GLUU Glu Mobile Inc

For video game developer Glu Mobile Inc. (GLUU), free hopefully means profits.

Glu early last year overhauled its entire business, getting out of costly games designed for a wide number of basic phones, and investing in a few high-quality titles for the Apple Inc. (AAPL) iPhone and smartphones using Google Inc.'s (GOOG) Android software. But the most drastic change was a decision to give the games away.

"There's no more powerful word in any culture than free," said Michael Breslin, who runs marketing for Glu.

Glu is among a host of developers embracing a seemingly contradictory concept known as "freemium," which involves offering a game for free, but including a system where players can pay for upgrades such as new levels, weapons or other custom touches. Users can readily play the game for as long as they like, but ante up for extra features.

Glu's freemium strategy is a bet on the virtual goods market, which Venture capital firm Kleiner Perkins Caufield & Byers expects to generate $2 billion in revenue this year.

"The concept has been around for a while, but it's really starting to take off now," said Tuong Nguyen, an analyst at Gartner.

The change has paid off for Glu shareholders. Since Chief Executive Niccolo De Masi took over in January 2010, the stock has nearly quadrupled. Shares recently traded at $4.10. Financially, the results are more mixed. Glu's losses narrowed--the company has never reported a profit--but its revenue fell because of the reduced presence in the feature phone business.

As a result, not everyone is jumping on this trend. Glu's two larger rivals, Electronic Arts Inc. (ERTS) and Gameloft S.A. (GFT.FR), have opted to stick with the traditional sales model, which guarantees revenue because consumers have to pay upfront for the game.

The free model, though, has attracted top-tier game makers such as Rovio Mobile, which created the smash hit "Angry Birds." While iPhone and iPad users have to pay for the game, it is available for free on Android and supported by advertising.

"We can't afford to say that we only do paid downloads or only do freemium, we have to adapt our model to what works in any given ecosystem," said Rovio founder and "Mighty Eagle" Peter Vesterbacka.

Companies such as Glu have to make the gameplay attractive enough that customers will not only keep coming back, but are willing to spend cash to improve their experience. Executives believe that model lends itself to more long-term revenue, while previous games based on licensed properties such as the "Transformers" would only offer a short-term pop.

Glu's most enduring game, "Gun Bros," allows customers to upgrade their guns and armor as their virtual avatar faces off against hordes of monsters. A fancier shotgun, for instance, costs roughly $4. Its newest game, "Contract Killers" is a first-person shooter and the third most popular free game in Apple's App Store.

The company plans to release as many as 25 titles this year which, like Gun Bros and Contract Killers, will be available for free.

The model is riskier because it is dependent on a small fraction of players to pay for the extra features. Games that don't find an audience have to be quickly scrapped, resulting in lost time and resources. In the last quarter, two out of the six games launched were profitable, while one was breakeven, CEO De Masi said in an interview.

To supplement its revenue, Glu uses advertising. In particular, the game gives players a chance to earn virtual currency by downloading and installing other apps, including Groupon or other mobile games. Those other app developers then pay Glu a "bounty" for each download.

"It's a weird business that's evolved," said Gary Gattis, chief executive of SpaceTime Studios, which sells another freemium mobile game called "Pocket Legends," and uses the same model to encourage downloads of other apps.

For Glu, it is a significant part of its business.

"That business is huge," Breslin said, and because it results in a download of another app, the payoff is larger than a traditional banner ad.

-By Roger Cheng, Dow Jones Newswires; 212-416-2153; roger.cheng@dowjones.com

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