Should I use freemium model? Part 1

Welcome to the free translation of the article by Jules Maltz and Daniel Barney, IVP partners who specialize in late stage investments in rapidly developing Internet start-ups and software companies.

For many months, the question of the profitability of the freemium business model has been actively discussed. Some argue that this is an “expensive” toy, because such a model sacrifices income, in every way supporting free downloads by users who will never become “paid” customers. Others take a different point of view and state that freemuim is the future of business, the logical conclusion of the development of the information world in which the cost of network bandwidth, data storage and processing tends to zero.

In one they converge: freemium is a very powerful model. It looks like a samurai sword: as long as you do not master the art of using it to the highest degree, you can “cut off your hand”.
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In fact, freemium is a destructive model that must be used wisely. Based on communication with the leaders of Dropbox, Evernote, HootSuite and others, 6 basic tenets of using such a business model were made.

1. Start with the product.

The idea that emerges in the reflections of company executives is constant: the startup manager must be sure that his number 1 priority is a product. Developing a quality product is as important a task as it is difficult to build a freemium business model. The ideal freemium product does not require marketing, it attracts new users (“paid” and “free”) with minimal effort and cost. This is only possible when the product you have created “falls in love” with the users themselves.

Conversion of users into “paid” clients for a typical freemium startup ranges from 1 to 10 percent. As a result, such a startup should have low cost and low sales and marketing costs. You will fail if sales, shipping or product support are too expensive. The product should attract customers due only to its "internal" advantages and advantages. For the user, it should be simple and "working." This does not mean at all that the product will be primitive and stupid - a dummy, although free, is still not needed by anyone.

Please note that the level of complexity and quality of your product should correspond simultaneously to both “free” and “paid” users. Many freemium companies fail because of the fact that they offer users a “tricked” product, which, however, carries no value. In fact, supplying users with an “average” product, you noticeably reduce the likelihood of changing “free” users to “paid” ones, thereby destroying the whole point of using the freemium model at the core of your business. Value for both groups of customers and continuous improvement of their own product - this is the key to success.

Once you have created the perfect product, it's time to thoroughly examine your client.

2. Do you need a freemium product for your main target audience?

Freemium, like a subscription or a perpetual license, is just one of the tools that help sell your product. Your first priority is to understand the client’s problems and invent a solution to these problems. As soon as you succeed in this, you can start experimenting with your product and, based on feedback from the client, understand how much the freemium model suits you.

We invite you to answer a couple of questions in order to predetermine the profitability of freemium:

A) How complicated is your product? If you go to a market where buyers are looking for RFP, RFI, and other strange acronyms with deep meaning, it’s very likely that the idea of ​​your product is too complicated for freemium.

In order for the model to start working, your client must be able to understand and start using the product very quickly, not really getting used to and adapting to it. If it is assumed that the user must first read the instructions, or study the demo, then, perhaps, freemium is not a suitable model.

B) Will your customers take the “free cheese” into a mousetrap? How would you react if a stranger offered you to sit with your child for free? Would you have taken a strange-looking sofa at the corner of the house if you could do it for free? The probability that a person will say “no” to a free offer is too high, because he has learned from childhood that there is nothing qualitative and free at the same time in life. In different situations, a person is ready either to pay for using a product / service, or to abandon it altogether, in view of the time consuming.

If you realize that freemium still suits you, it is time to understand the value of your “free” clients, and also understand how the model fits your vision of the business.

3. The value of free customers.

Free users only matter when they benefit your business. The most “seductive” freemium trap is an easy and low-cost attraction of new customers. What entrepreneur does not want to reach the mark of 100 thousand, 1 or even 100 million users worldwide? The point is that if all these 100 million never (directly or indirectly) pay for the use of a product, then they risk becoming a big burden that will slowly begin to ruin the company. In order for freemium to work properly, free users must belong to one of two categories:

A) Free users who go to the category of paid.

They do not pay anything today, but if you understand statistics and dynamics, you can predict how many of these people will pay you tomorrow.

Key Product Attribute: People recognize the value of your product over time.

Example: Evernote. On the first day, the new startup Evernote had no special content. The only thing users could do with a product was to invent their own, unique content. After they created enough notes, the founders returned to the product to integrate it with other services.

Note: I once had the opportunity to meet with their CEO Phil Libin, since he speaks excellent Russian. One of the topics for discussion was their business model. As it turned out, they are not so simple: it is strategically important for them that the percentage of paid users does not increase.
To my question “why?” He answered: “Then we will understand that the free Evernote functionality is not good enough, and since we want to go global, we need the number of free users to continue to increase, and then 3-4% of paid users will bring more profit. By the way, exactly 3-4% serve us as a line for which we don’t want to overstep. ”

B) Free users who attract paid.

These users also pay nothing today, and most likely will never pay. However, their loyalty to your product will attract other customers who will use the service on a reimbursable basis. In any case, they can be considered one of the marketing channels that do not require large expenditures from the budget and with a fairly measurable ROI.

Key Product Feature: Virality

Example: SurveyMonkey. The online survey service is a good example of a viral product. Free customers who create a mass of surveys are the key to attracting hundreds of other new customers for SurveyMonkey. With the right approach and conversion, such a tool can be very effective as a channel to attract users.

To be continued…

UPD: If you have examples of the use of freemium models in your companies, well!