Musings on freemium

By August 29, 2012Business models

I’ve been meaning to write a post on freemium since reading Alan Patrick’s When freemium fails, and doesn’t last week.

The point of Alan’s post is to say that whilst having a freemium business model works for some companies it is not as widely applicable as everyone (including me) thought a couple of years back. I think he’s largely right. The basic problem is illustrated by the story of Chargify (from WSJ):

for some, the "freemium" strategy is turning out to be a costly trap, leaving them with higher operating costs and thousands of freeloaders. That’s what happened to Chargify LLC, a provider of billing-management software to small businesses, which used the freemium business model when it started out in 2009. The Needham, Mass., company gave away its software to merchants that billed fewer than 50 customers a month. If a merchant wanted to bill more than 50 customers monthly, then the business owner would have to start paying $49 a month.

Most Chargify users never became paying customers. Within a year, the company was on the path to bankruptcy. Chargify eventually put up a paywall for all users. Last month the 12-employee company became profitable, with more than 900 paying customers. The starter plan is $65 a month.

Alan quotes David Cohen, founder of Techstars, as saying that due to low conversion from free to paid (typically 1-2%) freemium only makes sense for businesses that can reach millions of users. Otherwise they won’t get enough paying customers. This was Chargify’s problem.

For those that can’t reach millions that leaves two choices. Get everyone to pay or find another source of income – e.g. advertising, selling related products, or do something with the data. Of these, getting everyone to pay is at once the hardest model to execute and the easiest model to scale.

  • Sean Ellis talks a super-clear picture about freemium – a big takeaway point from him was that the point of freemium as he puts it is to build a valuable marketing resource of passionate brand advocates and endorsers – not just using “free” as another step in the funnel as an attempt to snare users with the hope of turning them into paying customers over time.

    Put another way, this way of looking at freemium requires there to be value gained from the free users even if they don’t covert to paid, and specifically this value should be in marketing (free users encourage other customers to come to your product) rather than monetisation value (e.g. advertising, data). I’m sceptical about the value of “offset funding” e.g. ads, data as described in Alan’s post – these seem equally likely to be scale plays and thus less likely to make a ballpark change in ARPU compared to vanilla freemium.

    Certainly a simple offering and clear benefits to upgrade while avoiding being distracted by the freeloaders are good things. I believe Sean suggested the “free” product should be essentially your MVP – sufficient for people to get excited about it but no more. But I think this idea of thinking of freemium in part of marketing rather than the conversion funnel is a significant and useful change in mindset – it’s a lot easier to figure out whether free users are bringing any tangible marketing benefit compared to hoping that they’ll upgrade someday, and even with low conversion rates it’s no longer as necessary to achieve as much scale to achieve a success if every free signup is adding to the engine of growth.

    So it seems the current “best practice” (for SaaS-y businesses) is something like:

    – focus on simple pricing – likely with free trial – designed for optimum conversion of new signups at good ARPU within a reasonable time window (e.g. 30 days)
    – provide a mega-simple free version with MVP style functionality *if* this will bring the benefit of an enlarged community of passionate users who will bring further growth through being vocal about their use of the product

    At GroupSpaces we’ve seen 3x improvement in conversion to paid since the beginning of the year (including 7x improvement on conversion within 30 days post-signup) by cutting down our free offering, simplifying pricing and focusing on the up-sell. Getting the balance right is clearly tough (and still a work in progress for us) but I disagree that “freemium only makes sense for businesses that can reach millions of users”. It depends on your positioning, but we’re now running a freemium model with over 20% conversion – and so long as we keep support overheads down our community of free users is definitely an asset rather than a burden..

  • Hi Andy,

    Looking at it logically, free users can have value in four ways (it seems to me):
    1) They convert later
    2) They are monetised via advertising or some other third party pays model
    3) They bring other users, some of whom convert (i.e. marketing)
    4) They increase the value of the service to paying users

    Your first point is that option 3) doesn’t need large scale to work. I guess that’s right although in the final analysis the maths on the conversion rate and cost of customer acquisition still have to work. A very ‘minimum’ free product makes sense as it will be cheap to administer and won’t cannibalise sales too much.

    You also hint at 4) – which is when the free users add value to the community overall. That is quite a specific case which might be relevant for you, but isn’t relevant at that many non-scale plays.

    To your experience at Groupspaces: if users are getting value from the features of a product then moving those features from the free to the paid area is bound to increase the conversion to paid. It sounds like you made a great move, but I’m not sure how to generalise that and draw a lesson for freemium models overall. Similarly, simplifying pricing generally improves sales.

    I definitely like to see free trials at SaaS companies – they form the basis of most efficient sales processes, but that’s a whole other post.

    sorry to be slow to reply. My email alerts from Disqus were interacting with my out of office replies when I was on holiday, and then I forgot to turn them back on…. Just catching up today.