played less and generate less revenues than premium games

and that greater variety in games' menus of paid items is associ-

ated with higher revenues. This implies that in order to achieve

competitive parity with firms operating the premium business

model, firms operating the freemium business model need to cre-

ate more value (e.g., through improved product quality, income

from advertisements, or unlocking network externalities) or oper-

ate at lower costs.

KEYWORDS

business models, demand-side view, freemium, value creation,

value capture, video games

Received: 23 April 2016 Revised: 20 September 2017 Accepted: 25 September2017 Published on: 13 December 2017

DOI: 10.1002/sej.1279

Copyright © 2017 Strategic Management Society

Strategic Entrepreneurship Journal. 2018;12:171–193. wileyonlinelibrary.com/journal/sej 171

1|INTRODUCTION

Over the past two decades, the business model construct has become recognized as a novel and relevant unit of

analysis in the fields of strategic management, entrepreneurship, and technology and innovation management

(Massa, Tucci, & Afuah, 2017; Zott, Amit, & Massa, 2011). Complementing existing theories in strategic manage-

ment and entrepreneurship, the business model is market centric, as it looks downstream to the product market as

a strategic element for value creation and value capture (Chesbrough & Rosenbloom, 2002; Demil, Lecocq, Ricart, &

Zott, 2015; Priem, Butler, & Li, 2013; Teece, 2010). The business model, defined by Amit and Zott (2001, p. 511) as

“the content, structure, and governance of transactions so as to create value through the exploitation of business

opportunities,”essentially describes how a firm creates value for its customers and the mechanisms it deploys to

capture that value.

1

Beyond the business model’s descriptive power, it has been argued that firms can compete through their busi-

ness models and that business models play a key role in explaining heterogeneity in firm performance (Amit & Zott,

2001, 2012; Casadesus-Masanell & Ricart, 2010; Markides & Charitou, 2004). Netflix’s DVD mail-order business

model, for example, disrupted the DVD rental market, and Ryanair was able to enter the highly competitive airline

industry through its “no frills”value proposition. While recent studies have importantly validated the business model

as a driver of firm performance (Kim & Min, 2015; Zott & Amit, 2007, 2008), there have been few studies that

investigate how the business model interacts with the firm’s products in shaping the firm’s value proposition to con-

sumers. Specifically, we know very little about how the business model influences consumers’perceptions about

the firm’s products and services and how these perceptions affect the firm’s value creation and value capture.

This article addresses this gap by taking a demand-side perspective on business models as a source of value cre-

ation and value capture. The central premises of the demand-side view are that value needs to be created before it

can be captured and that consumers are the final arbiters of value (Gans & Ryall, 2017; Priem, 2007). The demand-

side view further posits that firms can achieve competitive advantage without having access to uniquely valuable

resources, by devising strategies that exploit consumer heterogeneity in downstream markets (Priem et al., 2013;

Ye, Priem, & Alshwer, 2012). Building on this, the two main arguments put forward in this article are that:

(a) business models create value when they increase the benefits that consumers perceive from consuming a firm’s

products and services and (b) business models facilitate value capture when they enable heterogeneous consumers

to act on their willingness-to-pay (WTP). Business models are a source of competitive advantage when their ele-

ments improve how consumers perceive a firm’s products and/or better enable heterogeneous consumers to act on

their WTP, resulting in superior revenue generation vis-a-vis a focal firm’s rivals.

To test these arguments, I analyze the value created and captured from products brought to market through

the freemium business model. Freemium business models are increasingly popular in many markets for digital goods,

including mobile applications, social networking services, and video games.

2

Contrary to the premium business

model, where consumers pay a price before they experience any of the benefits a product offers, transactions in

the freemium business model are temporally decoupled such that (initial) consumption precedes consumer

payment(s). Additionally, transactions in digital goods are often decomposed into a menu of various add-on features

or services. The video-chat and voice-call application Skype, for example, lets users connect with other Skype users

for free but charges for calling landlines and mobile phones. The video game Candy Crush Saga, another example,

offers players a menu of add-on features allowing them to accelerate their progress, access extra content, or boost

their skills. I conduct two studies in the market for digital PC games to analyze how these elements of temporal

1

The term customers is used here to denote all downstream, business-to-business (B2B) buyers of a vertical chain’s products; the

term consumers is used to denote the final, business-to-consumer (B2C) buyers of a vertical chain’s products (see Priem, 2007 , for a

discussion).

2

While the elements of the freemium business model that are most visible to consumers are contained in the revenue model, the

implications of operating the freemium business model are far more consequential and require distinct firm capabilities, such as

involved consumer engagements and active monitoring of a product’s user base (Kumar, 2014).

172 RIETVELD