To Cripple or To Build

I've recently released an iPhone app and am looking towards future development but I'd appreciate the opinion of smart individuals like you.

Let's say I have $5,000 to spend on an update to my app. In your opinion, would it be best to cripple the app and release a free (current price is $2.99) "lite" version with an in-app purchase that unlocks all the features? This would be done in hopes that it would spur downloads and, hopefully, purchases.

Or would it be better to use the money to improve the app and add new features which might also improve purchases?

It comes down to why people buy your app. If a lite version is going to give them a chance to experience why they would want to use the full version without alienating them, then go for it.

But don't think of the reduced version as a crippled version, think of it as one that gives the flavour of what the full app should be with some obvious disadvantages. For instance, if your app lets someone produce images and email them, the lite version should let them produce images and email them, but put a "produced by App Lite version" watermark on rather than disabling email functionality.

That way they can see exactly what the advantage of upgrading is, without being restricted from using all the features.