With the recent blockbuster success of Pokemon Go, people are asking how a free game has managed to pull in more than $160 million in its first month.

Welcome to the “freemium” business model, which over the past decade has quietly completely changed entire industries.

In the video above, Vox outlines the simple mechanics of how an app which you don’t have to pay for can make you pay real money for virtual goods (often called in app purchases or microtransactions).

It’s all about one of the greatest business model innovations of the past few decades, called a “freemium” service.

“Freemium” products are free to get started with, but with premium additions you can purchase to improve your experience

You may have heard of several news stories of the past few years where people are racking up huge bills with in-app purchases, often by children.

In fact, I even found an example of a 15-year old who spent $46,000 in a free-to-play game.

Fortunately, this doesn’t happen as often anymore, especially as smartphone makers Apple and Google and the industry have put in place new regulations to make it much clearer that apps may not be completely free, and allowing parents to turn off the in app purchasing functionality.

The way Freemium works

Even though children aren’t running up huge bills anymore, the business model is only growing stronger and more dominant.

Many of the world’s most popular games use this model, including arguably the most played game in the world, League of Legends, which made more than $1 billion last year despite being free to play. The producer of smash hit “Clash of Clans” made $2.6 billion in 2015, with $930 million profit. And as much as I hate to admit it, the Kim Kardashian: Hollywood game has allegedly made over $100 million 

[Editor: Sad times for that last fact :(]

And while many people do never spend a single cent in the games, the small proportion of people who do end up paying money often end up spending significantly more than if the game had been free to start with. According to the video above, only 1.9% of players actually make in-app purchases, but they spend so much they are classified in the same way Las Vegas calls their most valuable players: Whales.

You could illustrate a typical freemium experience like this:

It’s all down to the fact that the games are designed with lessons from behavioral psychology in mind.

While people can play almost all of these games from start to finish without paying anything, there are often restriction built into the game which are designed to cause a degree of limitation and frustration to progress for free players. The most common of these are:

  • A limited number of moves which can be done per day
  • A countdown timer which makes you have to wait for your actions to complete (often for several hours or even a day)
  • Seeing premium items which don’t offer a gameplay benefit but change the look of a character, and can only be unlocked by spending credits

Almost all of these games use a “game credit” or currency, like gems, gold coins, stars, or hearts which you can spend to unlock items or remove frustrating limits.