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Summary:

Freemium can only offer the hope that customers will fall in love with your product and be willing to pay for it later. This is a scattershot approach to monetization. Rags Srinivasan argues that it’s time to take a deliberate and more targeted approach.

  • “We are now seeing the end of the freemium model — signing up users for free and trying to upsell,” said Christian Vanek, CEO of the Boulder-based SurveyGizmo, in a recent phone conversation.
  • “6.5 million unique users is not all that it’s cracked up to be. I don’t want hits. I want revenue. I want a real business,” said Matt Wensing, founder and CEO of Stormpulse, in an interview with Mixergy.
  • “Make a product people want to pay for,” said Marco Arment, founder of Instapaper, in a Planet Money interview.

Three easily available examples do not make indisputable evidence against freemium. Just like Dropbox, Evernote and RememberTheMilk do not make a case for freemium. But these three quotes reflect a return to the roots of marketing — starting with customer needs, choosing the needs you want to serve and getting your fair share of the value created.

In the oft-cited Hershey’s experiment that started the free-mania, behavioral economists from MIT tested customer preference for Hershey’s and Ferrero Rocher chocolates at two different price points. For one group, they offered Hershey’s at one cent and Ferrero Rocher for 26 cents. For another, they offered the chocolates at zero cents and 25 cents respectively. When the Hershey’s chocolate was free and the Ferrero Rocher chocolate was 25 cents, 90 percent of the participants chose Hershey’s. $0 price seems to have done the magic in driving customer adoption. The result became the foundation of the freemium school of thought — free is free marketing. First use the free version to drive adoption and build a large customer base, and then find ways to monetize that base by upselling the paid version and selling extras.

Ninety percent is an eye-catching statistic in books about the freemium model, but let’s stop and ask some basic questions about running a profitable venture.

  1. What do you know about your target customers?
  2. What urgent needs do the free and paid versions meet for these customers?
  3. Will the products remain relevant in the customers’ future?
  4. If fifty other sellers stand next to you and give away free Hershey’s chocolates, Skittles etc., what will happen to your share of the market?
  5. As a startup founder, which customers should you focus on first with your limited resources?

The five questions above are the key principles of marketing. Unfortunately, choosing a freemium model does not help answer these questions. Worse, it muddles the answers by misdirecting startup founders to focus on the product rather than customer needs. Stormpulse, a Web-based platform for managing weather risk, learned that free can attract all the wrong customers. The company’s CEO Matt Wensing told Mixergy, “Free brought us recreational users who tried us for superficial reasons, while those who found real value were the enterprise customers.”

Here is an alternative, which unlike freemium is neither new nor a fad:

Start with the customers, not your product. The product could be new but the customer needs are not. Whether it is a “bits” product with zero marginal cost or “atoms” product with non-zero marginal cost, customer needs come first.In fact, it is not a product until you have identified a set of customers whose needs you meet and who want to pay you for that value.

Make your choice. Stormpulse and the online survey platform, SurveyGizmo, both realized that a successful strategy involves making choices. They couldn’t go after every customer who is willing to try out their products. Instead, the leaders at both organizations chose to focus on enterprise customers, because these customers not only value the products but also have the budget to pay for them. Getting 90 percent of customers to take free Hershey’s chocolates with the hope that they will pay more for extras or will upgrade later is not a strategy. In fact, the presence of free products drags down the expected value of a customer. Which is another reason why SurveyGizmo decided to downplay its free offering.

Get your fair share of the value created. As Instapaper’s Arment said, charging for the product is still the simplest of all business models. Product innovation does not mean business model innovation. If your product adds compelling value to customers, charging for it is simply getting your fair share of the value created. You do not have to be ashamed of making a profit.

A small percentage of a very large number is indeed a large number, but can your startup stay solvent while you wait for the conversion to kick in? Freemium only offers the hope that non-paying users will fall in love with your product and start paying for it. Shooting an unlimited number of free bullets and hoping some will hit the target is a shotgun approach to monetization. It’s time to take a deliberate and targeted approach. Or as Vanek told me in our conversation, “it is time to retire the shotgun.”

Rags Srinivasan is a management professional who specializes in product strategy and strategic marketing. He is currently working on big data products. He blogs at Iterative Path and tweets at @rags

Feature image courtesy of Flickr user ColinGordon

  1. Very interesting article. While I do agree on most of the points, it is still evident that the “freemium” model is an effective approach. But I entirely agree that a company should start with there customers not their products.

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    1. “the “freemium” model is an effective approach”
      no. its not

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      1. That’s debatable. Many successful companies have taken that approach…one of which is my former employer, Zillow. Which is now a public company and doing quite well.

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      2. That’s debatable. Many companies have succeeded with this model – one of which is my former employer Zillow. Now a public company.

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      3. Would you mind adding more to the conversation than simply dismissing other peoples comments, maybe add fill out your argument and add some evidence?

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      4. David Rusenko Saturday, July 28, 2012

        I disagree.

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    2. Atomic Tango Sunday, July 22, 2012

      “a company should start with their customers not their products” – no, they shouldn’t

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  2. Ian Andrew Bell Saturday, July 21, 2012

    Agree with the advice but not the premise. I agree with @rags that we need to focus on building stuff people want and will pay for, and there is a long-standing addiction in Silicon Valley to the monetize-later strategy, which I do think actually works where you have lots of big players looking to grow horizontally through acquisition and leverage their scale. That isn’t the case these days.

    That being said, Freemium works. It is working at hundreds of startups in the valley and thousands of companies worldwide. Where Mr. Srinivasan may have missed the point is that in many Freemium-style businesses, value is extracted from the free users that benefits the business model as well.

    Freeloaders could provide the eyeballs for ads or content created by paying users, they could be the “product” that is sold to paying users in a social context (ie. dating sites), or they could generate data through usage that sustains a corpus of information that other people wanna pay for.

    Most likely, they could be propagating the brand/service and helping it get more customers as a benefit of being viral. This is the most obvious way. Free is almost never truly free, except when you have decamillions from ambitious VCs and hopes of selling to Y!/G!/MSN/AOL.

    The statement that “Free is free marketing” is overly simplistic and not universally true. Being free, mated to the mechanics of behavioural virality and a fundamentally sound product value proposition, works better.

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    1. True that

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    2. Filipe Leandro Tuesday, July 24, 2012

      Well said.

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  3. Steven Willmott Saturday, July 21, 2012

    This is really a non-sensical article: Freemium models make sense for certain businesses and not for others. Sectors may change over time – but a title like the above is really just flamebait.

    If you’re in a network effect market (e.g. dropbox, skype, …) where there’s cumulative value to all users due to new users, Freemium is an incredibly valuable strategy. If you’re in a non-network effect market it’s just a marketing choice which may be good or bad depending on the product.

    Focusing on revenue is all very well – but revenue is the outcome of a marketing and sales process. It’s not the process itself. You’re ultimate aim is to reach paying customers of one sort or another, paying fees one of one sort or another – freemium or not is simply a question of the route to take to get there: wide accessible funnel + filtering or narrow focused sales team to pick and choose your targets. Both can work – but it depends on the market.

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    1. Steve
      Revenue is not an accidental outcome of sales and marketing process. It is part of the business model. Freemium punts on the tough question on customer segmentation, needs and setting a price.

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      1. Way too broad assessment of Freemium.

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      2. Atomic Tango Sunday, July 22, 2012

        my typo: “Just LOOK at this article as a case in point…” (My kingdom for an edit or delete button!)

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    2. Atomic Tango Sunday, July 22, 2012

      I agree with Steven. While I’ve never been a fan of Chris Anderson’s “Free” argument, we’ve certainly seen successful startups use the freemium model, such as LinkedIn. Just like at this article as a case in point: don’t we consultants give our blogs and articles away for free to the vast majority of people, in hopes of being hired by the few?

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  4. I agree with many points raised in the article, but not with the link-baiting headline.

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  5. The post is just too all or nothing for me. But I think that was intention of post.

    Response to opening quote:

    1) Alright COSTCO stop giving away samples. The sales funnel is dead. Long live the sales funnel!!

    2) You have 6.5 Million users and you couldn’t sell any of them of premier features or anything that made money. I agree. Shut it down….it was a mistake.

    3) Agreed. But are they mutually exclusive? I think your taking his comment out of context.

    So if I offer freemium, I now can’t have a business model? I can’t have freemium and use a sales funnel to get to know my users and understand what they are willing to pay for?

    Maybe if the post was titled…”The hard questions to ask before offering freemium”…it would be relevant. But there are so many ways Freemium works and doesn’t work…to discuss after title like that.

    Black and white statements like this work for pageviews, but not for real business decisions. You have to get to know your industry and audience better.

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    1. Re: #2: I’m glad we didn’t take that advice. We’re charging now and things are great. The problem was that our product does not lend itself at all to “premium features.” When the only thing you can give away is the only thing worth charging for, freemium isn’t the right choice (unless you’re VC funded).

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    2. Kin
      Let us distinguish between a calculated and measured approach to marketing with trials and samples vs. getting as many as possible because with free and hope to convert them.
      Sticking with Costco example, the customers are already there (because they paid $50+ a year) to buy many different things. The whole Costco strategy – segmentation, targeting, supply-chain, product mix etc – are overlooked when you look at product samples. Costco’s strategy and business model is not based on free samples.

      Regarding point 2: If 6.5 million users do not see unique value in the product, have alternatives and willing to switch yes it is not worth serving them and instead choose to serve the segment that finds unique value and willing to pay for it.

      Giving away a product for free -forever- and hoping they will become customer or create marketing is not sales funnel. Choosing the right segment to serve, targeting it with compelling positioning and offering them a product they want to pay is the preferred alternative.

      Regarding business model – what is business model? It is value creation and value capture. If we choose to disregard finding out the value we add to customers and fail to capture any of it, there is indeed no business model.

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    3. Matthew Wensing Sunday, July 22, 2012

      I’m glad we didn’t take your advice and “Shut it down.” Things have been going great since we shifted from freemium to free trials. Not all product-market combinations are compatible with freemium.

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      1. Vikrama Dhiman Saturday, July 28, 2012

        Interesting. Mathew, what product are you associated with?

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  6. I’m also bummed that Gigaom will now stop its free blog after this post. Freemium just doesn’t work. And we will have to only pay for access to the wealth of knowledge available at GigaOm.

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    1. I don’t speak for Gigaom. Here is my outsider observation.

      Consider who they are targeting with what products and how they are monetizing it.

      The Gigaom blog is targeted at a segment that has appetite for tech new and some analysis. They monetize this through advertising. That is a calculated strategy vs. a hope.

      The GigaOm Pro is not targeted at the same segment that reads the blog. They target a different segment that values the actionable insight they get from meticulously researched reports and most importantly has wherewithal to pay for the service.

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  7. Dmitri Leonov Saturday, July 21, 2012

    I agree with Rags wholeheartedly (http://mashable.com/2012/06/05/freemium-model-doesnt-work/). Certainly freemium model works for some companies, but those companies have a) fantastic product, b) network/viral effects and c) value that increases over time. Most companies assume freemium will work for them, because it worked for Evernote and Dropbox. That’s simply not true.

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    1. Matthew Wensing Sunday, July 22, 2012

      Thank you, Dmitri. Nailed it. The only viral/network effect that matters to all startups is distribution. Once freemium accomplishes that, it may be time to reconsider the utility of the strategy for your business.

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  8. Janna Bastow Sunday, July 22, 2012

    It can be an effective approach, but it’s certainly not efficient.

    It’s only effective if the company can afford to provide their product for free, en masse. If they can’t, they’ll burn their resources before they hit a level of usage that creates a compelling product that adds value to a different type of customer (a paying one). These companies need to be backed heavily, or have a higher-than-average upgrade rate – Freemium isn’t suited for everyone.

    In any case, it’s not efficient. A lot of effort and resources need to go into supporting a freemium base of any kind, whether the upgrade rate is high or not.

    In B2C applications, freemium offerings are more effective – if only that consumers rarely pay for the types of services that applications offer. It’s unlikely many would pay for most of what Twitter offers. The B2B end of such services look at how they can provide tangible value, such as the exposure gained from Promoted Tweets. While a low percentage of users opt for this, it’s charged high enough to justify it, and the company is backed by enough power to keep the freemium product for the rest of the userbase stable.

    As soon as you start looking at pure B2B services, there’s very little reason to consider a freemium model.

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  9. $75/mo for a survey service. Seventy-five dollars per month. Are they crazy? Who in a right mind would pay so much for something like that? Sure — some services are more expensive. But they let you use a free account, too, without hiding it in a bloody footprint!

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    1. Those who see the $75/m price as high are likely not the target segment or do not yet see the value of the product. For most who just need a survey tool for what Matt called as “recreational purpose” there are other alternatives. The pricing is a result of their understanding of customer segments and their needs.

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    2. Disclosure: I used to work at SurveyGizmo.

      There are lots of folks who pay more, and if you look at the feature list you’ll see that there is a boatload of difference between SurveyGizmo and low end survey tools.

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  10. stylifyyourblog Sunday, July 22, 2012

    Freemium Model cannot be left out completely , the biggest names in the internet industry follow this Model and its been very effective in revenue generation.

    But the thing with it is that users gained from this approach are very less likely to turn into customers. Therefore a passive way of earning revenue has to adopted like Advertisements.

    In these times ,making a service fully paid is a sure short way to lose a lot of exposure & attention that could have been otherwise earned easily . Once you have the attention , providing a premium version of the service will surely reach a larger audience and have higher adoption

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    1. Some of the startups that gained exposure and attention happened to have freemium does not imply any new venture starting with free will gain that level of attention. Free is not free marketing nor it ensures success.

      I would classify earning revenue through advertising, which predates the origin of freemium is a different business model. This is a 2-sided market – you attract one side with entertainment/content and sell that to another side as Ad revenue.

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