Each year about 30% of Centresource’s overall revenue comes from start-up organizations. They are one of our favorite client segments. Because of this expertise, I have the opportunity to meet with about two – three start-ups each week. Many we meet with have a rough idea of a business concept but are interested in discussing the “cost” building out their business idea. If they are talking to us, chances are a major component of their business is web-based.
I’ve learned that in most cases, there isn’t much value in discussing costs associated with build-out until I fully understand the anticipated revenue model for their idea. One of the more common concepts is to make profit through advertising and to gain a base of users through a freemium model.
While the freemium model does have some validity and use case, many times the build it and they will come philosophy fails in practicality unless the start-up has very deep pockets. So I wanted to write a blog outlining the pitfalls of a freemium business model. But before I could finish writing the article, Getelastic wrote a much better summary than I could have written. So I’d like to share with you the concepts they outlined in their article below:
It’s tricky to do freemium well. You need a killer product, pricing and marketing strategy — and there are many mistakes you can make. Here are a handful you want to avoid:
1. Weak value proposition
Just because a product is free doesn’t mean there is no cost to the user. A potential customer must provide an email address, fill in a nasty form (or use the less nasty social sign on), and invest time in building out a profile, entering data, or otherwise exploring your product. There is also risk in investing this time and energy in your product when she could do this with someone else’s instead.
What if someone rocks as good as you? Or better?
2. Poorly defined business model
There are many flavors of freemium, with different end-games. Is your plan to build a large user base to win market share at any cost, with monetization a secondary goal until that objective is realized? Or is your free version a stepping stone to your paid product? Is the real revenue in add-on “virtual products” or services that both free and paid users can consume?
Evernote, for example, expected to convert 1% of users to premium. Despite it’s success at close to 6%, CEO Phil Libin wants to maintain its paying customer base at 5% or less. “If people start converting en masse, ‘that means our free product isn’t good enough,’ he says. ‘And if our free product isn’t good enough, what’s the point of being freemium?‘”
That’s fine and good if you share Libin’s philosophy. His business has mass appeal, not niche. Evernote’s strategy is to hook free users and upgrade them down the path — immediate paid conversion is not the goal. Other businesses have found it incredibly challenging to convert free users to paid.
Niche companies like CrazyEgg and 37 Signals found profitability after removing their free version. Their apps will never get billions of free users, they need paid users.
Your strategy may change over time, but knowing how important paying customers are to your strategy (vs. large user base) in the near term is key, considering the nature of your products and your target market.
3. Pitting free against paid
It’s important to know whether a large base of free users or more paying customers is your goal. But if your organization has separate teams for “free” and “paid” versions of your offering, you create a divide. The free team will push for marketing and site design that cannibalizes your paid product and vice versa (this is especially challenging for A/B testing). If you must have separate teams, make sure they share the same success metrics, and don’t step on each others’ toes to meet their own numbers.
4. Failure to count the cost of large user base
Mo’ users, mo’ problems. Not just for bandwidth, but also support. Some freemium businesses have found free users to be far more demanding than paid.
5. Making the free version too good
There’s a fine line between a free product that delights and retains users, and one that gives too much milk for free. The free version should be “good enough” to provide core functionality, the premium should have useful features that free users care about (and ideally, can’t live without once they’ve sunk their teeth into the free version).
6. Miscommunicating price changes
Any impending price or service change should be over-communicated to users over a period of time (don’t just rely on email and Twitter updates – bake it into the app). Warm up your customers and be as transparent as possible. People will assume you are trying to make more money, they may not understand that your service must go paid to survive (if that’s the case).
7. Charging for premium
Apart from the dangers above, charging for your product can be a mistake if it limits your potential revenue. Shazaam was originally a free app that allowed users to tag unlimited songs. It then moved to freemium (grandfathering existing users to premium), limiting free accounts to 5 tags per month.
But the real money for Shazaam isn’t in one-time download fees, it’s in affiliate revenue for song downloads. Unlimited tagging across all users makes sense, as there’s more opportunity to profit from the large free user base. It also gives more word-of-mouth opportunity as tagging is often done in public with friends.
8. Missing recurring revenue opportunities
Even if you have determined monthly or annual subscriptions can cover your operating costs, there’s a lot of money to be earned from add-ons like virtual goods or affiliate referrals (like the Shazaam example above). Get creative, what are some ways you can squeeze dollars out of free users – even if you’re not a gaming app?
9. Poor roadmap planning
There’s customer acquisition, and there’s retention – for both free and paid users. It’s natural to add features as your product grows, but they must be the features users want. You may not lose users by rolling out unwanted features, but you’ll eat your resources and profits in the process.
(Remember the rules of digital disruption. Find the adjacent possible, or the next thing that users want). Keep your paid customers satisfied and excited about your product, re-engage inactive users, and create reasons to market to your existing free users.
Despite the hype, freemium can be a tough business model to make work. Build a great product, plan your offering carefully. Don’t be afraid to tweak your strategy if you need to.