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Summary:

One of the great things about blogging is that you can pick one aspect of an argument — any aspect at all — and comment on it. Apparently Jason Fried of 37 Signals didn’t agree with something I wrote about the freemium model. Using it as […]

freemium-bag2One of the great things about blogging is that you can pick one aspect of an argument — any aspect at all — and comment on it. Apparently Jason Fried of 37 Signals didn’t agree with something I wrote about the freemium model. Using it as a springboard, Fried argues in a blog post of his own that “the bar for success in our industry is too low.”

Then yesterday a piece pops up on Gigaom called How Freemium Can Work for Your Startup. This piece references the “Using ‘Free’ to Turn a Profit” New York Times piece. Om Malik says “And it in reading Damon’s article, the qualities of a successful freemium product finally became clear to me.” Then in the next paragraph Om acknowledges that Evernote doesn’t generate enough revenue to turn a profit. Later he says “I’m sure there are many more ways to build great freemium applications, but one [Evernote] has stood out for me above all the others.” The product may be excellent, but until their business cracks a profit I don’t see how Om can say it’s a model for how to build a freemium application (or a business).

Fried’s comments jumpstarted a spirited debate on Twitter, with many of those tweeting in support of his stance. Lost in the hullabaloo, however, was the fact that my post was actually about the qualities of a good freemium application, some of which are regularly preached by Fried himself. My headline — How Freemium Can Work for Your Startup –- pretty much says it all.

I used Evernote as an example of a freemium application that’s successfully converting its free users to paid ones. Indeed, the more people use an application like Evernote, the more likely they’ll be to pay for a premium version of it.

Fried’s partner in 37Signals, David Heinemeier, once wrote of Basecamp, their flagship application.

It didn’t turn into a smash hit overnight either. We ran Basecamp for a year alongside our other obligations before it was doing well enough to pay all the bills and afford our full-time attention. Most good businesses didn’t become great ones within the 12-18 months that the poster boys of the startup lottery did.

If the ensuing success of Basecamp is any indication, then patience is a virtue. With that in mind, perhaps we should give the companies that are trying the new freemium model a chance to blossom. With enough time — say, 12-18 months — the likes of Dropbox and Evernote have a good chance of becoming profitable, largely because they, much like Basecamp, are striking a chord with their customers.

I like to think of this transition from free to premium as similar to the one made by a baseball player starting out in the minor leagues and working his way up to the majors. Like any good player, freemium applications can increase their odds of success if they follow some basic tenets. Many of the ones I outlined in my post were the result of conversations with several developers over an extended period of time.

The reason I wrote the post in the first place was because this is an emerging business model, and one worth paying attention to. If you read the full article (not just the selection that Fried focuses on) you will see that I stayed away from the profit discussion because of how young the startups I wrote about are and how nascent the model remains.

Of course Fried is right about the need to be profitable. No one, least of all me, is arguing against that most basic principle of business. But when you’re using a new business model, that can take time. I mean, it took nearly a decade for Amazon (whose founder/CEO Jeff Bezos, incidentally, is an investor in Fried’s company) to turn a steady profit.

If Fried read this blog on a consistent basis then he would know that we consistently examine the need to be profitable and the best way(s) to make that happen. In particular, we’ve talked about the correlation between viral growth, traction and revenues. That’s because, in the end, we all want to know what — other than advertising — will work. I think on that point Fried and I do agree.

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  1. OM,

    I suspect as time marches on, your view of this topic will become more… let’s say… conflicted… between romancing the novelty of the freemium model as a journalist… and understanding the realities of “being patient” as a venture partner. After all, I suspect the “let’s be patient” talk is going to get a little tiring in many board meetings & funding discussions.

    At the core of this argument, I think Jason’s point was spot-on… holding-up a company bleeding cash & producing only <$1M in revenue as an example of "success" is pretty useless… pick a better example.

    1. @Hahnfeld

      If you look at our own efforts from GigaOM and GigaOM Pro, you know I am talking from experience and we are living this model. It is not software or apps, but one cannot deny that these things take time and you need to build it into your model and that is exactly what we are doing.

      In case of Evernote, if it converts about 4% of say 2 million users into paying customers, the company generates revenues of around $3.6 million a year. Not bad for a company of about 15 people. And as I said in my post, the more they convert to paying customers, the better their business becomes. I think “let’s be patient” within reason is justifiable.

      1. OM, I wouldn’t debate GigaOM’s strategy with you.. or argue your experience or credentials in judging these things – I’m just trying to understand the thinking.

        With that in-mind. I think your math with regard to Evernote is a little challenged.

        How many employees Evernote has… is a nicety. To me, it matters more how much $$ it takes to get them to a given level of value.

        Let’s assume your proforma model is accurate: By 2011 4% of 2 million users are premium = $3.6 annual revenue.

        Let’s also assume they don’t need any more funding. Rather, they get to this milestone off their Dec-08 B-round of $4.5 million (total investment $13.5 according to CrunchBase). This seems like a big assumption.

        So, at this stage… let’s assume get Skype’s valuation… 4.5x revenue

        Isn’t this a non-event? $16.5 million created in year 5 off the back of $13.5 million invested? Add to this the effect of an employee option pool or liquidation preferences & this company is either a loss for the investors or a $0 for the employees at this stage.

        So, now “let’s be patient” really means we have to buy-in even MORE to the proforma plan, right? No argument if premium conversion grows to 22% like they suggest (vs. 4%) it’s a HUGE winner… problem is, it seems like a pretty big leap of faith & all goes back to using proforma results as a showcase of “success” – worthless.

  2. Businesses take time to build. The more time you have, the better off youwill be at finding the right mix/model to make it a success. If you need it to pay for food and gas within the first month, forgettaboutit!

    1. SOME businesses need added time to find the right mix/model, not all. MANY understand their “mix/model” up-front and have unrelated barriers to profit.

      This discussion is about what is being held-up as an example of “successful”, that’s all.

  3. What I think most of the contrary readers to the original post miss is the fact that the start-up landscape has changed right along with the new venture mindset. This is also compounded by the issues surrounding the freemium evolution for most traditional news content today. When the entrepreneur realizes he needs to get his venture up and running for the required ramp-up time that freemium requires with little or none of the angel money he is used to … then I think what you will see are many more mature opportunities available for investors and they will hold high value for a second reason; they will be lean machines that have a functioning freemium revenue model that wont be so dependent on numerous rounds of funding to prosper. The examples of Facebook and Twitter explosive growth with no working business models with become rare indeed.

  4. Brother OM – don’t be like the dumb politicians and start the sematics machine. It does not do much. I read this post and I see the contradictions becoming more prominent relative to the previous post. YOU ARE BETTER THAN THAT BUDDY.

    As I commented yesterday – let me say this again – slight different way – FREEMIUM is NOT a BUSINESS MODEL – it is a NOTION of innovation floated by VCs who do the “spary and pray” investments. And even the religious will tell you – praying will only get you a Preachers Nod – never a Bankers Note.

    Amazon sold books – did not give it away for free. They were not profitable for a long time – because Bezos was laying the infrastructure. A comparison of Amazon to the Freemium fantasy is devoid of logic.

    I still think you know your stuff – so don’t take this comment too harshly. Next post please :-)

    1. Do you remember how much money Amazon lost per book?

      Nevermind, what you say is that Amazon was building infrastructure for the future, is right. So are these app companies. Instead of building physical infrastructure, they are building a customer base who can then buy other things. Think who Salesforce evolved.

      Anyway I am not in favor of giving away things forever, but if within 12-to-18 months revenues and profits flow to a company, then it is pretty okay.

      Let’s just agree to disagree on this and we can take it up when the right opportunity/news arises again.

  5. “Let’s just agree to disagree on this and we can take it up when the right opportunity/news arises again.” – Agreed without prejudice.

  6. Nikhil Kulkarni Thursday, September 3, 2009

    What I find amusing is that if GigaOm believes “from the bottom of its heart” that its argument makes sense, why the need to defend against criticism? Or am I missing something here?

    1. You are missing a clue about the point of debate.

  7. Partha Bhattacharya Friday, September 4, 2009

    The unseen factor behind the arguments here seems to be the current downturn in investment sentiment. I feel GigaOm does have a point when he says, “…if within 12-to-18 months revenues and profits flow to a company, then it is pretty okay.” His contention is all the more plausible in the present scenario because of uncertainties – that hadn’t been thought of – faced by Internet startups. Twtapps is a case in point [http://mashable.com/2009/09/03/twtapps-on-sale/].

  8. Bruce Christensen Friday, September 4, 2009

    I come into this industry from a manufacturing perspective.
    Here is what we do:
    Find a group of people who have a need for some tool… Research until you know exactly what they need created to make life easier for them… Work to develop a tool that some will see as a benefit… Build and test the tool so that it is beneficial to a selected group… Give it valuable features…
    Then sell it for a profit.

    We don’t give away our manufactured goods; we sell them, because they have created a value to somebody who has raised their hands for our tool. We don’t need 230 million people visiting with us “uniquely” every month, just a couple thousand happy and satisfied customers.
    We have selected a group to satisfy and we let the next guy select and satisfy the others.

  9. I think the point of difference here is whether freemiums should be taking millions in VC. If I remember correctly Basecamp was started with no VC and Jason prides himself on not having any VC. His point really isn’t will a freemium be profitable in 12-18 months… it’s does it need VC in order to even begin. This is where he and you can never agree if you are a VC looking for that next facebook.

    You have money that you want to invest to make a profit. In his view pouring money into something that does not yet need that kind of money only leads to waste. Instead of putting a million into a freemium, a smart VC might create it’s own 10 freemiums for every million invested and hope that one of them will pan out in 12-18 months.

    The flip side is for as successful as Jason and Basecamp are, they will never get beyond a certain size. It works for him because it is good enough for him and his team. It’s a success limited by design to not accept any VC, but he is vulnerable to a Google coming along and giving away free for what he charges. They serve a niche (3 million users in 5 years, although it says 1 million on his blog… not sure how many users Basecamp has?) and survive by loyalty, that can get tough in certain market conditions.

    Jason does not get or understand VC becasue his success was not based on it. He doesn’t get that some players get into this solely to make money. They are not passionate about what it is that makes the money as long as it makes money and sometimes they can wait for the money to work. He does not understand that actually his way of starting a business is not common. From franchising to proprietorships, sometimes it takes years of losing money to make the investment needed to succeed long term.

    None of this negates the fact that Evernote may never see a profit given the hole it has started in.

    1. This is a great comment, it aligns with what I was trying to illustrate yesterday.

      From the perspective of measuring “success” – this is really about 2 separate things (although, you’d like to think they’re intertwined).

      #1 – The business and its profitability. Classic P&L. How much profit from sales does the company generate? Not how much MIGHT it generate (see #2)… HOW MUCH MONEY DOES IT MAKE, PERIOD.

      #2 – The creation of shareholder value. ROI. Although you’d like to think this is tied directly to #1, often the “exit” is really tied to a convincing but unproven proforma plan which has not played out yet. Sometimes value is unlocked just to mitigate risk! In our Evernote example it is not far-fetched to speculate someone like MSFT taking it out for $30 million to protect a profitable OneNote franchise! Crazier things have happened. The investors would consider this a “success” although the company may have never proven itself on its merits.

      Counting on #2 is high-stakes poker & where I suspect where the “cringe factor” comes into play for folks like 37 Signals. Their no-VC & revenue based model should pull at the heart strings of every true entrepreneur as the way “real entrepreneurs” build a company.

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