Watch out: Freemium might be the future of (mobile) gaming

by Phil Hornshaw

Freemium games -- they have a tendency to do well.

When it comes to the Apple (AAPL) iTunes App Store, the move toward “freemium” -- games that are free but include in-app purchases for virtual items -- is growing. This is mostly because freemium is a pricing model that gets a lot of downloads and has started to earn a few companies a lot of money. And while on its face, freemium looks like a great model that gives gamers the ability to play cool titles along with the option to expand their experience if they choose, the problem is that, as more developers see dollar signs, the “free” portion of freemium is probably going to diminish.

More and more, freemium apps are doing well in the App Store. They currently make up about one-third of the top-grossing titles. If you’re not clear on the concept, turn your attention to the games found on Facebook, which are generally freemium in one form or another. These are games in which developers like to include the ability to make small purchases from within the interface (called micro-transactions). The word “freemium” refers to the fact that the game is technically free, but includes “premium” content worked in, which requires a payment. The biggest games on Facebook, like CityVille, FarmVille and Mafia Wars (Zynga games all), have huge communities and rake in a whole lot of money even though the games are all free to play.

The same is true (at least for iPhone) in the App Store. A move to a freemium model of games has been particularly great for Glu (GLUU), the casual game maker behind titles such as World Series of Poker Hold’em Legends Free and Deer Hunter Challenge. Glu was on the decline only a year ago as it struggled in the App Store, but now is in the process of turning its ship around largely because it opted to start making some its games (sort of) free. Shares of Nasdaq-traded Glu have doubled since Glu CEO Niccolo De Massir took the job and Glu went to freemium at the beginning of 2010. Go ahead and call that a comeback.

Glu has even surpassed big game developers like Electronic Arts (ERTS) (a monster of a player in video games in general) and Gameloft (GLOFF.PK) when it comes to capitalizing on freemium. The company isn’t out of the woods just yet, since freemium games first have to garner a lot of downloads, then need time for players to want to get more out of them and start tapping those “purchase” buttons. But in just a year, Glu has managed to overtake the guys who have been doing this a lot longer than them on what is arguably the leading edge of making money in casual and mobile gaming.

The shape of things to come

EA isn’t standing on the sidelines when it comes to figuring out how to make money with free games. One new attempt is the recent release of Madden NFL 11 by EA Sports Free, a scaled-back, no-cost version of the game of the same name, which runs usually for $4.99. The Madden football series is one of EA’s biggest franchises on video game consoles, and the mobile version is a well-made sports title that plays surprisingly well on the iPhone and iPad.

Madden NFL 11 Free says “free,” and it is -- but the functionality of the game is reduced substantially from its paid counterpart. Whereas in the paid version you can play football games on the fly, manage your team through seasons and playoffs, and even compete online, the free version allows you to play a single game: the Indianapolis Colts versus the New Orleans Saints. You can pick one or the other team to play as, and you can play through the whole game, but that’s all Madden NFL 11 Free lets you do; everything else requires the $5 full-game purchase, made possible by a premium purchase within app.

Madden NFL 11 Free handles a lot like a “lite” version of the football game -- the difference is, lite versions are often either very short demos or ad-supported versions of paid games. Madden NFL 11 Free is something in the middle of those two concepts; it’s a great game that lets you get excited about it, then throws a door in your way that only $5 can open.

I’m not faulting EA for releasing a free version to get people interested in a mobile version of its flagship football video game franchise. On the small scale, a free version of Madden is very cool, giving players the ability to hop into football action that’s not far off from what you’d get on a console like the PlayStation 3 at a rate of $59.99. They can try the app before they commit to the full purchase, which is a nice opportunity considering the App Store doesn’t offer any refunds for apps users don’t like.

Paying piecemeal can be great - in small doses

Freemium as a concept isn’t necessarily a bad thing. It’s actually quite nice when implemented well. A developer will create a game that offers a lot of fun and doesn’t require anything from the player. Games like these build up big communities, like the ones on Facebook, and players get to choose what they might want to pay for, if they want to pay for anything at all. It gives a lot of freedom to the player to choose what his or her game experience will be and what to invest in it.

The problem is that a freemium model of gaming, when applied to a lot of games, gets scary. Once you’ve downloaded Madden NFL 11 Free and played the Saints against the Colts, for example, you’re out of game. If you want anything more, you have to pay. The game is no longer free, and in fact, maybe it never was. Madden’s free version is just plain skimpy, just like a lot of freemium games in the App Store, and it can feel like something of a bait-and-switch to suddenly hit a pay wall to keep playing.

Freemium games make a ton of money. You might have heard the story of Smurfs’ Village and how it made buckets of cash, even though it outraged parents because it seemed to accidentally allow kids to spend lots on in-app purchases. That wasn’t even (completely) Smurfs’ Village fault, more or less, but rather a feature of how purchases on the iPhone work after you input your Apple ID password. You don’t need to reauthorize a purchase within 15 minutes of entering your password, so kids were going nuts spending their parents money on mobile Smurfs. Despite the controversy, Smurfs’ Village - like Zynga and Glu games - perform really well in the App Store.

So don’t think that other developers aren’t taking notice. EA and Gameloft are certainly aware of Glu’s success, and are looking for ways to capitalize. And if freemium continues to look great, build massive communities and make lots of money for developers, we’ll see more games swing that way. This is just simple economics.

Free... but not quite

The trouble is, if free versions of games keep performing well, the logical outgrowth is to see more games like Madden NFL 11 Free. This could be bad news -- especially if they start to eclipse the paid versions of those titles. Imagine an App Store filled (even more) with freemium apps, because they seem to do so well, but with the free part becoming smaller and smaller. There would be more games that claim to be free, but offer severely limited capabilities unless you want to dish out for them. Games that might have gone for $0.99, $1.99 or even $4.99 like Madden will ultimately cost more because you’re purchasing everything within them piecemeal.

In Smurfs’ Village, players can use an in-game currency called “Smurf berries” to speed their progression through the game. In-app purchases of Smurf berries can cost as much as $99. Smurfs’ Village is considered successful -- imagine if you had to purchase Smurf berries to push through the game, and many games had their own version of Smurf berries. That’s a worst-case scenario, but the industry could definitely be headed in that direction.

Micro-transactions are believed by many people to be the future of how gaming works and how developers make money. But it’s a scary thought about value that buying your game in small chunks may soon be the norm as more developers find ways to clean out their players, one dollar purchase at a time.