When freemium makes sense

Excerpt from Subscription Business Models Are Great for Some Businesses and Terrible for Others by Robbie Kellman Baxter:

I love freemium, the idea of combining a premium paid membership with a free membership that provides value forever. But freemium needs to work in service to a larger business strategy. Freemium works best in three scenarios:

– As a means of trial. Many people who have a free subscription to Dropbox get all of the online storage they need. But for others, as they make Dropbox part of their daily routine, they find they need more storage and greater functionality. As a result, they upgrade to the premium service.

– To create a networked effect. Each new member that joins LinkedIn for free creates additional value for the recruiters, salespeople and jobseekers paying for LinkedIn subscriptions. And if no one used the free version of LinkedIn, there’d be little reason for those people to pay at all.

– To serve as a marketing channel. Some people never pay for a SurveyMonkey subscription, because they only need small surveys sent to a few people, with limited analytics. But when those people send out their surveys, they are advertising for SurveyMonkey to everyone who receives the survey. If one of those survey recipients subscribes to the premium offering, the sender (who’s a free member) becomes a marketing channel for attracting and converting new members.

(1) Thank you Daniel Shvartsman for the article recommendation.
(2) Note the similarities with Tom Tunguz’ The 3 strategies of freemium companies.
(3) Cf. The 3 conditions of a great freemium business.

The contrarian view: With freemium, it’s easier to start with the paid product

Edited excerpt from “Monetize Backwards” to Build a SaaS Business That Lasts by Chris Savage:

At Wistia, we started with a paid plan only, and over the last eight years, we’ve progressively made the product more and more free. It’s counterintuitive, but constraining growth by not making our product free from the start has been one of the best decisions we’ve made.

The #1 question when you’re starting out as an entrepreneur is whether or not you are building something that people actually want. If someone signs up for a free product, you’ve only learned that someone was willing to exchange a small slice of time to try it. That teaches you very little about whether you’ve built something useful. The startups that survive aren’t the ones with the most experience—they’re the ones that can learn the fastest. Someone’s willingness to pay a good hunk of cash for your product provides you with undeniable validation that you’ve found an opportunity to build a business.

It’s hard to have any conviction about the worth of your product if no one has paid for it before. Typically, data from previous sales informs your pricing decisions. When you’re first starting out, you don’t have any information, so it’s crucial to start gathering pricing data. You can only do that if you charge for your product.

Monetizing backwards constrains user growth early on, and it makes it unlikely that you’ll be an overnight success. But for us, slow growth was one of the best things that could’ve happened for our company. Having few, paying customers forced us to focus 100% on what those customers needed.

(1) If you start with paid you generate revenue earlier. This is a significant advantage which Chris doesn’t mention.
(2) My personal view is that while both approaches have advantages and disadvantages, you’ll be more successful if you work at figuring out the end game — monetization — as early as possible.
(3) In most cases that means paid before free. The exception is if you are able to monetize your free product. At Seeking Alpha, for example, we have a meaningful advertising business from monetizing our free content. This has given the company income to grow our free audience and figure out our paid products, such as our Marketplace.
(4) “Coming up with the free vs. paid line can be incredibly difficult and is a careful balancing act”, says Sachin Rekhi. Cf. The challenge of monetizing free products and The biggest risk of freemium.

With freemium, you know you’re solving a customer’s problem

Edited excerpt from What Do You Need to Do to Improve Sales? Here’s a Start… by Mark Suster:

Ask yourself whether the person you’re dealing with has a problem that is solved by the solution you offer. If they don’t – you simply won’t sell anything.

That’s why many great sales starts with generating inbound marketing leads. If you create content marketing programs and drive traffic to websites where you can measure how long somebody spends reading your materials or downloading your white papers you’ve at least confirmed some level of interest.

If you have a product, knowing who the “typical buyer” by department or title is helps you greatly because you can quickly get to somebody likely to be familiar with the space in which you’re selling.

If you generate outbound email campaigns to groups of potential buyers you can use SalesLoft or tools like Yesware and ToutApp to track whether people opened your emails, clicked on your links, downloaded your documents, etc.

The other obvious area in determining interested parties is to find referrals from trusted sources. That’s why companies partner with vendors with complementary service offerings.

Let me make it simple: If you can’t identify a problem that a prospect has that you can quantifiably solve you won’t sell anything.

(1) Note the similarities to What problem are you solving? and Focus on the job, not the customer type.
(2) This is the beauty of freemium models. You create the customers’ problem by making them hit the paywall, and your conversion data tells you if the problem is serious enough that customers will pay to solve it.

Free, paid and freemium in consumer internet

Edited excerpt from The First Law Of Internet Physics by Fred Wilson:

I’ve seen so many people try paid content on the Internet and the result is fewer users, a lot fewer. You can extract a higher average revenue per user (ARPU) from a paid model, but you get so many fewer users that it’s better to extract a lower ARPU with a free model and get many more users.

The rule: many users * low arpu >>>> few users * high arpu

I guess a corollary is that you can implement a freemium model on top of a free model and turn some of your users into high ARPU customers, but they will always be a small portion of the total number of users.

That’s a long way of saying that you can do paid, but you had better have a free tier first and foremost as most users will go for that. And if you put too much of your content behind a paywall, you’ve effectively turned your core product into a paid one and you are back to {few users*high ARPU}. So be careful with the freemium offering.

The 3 strategies of freemium companies

Excerpt (with edits) from The Common Characteristics Of Successful Freemium Companies by Tom Tunguz:

Successful freemium companies do three things:

1. They use free to market, educate and win mindshare. The Internet enables potential customers to research products much more deeply before engaging with a sales person. Freemium is the ultimate embodiment of that change because customers can use the product before buying it.

2. They leverage usage data to improve their product. The large amount of users using the product enables A/B testing with statistical significance, a non-trivial strategic advantage. Marketing teams can sift through the data to understand market segmentation and funnel efficiency, and product management can parse the data to improve the on-boarding experience.

3. They gather information about their customer base to prioritize their sales efforts. When customers sign up or download a free product, freemium companies should gather data about the user to understand who they are and analyze the usage patterns of these users. With enough user data, it’s possible to predict with great accuracy which users will become large accounts.

Freemium as an alternative to advertising

From Flipping abundance and scarcity by Seth Godin:

We spent a generation believing certain parts of our business needed to be scarce and that advertising and other interruption should be abundant. Part of the pitch of free is that when advertising goes away, you need to make something else abundant in order to gain attention. Then, and only then, will you be able to sell something that’s naturally scarce.

Fred Wilson on the benefits of freemium

From Free Vs Paid by Fred Wilson:

We’ve struggled with early stage investments in enterprise oriented web services. Sales to enterprises often require expensive sales teams and it’s much harder to know if you’ve nailed the product/service with feedback from a limited number of enterprise customers.

It’s much better, in my opinion, to go with the freemium model, give a version of the service away for free to all comers, get a lot of users, get good market feedback, then develop a premium version of the product/service for sale to enterprise customers. If your free version is popular with a lot of users, your customer base is the target for the upsell and you might be able to live without an expensive sales force initially. And, of course, keep your costs really low until you start to get revenues.

(1) Fred’s post was written in October 2008, when the freemium model was being questioned. Just as relevant today.
(2) Cf. Does freemium work for b2b?

Freemium works if 4 conditions are met

Excerpt (with edits) from The Common Characteristics Of Successful Freemium Companies by Tom Tunguz:

Startups should consider freemium when four conditions are met:

1. The number of potential free users numbers in the tens of millions. Freemium conversion funnels tend to be very lossy. On average, 1-4% of users convert to paid. To reach $100M in annual revenue, a freemium business charging $100 per year with a 4% conversion-to-paid rate would need a total user base of 25M users.

2. Free distribution is a competitive advantage in the market. Because the freemium model relies on customers to educate themselves, freemium is best used as distribution advantage in established markets with incumbents who bear large customer-acquisition costs.

3. The product used by a free user has a simple and straightforward value proposition. Because customers are educating themselves, freemium products have a very short window of attention to seize and convince a user to convert to paid. Therefore, the product has to be straight to the point and solve an immediate need or eliminate pain.

4. The marginal cost to serve a user is negligible. If the cost-to-serve a free user is significant, the freemium model will demand lots of cash to support hordes of free users.

(1) On conversion rates, see These benchmarks can tell you whether your business plan is viable.
(2) Cf. The 3 conditions of a great freemium business.

Does freemium work for b2b?

From Does free/freemium work in the enterprise? by Boris Wertz:

When developing a business model, every software and app start-up eventually faces the same core question: Should we focus on monetizing customers or driving usage?

For consumer apps, this question has been answered (or mostly answered): the best approach is to offer a free service to help attract and retain users. As Fred Wilson put it: “When scale matters, when network effects matter, when your users are creating the content and the value, free is the business model of choice.”

But what about enterprise apps? While free rules the consumer world, it can be a different story in the enterprise:
— Offering an app/service for free can send the wrong message. Here, free can be equated with low quality.
— While viral growth and network effects exist in certain enterprise settings, network effects are typically more limited in a B2B environment compared with B2C.
— Free isn’t necessarily sustainable with B2B. Acquiring business users may prove too costly, forcing start-ups to raise incredible amounts of money to finance aggressive sales and marketing efforts for a free app.

The challenge of monetizing free products

Fred Wilson explaining why the $1bn sale of Tumblr to Yahoo! didn’t generate excitement:

Tumblr really struggled to build a business, a sustainable business that could make it an independent company the way that Twitter successfully did, the way that LinkedIn successfully did, the way that Facebook successfully did. The sale to Yahoo in some ways was, I think, a reflection of the fact that they ran out of time on that.

The sale price was awesome… But I do think that the narrative there wasn’t quite the same thing. It was maybe a little bit like what could’ve been, had Tumblr been able to figure out how to make itself a stand-alone business. Maybe it could’ve ended up going public and being worth five or 10 times what it sold for.

(1) “They ran out of time” — lack of revenue meant that Tumblr wasn’t in control of its own destiny.
(2) The best monetization of a free product avoids taxing the user flow. Tumblr couldn’t figure out how to do that, and it’s not clear that Facebook, Twitter or Yahoo have either.

The biggest risk of freemium

From Jason Lemkin:

As a rule, the less the customer pays, the more feedback they provide, and the less engaged they are (making their feedback worse). The best feedback — and least noisy feedback — is from your most engaged (and generally most profitable customers). The biggest risk of all is listening to all the wants/wishes/complaints from the free and low-value converts and ‘potential’ converts. From that perspective, freemium can in many cases be not only dangerous, but fatal in the early days.

The 3 conditions of a great freemium business

  1. The free product is compelling.
  2. Users of the free product inevitably bump into constraints as their usage grows.
  3. The constraints are removed by paying for a subscription.

Perhaps this is obvious, but in What do failed startups have in common? Erin Griffith writes:

Founders don’t ask themselves who is going to pay money for the product. “We see lots of freemium strategies,” he [Steve Hogan of TechRX] said. “Freemium is freemicide. Getting someone to upgrade from a service that is adequate and free never works.”

Adequate and free = users don’t bump into constraints as their usage grows, so they never pay.