Providing Pricing Flexibility.

 Renowned investor and Berkshire Hathaway CEO Warren Buffett once said, “You can determine the strength of a business over time by the amount of agony they go through in raising prices.” Buffett and his partner, Charlie Munger, realized that as customers form routines around a product, they come to depend upon it and become less sensitive to price. The duo have pointed to consumer psychology as the rationale behind their famed investments in companies like See’s Candies and Coca-Cola. Buffett and Munger understand that habits give companies greater flexibility to increase prices. 

For example, in the free-to-play video game business, it is standard practice for game developers to delay asking users to pay money until they have played consistently and habitually. Once the compulsion to play is in place and the desire to progress in the game increases, converting users into paying customers is much easier. The real money lies in selling virtual items, extra lives, and special powers.

As of December 2013, more than 500 million people have downloaded Candy Crush Saga, a game played mostly on mobile devices. The game’s “freemium” model converts some of those users into paying customers, netting the game’s maker nearly $1 million per day.

This pattern also applies to other services. For example, take Evernote, the popular note-taking and archiving software: It is free to use but the company offers upgraded features, such as offline viewing and collaboration tools, for a price—which many devoted users are happy to pay.

Evernote’s CEO Phil Libin shared some revealing insights about how the company turns nonpaying users into revenue-generating ones. In 2011 Libin published a chart now known as the “smile graph.” With the percentage of sign-ups represented on the y-axis and time spent on the service on the x- axis, the chart showed that, although usage plummeted at first, it rocketed upward as people formed a habit of using the service. The resulting downand-up curve gave the chart its emblematic smile shape (and Evernote’s CEO a matching grin).

In addition, as usage increased over time, so did customers’ willingness to pay. Libin noted that after the first month, only 0.5 percent of users paid for the service; however, this rate gradually increased. By month thirty-three, 11 percent of users had started paying. At month forty-two, a remarkable 26 percent of customers were paying for something they had previously used for free.

Supercharging Growth.

Users who continuously find value in a product are more likely to tell their friends about it. Frequent usage creates more opportunities to encourage people to invite their friends, broadcast content, and share through word of mouth. Hooked users become brand evangelists—megaphones for your company, bringing in new users at little or no cost.

Products with higher user engagement also have the potential to grow faster than their rivals. Case in point: Facebook leapfrogged its competitors, including MySpace and Friendster, even though it was relatively late to the social networking party. Although its competitors both had healthy growth rates and millions of users by the time Mark Zuckerberg’s fledgling site launched beyond the closed doors of academia, his company came to dominate the industry.

Facebook’s success was, in part, a result of what I call the more is more principle—more frequent usage drives more viral growth. As David Skok, tech entrepreneur turned venture capitalist, points out, “The most important factor to increasing growth is . . . Viral Cycle Time.” Viral Cycle Time is the amount of time it takes a user to invite another user, and it can have a massive impact. “For example, after 20 days with a cycle time of two days, you will have 20,470 users,” Skok writes. “But if you halved that cycle time to one day, you would have over 20 million users! It is logical that it would be better to have more cycles occur, but it is less obvious just how much better.”

Having a greater proportion of users daily returning to a service dramatically decreases Viral Cycle Time for two reasons: First, daily users initiate loops more often (think tagging a friend in a Facebook photo); second, more daily active users means more people to respond and react to each invitation. The cycle not only perpetuates the process—with higher and higher user engagement, it accelerates it.