Time for a guest post from @seanellis.
In between, Sean’s advised and helped build the go-to-market strategies behind Dropbox, Lookout and Eventbrite, among others. There’s nobody on the planet that knows more about all things Freemium than Sean.
His post was just picked up by the WSJ The Accelerators series and follows. Happy reading 🙂
GUEST MENTOR Sean Ellis, founder and CEO of Qualaroo: Freemium is a popular emerging business model among software, web services and media companies. It generally means giving away a free version of your product and generating revenue by “upselling” some users to paid versions or services. It is possible to give away a free version because there is little or no marginal cost for most digital products.
The model has always been a bit controversial. I remember when we implemented it at my first startup nearly 10 years ago. My father, who also happened to be an investor in the startup, was doubtful asking: “How can you make money by giving away something for free?” Since that time, I’ve helped implement or execute the model in startups that now have a cumulative market cap of around seven billion dollars.
Why Freemium Works. Freemium is the perfect response to the increasing competition for consumer attention on the Internet. According to this IAB report, over the last seven years, marketers have increased their online advertising in the U.S. by about 330%. It is now harder than ever to drive attention and trials for a digital product through online advertising.
Rather than competing to buy attention through advertising, freemium apps and services rely on strong evangelism from their free users for a large percentage of their new signups. Free users tend to be the types of people, usually individuals or very small businesses, who are attracted by the free price and spread the word when a free service provides real utility.
As you aggregate free users you create your own exclusive advertising medium for marketing your paid version to them. In advertising context is extremely important, and the free version of your product provides the perfect context for introducing your premium versions.
Common Freemium Mistakes. A common mistake when trying to execute a freemium model is to introduce a weak free offering. While this may give you a higher upgrade rate, you’ll be selling into a very small pool of free users. It is important to remember that the best freemium businesses have a valuable free version that inspires user evangelism. This user evangelism is the growth engine that makes freemium work. Without strong user evangelism, freemium generally fails.
Instead of marketing a weak free version to drive upgrade rates, focus on clearly differentiating value in your premium offering. Remember that a 2% upgrade rate on a fast growing free user base creates a more valuable company than a 4% upgrade rate on a free user base with no growth.
Freemium is Not for Everyone. Given my advocacy for the freemium model, people are often surprised that at my latest startup, Qualaroo, we recently discontinued our free version. We did this for a couple of reasons. First, our product isn’t really intended for individuals. Our primary customers are marketers, who use it to manage the customer experience on their website.
The second reason we stopped offering a free version is that our free and low-cost versions were anchoring our solution at a price point that did not support our revenue growth objectives. New customers are now happy to pay the higher prices because they haven’t been conditioned to think of it as a cheap or free solution. And as we now generate higher average revenue per customer, we can spend more money profitably acquiring them.
However, I continue to be a strong advocate for freemium as a board member at two other companies (Mavenlink and SignNow). These companies both have collaborative business solutions that benefit from not having purchase friction on an initial collaborative user experience. SignNow also meets a second factor that helps freemium work, the ability to digitally sign documents on a computer or mobile device is a value for individual users.
Should Your Company Consider Freemium? If your business category can support a freemium model, you should give it careful consideration. If you don’t use the model yourself, you’ll likely find yourself competing against someone else who does implement it.