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Summary:

Don’t spend money on marketing, do offer flexibility and data exporting to eliminate buyers’ regret, make sure to capitalize on and value goodwill, and only charge for things that are hard to do. These were the lessons of successful startups at today’s Freemium Summit.

Don’t spend money on marketing, do offer flexibility and data exporting to eliminate buyers’ regret, make sure to capitalize on and value goodwill, and only charge for things that are hard to do. That’s what some startups say is the key to success in the freemium business. But the biggest reason the five presenters this morning at the Freemium Summit in San Francisco — Pandora, Dropbox, Evernote, Automattic (see disclosure at the bottom) and MailChimp — are doing well is because they have great products that people want. They’ve been able to get those products to a broad audience by using the freemium model — that is, offering a free service with the option to upgrade. It’s an increasingly important business model, but one that’s hard to navigate, so their anecdotes, open sharing of data, and lessons learned were really valuable.

Pandora’s reverse-freemium approach: Pandora first launched in August 2005 with something that sounds quite similar to freemium: users got 10 hours of free online radio at signup, after which they were asked to pay $36 per year. “In the first couple weeks we had 100,000 people come through and the vast majority listened to every last minute of their free ten hours,” said CTO Tom Conrad. “Then we asked them for their credit card and they would wander off into the wilderness.”

Pandora CTO Tom Conrad

That November, Pandora switched on an “ad-supported” option. It was ad-supported in name only, however, because they had no ad server, no ad staff — not even a place on their page to put ads. But growth quadrupled overnight, and within three days, Apple called and asked to buy out ad inventory through December. Conrad and his team of course said yes, arriving at the price of $10,000 for the month. “We literally hard-coded the ads on the page,” he said. “We didn’t want them to know, but every time they changed their creative we’d have to relaunch the entire site.”

Pandora now has 20 million uniques and took in $50 million in revenue last year. Subscription rates had dropped to well below 1 percent of users. But 1 percent of a large number is still a large number, so last year the company launched Pandora One, a new take on premium with higher quality streams, a desktop app and fewer usage limits. It now has 300,000 subscribers, accounts for 1.6 or 1.7 percent of monthly uniques, and is expected to bring in 15 percent of 2010 revenue.

Dropbox’s numbers game: Dropbox CEO Drew Houston says you should know one thing about freemium: “It is a numbers game, so bust out your Excel spreadsheet. It’s all about finding things in the margins — lots of little things rather than one key thing.” Houston went into detail about the backup service’s attempts to recruit users through search marketing. The company found that obvious keywords like “online storage” were bid up, and the long tail of search terms had low volume. Then, people coming from search who actually signed up might not even pick the paid version (which has more storage and features).

Dropbox CEO Drew Houston

Ultimately that meant “our cost per effective acquisition per paid user was thousands of dollars for a hundred-dollar product.” So for a time, Dropbox went to great lengths to hide the free option to users coming in through search, and as a result confused users and felt terrible. “So the big lesson there is if you adopt a freemium business model your marketing cost is the free users.” The fact was that Dropbox was offering a product that people didn’t know they needed until they tried, and “search is great for harvesting demand, not creating it,” Houston said.

Having dropped search marketing as a strategy, Dropbox has actually grown incredibly fast. At some point, the company realized that user referrals were its biggest source of growth, so now it encourages referrals with an incentive program. That increased signups by 60 percent, said Houston, and it now drives 30 percent of total signups. The company now devotes 30 percent of its engineering to acquiring active users.

Houston also told a second story about Dropbox’s realization that its unlimited undo history — available to free and paying users — was responsible for a huge and growing share of its costs. And further, few customers actually used the feature. “We said ‘holy sh*t!’ More than half of our hosting costs are going to deleted, not restored prior versions of files,” said Houston. The company was wary of rolling back a free feature, but was able to manage the transition without too much fuss by telling customers about it openly, and giving existing users the option to keep the feature if they liked.

Evernote’s key metric: Evernote, the personal note-taking service, faces a challenge to spreading virally in that it’s not at all a social product, said CEO Phil Libin. But what Evernote can focus on is deriving maximum value from the users it does have. The company, which launched in June 2008, has 2.7 million users, with 7,000 new users per day (mostly through word of mouth, despite the lack of social features, said Libin), and 50,000 paying users (who convert in order to use the service on multiple platforms and for other premium features).

Evernote CEO Phil Libin

The thing is, over time inactive users drop off, and active users start paying. Once Evernote finally figured that dynamic out and started talking about it, term sheets and partnerships requests started flowing in, Libin said. “Our key insight is users are growing really fast, but revenue is growing faster.” Currently, users are growing 10 percent per month and revenue is growing 18 percent. “It’s like our users are a fine stinky cheese or wine — it gets better with age,” said Libin. “More and more people who aren’t going to pay just leave, and more who stay pay.” So 0.5 percent of people who sign up in a given month go premium, but 2 percent of people who signed up a year ago are now paying Evernote.

Libin’s key metric is comparing revenue per active user with variable expenses. At this point, the company makes $0.25 per month per active user, and spends $0.09 on variable expenses like infrastructure, customers service and network operations. He said freemium can work for any business if you have 1) a great long-term retention rate, 2) a product that increases in value over time and 3) variable costs.

Automattic CEO Toni Schneider and MailChimp CEO Ben Chestnut added a few more key lessons in their talks. Schneider talked about the blogging-software company’s decision to offer a-la-carte freemium services instead of tiered levels, giving both his team and users more flexibility. His company now makes 40 percent of its revenue from premium services like domain mapping, with the remainder from ad sales and enterprise products. But he said the problem with this approach is customers may not know of services they could receive, because it’s harder to market them individually.

Chestnut talked about the fact that free products are ripe for abuse. His 10-year-old email marketing company started offering a free version seven months ago, and has seen 240 percent user growth, a 225 percent increase in email delivery volume from 200 to 450 million, and a 200 percent projected revenue increase. But the biggest bumps of all? A 354 percent increase in abuse-related issues like spamming, followed by a 245 percent increase in legal costs dealing people trying to game the system. Luckily, MailChimp was able to develop automated ways to discover and deal with some of these issues, but even as an anticipated side effect the increase in abuse from going freemium has been huge.

Photos courtesy of Flickr users Hillary H, gaborcselle and hzeller, respectively.

Disclosure: Automattic, maker of WordPress.com, is backed by True Ventures, a venture capital firm that is an investor in the parent company of this blog, Giga Omni Media. Om Malik, founder of Giga Omni Media, is also a venture partner at True.

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  1. Rolv Heggenhougen Friday, March 26, 2010

    Email Marketing does not have to mean mass email!
    Companies invest a great deal in their website which in many cases is their only “store” where they showcase products and services. The challenge is to drive people to the website but as we all know, more people in the store will lead to more sales. Corporate employees send emails every day to clients, prospects, friends and others but these are plain emails that do not generate any traffic to the website.
    WrapMail – http://www.wrapmail.com – offers a solution that does not require any installation but that seamlessly adds interactive letterheads (designed by the client) to every outgoing email so that each and every one becomes a promotional piece for the company and when clicked delivers the reader to the website. Furthermore the solution tracks the clicks and reports who is clicking on what and when (also in real time), turning the system into a research tool.
    This “hidden” advertising medium is probably the most viral available and the least costly, WrapMail only charges $5 per user per month.

  2. Eric in Silicon Valley Sunday, March 28, 2010

    It would be interesting to see a discussion, not only of the value of each of the popular freemium services in isolation, but as a group. For example, using EverNote to make quick notes on a mobile device, and saving it to a dropbox folder for future use. There are probably many other combinations as well. Makes you wonder if people would pay for the value of the bundle if they had to make a choice.

  3. What’s interesting is that “freemium” is really “trailware” and its neither new or novel online.

    1. I disagree “trialware” generally only allows you to use a product for a limited period of time. In some cases an essential feature is blocked of (for example Partition Magic’s trial version doesn’t actually allow you to partition!).

      The freemium model allows you to use a product completely for free only paying a “premium” for certain extra features (generally for the power user).

      1. But when Pandora offered a trial they didn’t get uptake. One thing that freemium does (and yes, perhaps it’s just how you word it) is give customers the idea they are getting the full service for as long as they want without pressure to pay unless their needs change. Then, they can upgrade or downgrade for added features as they see fit.

    2. You are not wrong, but this is the evolution of the term and in many ways, the industry too. In his book Free, Chris Anderson defines several methods of freemium such as Time limited, Feature limited and Capacity limited. All of which amount to trialware as you’ve said. The difference is today the free is an incentive to buy the premium, where once it was a trial of the product itself. The marketing tactics, and indeed the industry, has evolved :-)

  4. Rags Srinivasan Sunday, March 28, 2010

    Liz
    These are just three examples and write in absolutes without accounting for alternatives and the possibility that these cases could be exceptions and not the rule. It is easy to look at survivors, look at key observable characteristics and attribute their success to these. That is survivor-ship bias. What about businesses that followed the same principles of these success stories and did not make it?

    We should also note, despite what the article implies, that the freemium model is not the best of all available options. It is not clear to me whether the start-ups have evaluated all available options and decided freemium was the profit maximizing route.

    The conversion from free to paid versions are neither predictable nor reproducible. The businesses did not have set themselves a target rate before they launched the freemium model. I do not understand how quoting this metric will serve others considering this model. Getting customers to sign up for the free version and hope a percentage of them will upgrade to paid version is not strategy – customers can remain happy with the free version longer than businesses can stay solvent (hat tip to Keynes).

    If these are all products customers really want/need and value then why not charge for it?
    -rags
    http://twitter.com/pricingright

    1. The essay is not actually promoting the freemium model. It is merely providing a four pronged case study of where it has worked.

      Also, while the conversion from free to paid is not predictable at first, neither is whether ads can create a substantial demand. Once the process has started, statistical analysis shows trends for both.

      Why is it not a valid strategy? It is a risky one, I’ll give you that, but it is still a strategy.

      To get any real benefit from following these businesses, one would have to go far deeper than the scope of the article.

      In short: your arguments are outside the scope of the article.

  5. Making Money With SaaS: Pandora, Dropbox, Evernote, Automattic and MailChimp [Via GigaOM] | Cloudomatic Blog Sunday, March 28, 2010

    [...] Read full article at GigaOM Read full story » 28. Mar, 2010 [...]

  6. links for 2010-03-28 « Blarney Fellow Sunday, March 28, 2010

    [...] Case Studies in Freemium: Pandora, Dropbox, Evernote, Automattic and MailChimp (tags: freemium business brezmejnik startup) [...]

  7. Giles (Webconomist) Sunday, March 28, 2010

    Seems one these business models that still isn’t quite proven. I think there’s some evolving left to do.

    1. It seems that word of mouth works for a lot of these freemium products. But with Evernote for example, (and I can personally attest to doing this), people sign up and then don’t use the product. If they’re signing up for the product and downloading the app, they’re showing some legitimate initial interest. It seems that its immediate value isn’t as apparent to some users.

      Check this post out – it discusses a great way to help eliminate this problem with an optimized conversion funnel mixed with behavioral ad targeting.

      http://www.retargeter.com/retargeting-with-a-freemium-model-long-term-roi

  8. Link Post for March 26th through March 28th Sunday, March 28, 2010

    [...] Case Studies in Freemium: Pandora, Dropbox, Evernote, Automattic and MailChimp – Don’t spend money on marketing, do offer flexibility and data exporting to eliminate buyers’ regret, make sure to capitalize on and value goodwill, and only charge for things that are hard to do. That’s what some startups say is the key to success in the freemium business. But the biggest reason the five presenters this morning at the Freemium Summit in San Francisco — Pandora, Dropbox, Evernote, Automattic (see disclosure at the bottom) and MailChimp — are doing well is because they have great products that people want. They’ve been able to get those products to a broad audience by using the freemium model — that is, offering a free service with the option to upgrade. It’s an increasingly important business model, but one that’s hard to navigate, so their anecdotes, open sharing of data, and lessons learned were really valuable. [...]

  9. Web curation for March 28th 2010 Sunday, March 28, 2010

    [...] Case Studies in Freemium: Pandora, Dropbox, Evernote, Automattic and MailChimp – gigaom.com Don’t spend money on marketing, do offer flexibility and data exporting to eliminate buyers’ regret, make sure to capitalize on and value goodwill, and only charge for things that are hard to do. That’s what some startups say is the key to success in the freemium business. But the biggest reason the five presenters this morning at the Freemium Summit in San Francisco — Pandora, Dropbox, Evernote, Automattic (see disclosure at the bottom) and MailChimp — are doing well is because they have grea..   show all text newsycombinator: Case Studies in Freemium: Pandora, Dropbox, Evernote, Automattic and MailChimp http://bit.ly/cr0tAA  [...]

  10. Business: Beispiele für funktionierende Freemium-Modelle » t3n News Monday, March 29, 2010

    [...] Informationen finden sich in dem umfangreichen Blogpost bei GigaOm. « vorheriger Beitrag [...]

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