Spotify Freemium

Spotify offers free music streaming to its users; a classic example of the 'freemium' business model, where access to their service is given away for free forever. And who can say no to free music right? This attracts an endless number of users to the site, and the more users the better! However, once Spotify's users get used to the idea of free access, they won't be too keen on paying for it later on. So the question is: 

How on earth could it ever be a successful business if there's no willing-to-pay users helping them to make a profit? 

"Play on-demand, offline and ad-free."

As soon as you visit the Spotify website, it is made crystal clear that there is a 'premium' option available to users. The majority of people will probably click 'play free', or make a promise to themselves to cancel the trial at the end of the 30 days, but it's inevitable that at least some of these users will be willing to pay for premium access. There's a key underlying factor behind this business model; once people begin using a freemium service, they start to value it over other similar services, just for the sheer fact that they are using it. Overvaluation like this is known as the 'endowment effect' (Thaler, 1980). But why would using Spotify - even if it means paying for it - seem the better option as opposed to using other identical services? Because people show loss aversion. 

Reactions to losses are much stronger than reactions to gains, as the steeper line gradient in the above graph shows. After having a taste of the 'premium life', users are faced with a decision whether to continue it, but at a cost. At first glance, most would consider paying for a Spotify Premium account as a loss because they are then required to spend their money on a monthly subscription. However, in this case the losses actually include what comes with reverting back to the free account, like having to depend on an internet connection, or having to endure advertisements that they don't really care for. It's these factors that have more weight behind them when making this decision, rather than the gains they might make by not paying for a premium account.

Obviously not everyone ('everyone' meaning us poor, stingy students) can justify paying £9.99 each month just to skip adverts, but as of June 2015, Spotify reported having 75 million active users and more than 20 million premium subscribers. This translates to roughly 21% of all users converting to a premium account. It might not sound like much, but compare that to what is considered the average conversion rate (~10%) and then it seems much more successful!

References

Thaler, R. (1980). Toward a positive theory of consumer choice. Journal of Economic Behavior and Organization, 1, 39-60.