Wensing, M.

Things I'm learning about business and life through the act of starting a startup.

June 15, 2012 at 1:39pm

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The Anatomy of Profitable Freemium

Choosing the freemium business model can be brilliant or deadly.  The difference lies not only in the execution of the marketing, but also in the nature of your product and the design of your business.  Can you coordinate all three to become sustainably freemium by making a profit? 

Summary

  • Freemium requires a business to maintain two value propositions with a well-designed interaction between the two.
  • The premium offering can deliver different kinds of value.  You should choose the most profitable one you can under your constraints, which best fits the value your product delivers.
  • Using a free car analogy, the kinds of premium value (types of freemium) include: Cargo Freemium, Airbag Freemium, Bomb Freemium, Cruise Control Freemium, and Bells & Whistles Freemium.  
  • Each type of freemium has unique risks as well as market and funding requirements in order to be sustainably profitable.
  • Any of these types of freemium can be implemented poorly.  Some types may not work with your product.  Correctly implementing any of these types of freemium requires a deep understanding of the value of your product. 
  • Entrepreneurs should be convinced that freemium is the right choice for their product/market, choose their type of freemium out of knowledge (not fear or ignorance), and re-evaluate this decision regularly.
  • Freemium can be extremely beneficial for gaining market share, but if it can’t create sufficient conversions to a premium offering, it isn’t sustainable.

Not One, but Two

Your value proposition is the proposal you make towards a prospective user or buyer, wherein they exchange their time or resources for the life-changing experiences (for better and for worse) your product provides.  The freemium business model actually contains two such proposals — one set of experiences the user can get for free, and another set of experiences that can only be acquired through purchase.  To be successful (profitable), we need to understand when and in what manner (constructive or destructive) these propositions touch.  In familiar terms: how, when, and why does the user “convert”?

Kinds of Premium Value

For illustration, let’s imagine the free component of your offering is a basic car.  We should choose the Everyman Car, because one element of profitable freemium is having a massive addressable market (preferrably “every human on the planet” or “every business on the planet”).    

So what kinds of paid offerings can we provide to the drivers of our free vehicles?  Let’s look at 5, in order from most to least desirable and even dangerous.

Cargo Freemium 

Your free car comes with 2 seats and a very small trunk - fine when you have no kids, or 1 kid, but once you have 2 kids and their carseats and a stroller, trips to Costco become a circus of arranging and folding seats and jockeying diaper bags around your feet before heading to the warehouse for your 10 lbs. of oatmeal.

The paid offering says that for just $X per year you can add a roof rack or a trailer to your car (or limousine extension) which will make all of these problems go away.  Stubborn and frugal drivers will continue to struggle and shove and jam and limit themselves to the free capacity, but every week the pain comes again and every time you think of incrementing your offspring count you have to reconsider whether this is sane.  Most people will eventually get the extra capacity.

Examples: Dropbox, iCloud

Notice the change that takes place in the value of the free offering between 1 and 2 kids.  At 0 and 1 child, the value of the free offering is constant.  Once we reach 2, there’s actually a decrease in the value of the free offering relative to the paid, because of the constant hassle of dealing with the limitation.  This is a subtle but critical way to rig the contest between the free and paid offering and help encourage people to convert.  

Key characteristics:

  • Inevitability of upgrade for most people as long as they keep using the product
  • The premium value is “More of the same” - the free car offering’s primary benefit is moving people from point A to point B.  The premium offering extends this primary benefit.
  • Regular, repeated temptation to upgrade through normal usage of the product
  • Decrease in the value of the free offering (even) if user stays within the confines of free
Ways this can go wrong: 
  • You choose the wrong dimension to limit and violate the “more of the same” requirement.  It can be tempting to choose to throttle your user’s storage space (bytes) but unless storage is the primary benefit / value of your product, you should choose a different dimension.  (See comments at the end of this article about Flickr).
  • You choose the right dimension but the wrong place to draw the line between free and paid.  

Airbag Freemium

Everyman wants a car, but every man has a different risk tolerance.  You can sell him a car that has a certain level of safety (a minimum viable level, perhaps?), and offer him an upgrade that provides risk mitigation.  Depending on what you offer, this premium value may offset risk only under extreme cases (e.g. a dedicated technician in the event of a server meltdown), or simply offer more safety and peace of mind around-the-clock (e.g. an uptime guarantee).

Example: Wordpress, Red Hat.

Key characteristics:

  • Some people by nature will necessarily be interested in the premium offering.  This might be through corporate or government mandate or in a B2C setting, a paranoia that requires it.
  • Some people will be perfectly content with the free offering until something bad happens to them or someone they know.
  • Some people will never upgrade because they like living on the edge.
Ways this can go wrong: 
  • Your product is used in a low-stakes setting where failure is OK.  People don’t upgrade.
  • Your market doesn’t contain enough people that will use the product in a high-stakes setting.
  • Another company figures out how to sell the safety and security as an add-on that doesn’t involve you.
Bomb Freemium

You know that scene in Speed where the bomb gets activated once the bus goes over 50 mph, and then they can’t ever let it go below 50 mph or the bus will explode?  Not everyone will want an airbag (see above), and not everyone will necessarily go 55 mph, but the people that do find themselves going 51+ mph will find themselves desperate to convert to your paid offering to defuse your well-designed bomb.

Example: Yammer, Salesforce to a lesser extent.  Most companies will never care that their employees are chatting away on yet another social media site, but some companies will see this as a disaster waiting to happen.  Premium offering appeals to CIO who can defuse the bomb by enacting controls that keep the usage of the product within certain acceptable/manageable boundaries.

Key characteristics:

  • Product is easy to adopt in a high-stakes setting.
  • Once the product has infected the high-stakes setting, its usage spreads virally.
  • The more the product gets used, the more dependent the company becomes on its proper performance and usage.
  • The premium value gives the company control over the product.

Ways this can go wrong: 

  • Your customers feel extorted
  • Your product never goes viral
  • Your product never gets used in a way that creates an exposed risk for the organization

Cruise Control Freemium

A favorite feature of the long road trip is cruise control.  Who wants to keep their foot pressed evenly on the gas for 3 hours at a time?  Then again, if the driver only plans to use your car as a commuter, you’ll never get him to buy in.

Example: GitHub.

Key characteristics:

  • The free product is good enough for anyone that can avoid certain usage patterns or needs.
  • Even the people that can’t avoid these usage patterns or needs will not necessarily need the upgrade on Day 1.  
Ways this can go wrong: 
  • The people that can’t avoid these usage patterns worm their way out of the pain or put up with it while it lasts.  
  • You don’t retain users long enough for them to ever hit a point in time where they need cruise control.
  • Your cruise control is a vitamin and not a painkiller.
Bells & Whistles Freemium

The fallback and default state for all freemium offerings (the state wherein you don’t know enough about the users to know better) is to offer shiny things and upgrades that may be appealing, but will never be a need for the vast majority of your users.  In these cases your best chance is to make the bells and whistles into needs (through marketing that convinces them of the great value), or learn more about the market so you can graduate to a different kind of premium offering (see above).

Examples: pre-2012 Stormpulse (before we shifted to free trials/paid only), and many other startups.

Key characteristics:

  • Startup founders don’t know much about the market but understand that power users always exist.
  • Premium offering tries to sell features to power users.
  • Product gets clogged with features that “oooh” and “ahhh” but are very hard to quantify in terms of ROI.
  • Marketing messages focus on the cost of running the business and the need to monetize to support operations rather than the value of the premium offering

Risks:

  • You run out of money because your conversion rate is low and your retention is poor (once people realize they don’t need the upgrade they downgrade or don’t renew).

Talking Points

What kind of freemium are you?  Can you re-design your offering to get higher on the value ladder?  Do you have enough funding to support yourself until your users start to convert?  These are all important questions that will determine the fate of your business, and ignorance will not shield you from failure.

Comments below and also on Hacker News.


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