Wallen's

A map on freemium business model

There is a continuous discussion about business models in the web. I’ve put together overtime a few maps on each major business model. Here is the map on freemium that gives a comprehensive view on this business model. There are 3 sections in this map.

1. The first branch gives a general perspective on the freemium business model. For those really motivated they are 2 academic papers on the value of a free customers at the end of this branch.

2. The second branch goes into the key success factors such as scale, pricing, metrics, etc.
3. The third branch focuses on benchmarking real life numbers on conversion, price points, average rates, etc. Non-EU people, may find interesting to have a look at the annual reports of Xing, a local competitor of LinkedIn that is publicly traded.

Just click on the pearl below then on the play button and the arrows to be guided through this map.

NB: if you have some relevant posts to complement the map, don't hesitate to post them in the comments, especially posts on real life numbers or experience (vs. "conceptual" posts).

 

The cost drivers impact on so-called freemium models

There is quite some discussion on the freemium business models these last days with Jott and Sprout killing their free services. Charles, Mark and Shai have very good posts on the topic. I had written a post a few months ago on freemium where I said that there were 4 key conditions for this model to be viable:

• A "free" service with real value to build a user base
• A good balance between "free" features and "paid" features
• Well-thought price points that match the willingness-to-pay of certain segment of the user base
• Good marketing tactics to encourage conversation from "free" to "paid"

These conditions where looking at the revenue side of the equation - not the cost side. But it is key to distinguish between two type of cost situations with “freemium” models:

1. Marginal costs of serving “free" customers is close zero (or is offset by revenues directly attributable to the “free” users, e.g., ad)
2. Marginal cost are significantly above zero

In the first situation, freemium is a "real" business model in the sense that it is an "endogenous" system that can be sustainably profitable with limited investments (provided that the 4 above conditions hold of course). This model is particularly attractive for services where free users provide indirect value to the overall product (users network effects).

In the second situation, freemium becomes an operational marketing technique: it is an investment  to acquire new users of paid services. It is actually similar to the traditional free sample/trial commonly used in numerous industries in particular the consumer goods sector. I am not judging whether it's a good or bad marketing technique. Actually, as long as you have cash and that the customer acquisition cost is below the expected revenues, it can be profitable. However, a company cannot build its entire revenue model on one single marketing technique. Free sample/trial is part of a portfolio of available marketing techniques. Various techniques maybe more suitable at different times depending on the situation. For example, Jott services necessitates the transcription of oral messages into text requiring human labor (which I translate into significant marginal cost). With hindsight, in a way, Jott executed a 2 year “free trial campaign” to acquire new customers.

In other words, when marginal cost are significantly above zero, the business model is not "freemium" - it is "subscription/payment for a service"... just as in 99% of the economy. It is vital for start-ups to keep this in mind because the way a company defines itself impacts the solutions it looks for. And in the current environment, solutions they will need. You can bet that we will see more and more companies killing their free services in the coming months.

Freemium can be a viable revenue model... sometimes

Mark Evans wrote a post two days ago claiming that freemium is not a business model. Peter Christensen followed with another post on the topic saying that it is not a business model but just a marketing strategy. IMHO freemium can be a viable revenue model... under certain conditions:

• A "free" service with real value (either directly or through network effects) to build a user base
• A good balance between "free" features and "paid" features, i.e. "paid" features really need to add value to the "free" service. Not all web products can cater with this segmentation
• Well-thought price points that match the willingness-to-pay of certain segment of the user base... and that is very difficult to get right, especially when there is no market benchmarks
• Good marketing tactics to encourage conversation from "free" to "paid"

There might be other conditions but the point is that not all web products are candidates to freemium due to their inherent characteristics. Nor is it easy to implement. It's an iterative process with trial and errors. But if a product builds successfully a freemium model, it can be an elegant substitute to an advertising revenue model, especially if the product doesn't fit with an ad model. Think about it, if 5-10% of the user base pays USD 2-4 per month, it could generate as much revenue as advertising from the entire user base. A value added service is bound to find people willing to pay the price of a coffee.

A good example is Xing (a European publicly quoted competitor of LinkedIn). Xing has 8% of it's entire user base or 26% of its unique visitors with a paying subscription. They pay an average of EUR ~55 (USD ~75) representing EUR ~15 per unique visitors vs. EUR 3.4 in advertising and job listing. Of course users have a higher willingness-to-pay for their career than for other typical web services. But still it makes the point that freemium can be a viable and lucrative revnue model and at the same time not hinder the user experience.