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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.

Sean Ellis is CEO of Qualaroo and GrowthHackers.com. He s also an angel investor

and prominent marketing advisor for a range of startups.
The network that gets the most users early on becomes the most valuable, locking
in users and locking out competitors. Big networks carry heavy switching costs.
As a result, products in winner-takes-all markets can also afford to (and should
) spend more for early users than for later ones because these users help to sec
ure their networks dominance and establish lock-in. Its definitely worth overpayin
g for them, even if it means giving the software away for free.
The Year Long Trial and the Penny Gap
Most networks use an ad-supported model to keep the service free while driving r
evenue to keep growth going. WhatsApp certainly understood the critical nature o
f network growth and the winner-takes-all implications of building a business on
top of a massive user base, but they also knew they didnt want an ad-supported p
roduct.
WhatsApp s free for the first year model allowed them to solve for both business r
equirements it got users over the dreaded Penny Gap and onto the platform, contr
ibuting to its rapid growth and creating lock-in. The eventual revenue meant tha

t WhatsApp didn t have to worry about monetization through advertising something

the founders are still against. In addition to solving this challenge, the year
trial gives users enough time to try and get hooked on the product, but still s
ets the precedent from the beginning that WhatsApp will not be free forever.
Paying for Early Users
When network effect is at play, it s well worth it for startups to overpay for e
arly users in order to establish dominance. Those early users create value by br
inging in and creating new connections.
You can overpay for these users in two ways: By overspending on pay-per-install
above your anticipated lifetime value, or by absorbing the cost of giving away t
he product for free. In WhatsApps case, they chose the latter.
While they look like equivalent choices (after all, its paying one way or anothe
r), the reality is that paid installs can often be inferior to and more expensiv
e than giving your product away. For WhatsApp, paid acquisition wouldve been slow
er, the network effect wouldve struggled to take hold, and the user experience wo
uldve been much more cumbersome, resulting in less word-of-mouth marketing and st
ifling adoption.

Morgan Brown is Head of Growth at both Qualaroo and TrueVault. Previously, he co

-founded Full Stack Marketing. He s directed marketing at several startups and i
s the author of books on the subject of digital marketing and growth.
Had WhatsApp not pivoted to free upfront, we probably wouldn t be talking about i
t today.
Letting the Trial Ride in Growing Countries
WhatsApp gets the Penny Gap. In some fast-growing countries where theyre trying t
o establish dominance theyre letting the $0.99 year one charge slide, continuing
to pay upfront for early users in markets where the company is trying to establi
sh itself as the clear winner.
But WhatsApp is not the only company paying a premium for new users in emerging
markets. In places like India, Malaysia, and Brazil, the potential audience is h
uge, yet customers often can t afford costly data plans that come with regular m
obile internet use. In a bid to establish network lock-in in these new markets,
social networks are arranging deals with mobile carriers, paying all or some of
customer data costs. Theyre trying to prevent payment friction from slowing down
network adoption.
This process is no doubt expensive for the companies in question, with the cost
of subsidizing data likely exceeding resulting early revenue. Yet these types of
strategies are becoming necessary as more apps fight for growth and try to stav
e off in-country competitors. They all know the value of Metcalfes Law.
The Takeaway
While WhatsApps success is no doubt due in large part to the fact that they solve
d a major problem for a large number of users exorbitant SMS charges and restric
tions of local carriers their savvy pricing decision is equally noteworthy. It n
ot only helped them overcome the Penny Gap, but also allowed them to avoid adver
tising on the platform while creating the network value needed to lock in users.
It s this strategy that crowned WhatsApp as the early victor, capturing enough o
f the mobile messaging market to be worth $19 billion to Facebook. For any compa

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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