With ad demand dwindling, could freemium be the future?

Spotify was largely unscathed in Q2 thanks to a stream of income outside of advertising. Experts discuss how the model could work in other contexts.
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Spotify released its Q1 at the end of April and even though ad activity was down during the pandemic, most of its key performance indicators for the rest of the year have been unchanged. The company credited the strength of its freemium model for meeting or exceeding business forecasts for all major metrics – with subscriptions helping to pick up slack during a time when the ad market is lax.

While Canadians don’t quite have as many options for freemium and multi-tiered models as the U.S., the market is catching up. CBC’s Gem operates on both an ad-supported and subscription-based, ad-free model. YouTube has a paid tier available for ad-free viewing as well (neither company offers numbers on how many paid subscribers they boast). And many apps in the growing mobile game market also offer paid tiers to forego ads.

But other services like Netflix and Crave or, in the case of music, Apple Music, have long operated as only having paid, ad-free content.

Other services such as Quibi and Hulu (U.S. only) also have multi-tiered models that include ad-supported and ad-free – all are paid, but the presence of ads makes for a cheaper subscription. With ad demand down and an uptick in content cravings, could the freemium model be the answer for other services in Canada?

Kaan Yigit, president and research director for Solutions Research Group (SRG), says it’s unlikely that some of Canada’s current streaming media giants venture into a multi-tiered approach – they always have been and will likely always be smaller than international giants like Netflix.

“Our issue always in Canada is one of scale, which makes it tricky for break-even,” he tells MiC, adding, “Unless they are cross-border players like Spotify.”

Peter Csathy, founder and chairman of California-based Creatv Media, says Spotify’s growth in revenue is only one side of the story – and that whether or not a service operates on a premium, freemium or ad-supported model doesn’t guarantee its success, even in markets with larger populations like the U.S.

“Certainly freemium has worked for Spotify in terms of baiting and hooking customers into paying,” he says. “The interesting thing about Spotify is that the more it grows, the more money it [spends]. It has variable costs that are significant. No matter what, it has to pay 70-cents  on the dollar for licensing costs to the music labels.”

One needs only look at its venturing into podcast – diversifying its revenue stream – as a sign of that, he says. “That’s one of the reasons why it’s gotten into the podcast business because with podcasts they don’t have to pay variable costs – and they hope to monetize podcasts. That’s kind of a meta point on all of these kinds of services, that whatever business model they have, there’s a constant need for expansion of them.”

As for Hulu – which is not available in Canada – Csathy notes that it’s one of the prominent examples of a service that once explored freemium, but since transitioned to a multi-tiered approached with no free tier. It dropped its ad-supported, free service in 2016, which Csathy says is a sigh that it must not have been working.

Csathy thinks business model expansion should be an essential goal of all companies like Spotify, Netflix and Hulu.

“We think Netflix is tremendously successful – and it is in terms of subscriber numbers. But while it is profitable on the books, it is a cash loser. It’s cash-flow-negative all the time. Every quarter it’s losing money but it’s deferring those costs and that’s why it’s continuously raising debt. Netflix needs to expand into new revenue streams or ultimately it will be bought to be part of a bigger machine.”

Whether or not that’s ads is another question. Csathy believes media companies and content-driven companies should think more broadly in terms of business models such as the modified freemium model being used by some publications where readers have access to a fixed number of articles for free each month but then must subscribe to have access to it. Indeed, Canadians might be slowly warming up to paywalled news content. Torstar’s latest numbers show that its paying digital subscribers have grown year-over-year. And behind those paywalls lies not only content, but also advertising.

He also points to the gaming free-to-play model, which is used both in mobile games and PC and console games, as a possible model that media companies looking for new media streams could imitate.

“You can use the game app as much as you want and access the basic features but while you’re playing the game if you want that light sword or this special cookie, you have an opportunity to make a micro purchase right then,” says Csathy. “That model is now starting to find its way into the music world through apps like TikTok. How that enters other forms of media is the kind of thinking that needs to go on.”