Today at Y Combinator’s Startup School, Chris Anderson from Wired gave a fascinating presentation on leveraging Business Models (a great Techcrunch summary is available here). With economic times being as challenging as they are, the allure of leveraging “a free service” to build users makes sense. “Freemium” gets people using a service while at the same time, giving them an easy path to pay for a premium features.

One point Chris highlighted was the barrier to entry for recommending a free service is low (it’s a free service after all). If your friend was looking for a better way to manager their money online, its a lot easier to recommend using a free service like Mint.com vs Intuit’s costlier Quicken software. This feeds directly into a concept Chris described as “free users aren’t freeloaders”. These free users actually offer free marketing by spreading the word about a product. The more users recommend the product’s free services to friends, the more users the product has. The more free users a product has, the more paid users they’ll develop. It’s a simple formula. According to Chris, customers who upgrade from a free service to a paid service are a “higher quality customer” vs. those that sign up without a trial.

Another good point Chris mentioned is that if you have a freemium service with a low conversion rate, it may be because your free version has too many features (no need to upgrade), or too few features (too crippled to really try it).

The most intriguing point Chris mentioned is that the churn (or turnover rate) of paying customer using a Freemium model is far less than other business models. Why? They already know what they’re getting when they pay for the service. Any marketing book will tell you its far cheaper to keep paying customers, than to bring on new ones.

For more background on developing a freemium model for your product, see our earlier post on the topic.

]]> http://blog.recurly.com/2009/10/chris-anderson-on-why-freemium-models-work/feed/ 0 http://blog.recurly.com/2009/10/planning-a-freemium-revenue-model/ http://blog.recurly.com/2009/10/planning-a-freemium-revenue-model/#comments Fri, 09 Oct 2009 18:56:37 +0000 Tim http://blog.recurly.com/?p=24 When entrepreneurs come up with an idea- revenue plans are rarely the first thing that come to mind. After all, asking  “how do we solve this incredibly painful business issue” can be a lot more exciting then “how are we going to monetize this”.

Since the first dot-com-boom, several models for revenue have come, some gone, and most have evolved- from the straightforward ad-revenue based model to the more open-ended-funding model (similar to Twitter).  A trend that’s been getting a lot of attention lately is the “freemium” model. This typically offers users a stripped down version of a web service for free, while enabling users to “upgrade” to a fuller-featured version for a fee.

Clearly this works best for feature rich products and services that can be subdivided in some way- deciding how to price these features is the next step.

What to sell? What to give away?

A good first step is deciding what features users are willing to pay for vs. getting for free. Is there a pivot point in your product or service that can easily separate the paying customers from the free customers? If you’re an online storage backup site, a paid account might give you more storage, or automated backups. A customer relations management site might enable you to track on 10 accounts for a free version, but unlimited accounts in the paid version. In any of these situations, customers should not only be able to smoothly upgrade from a free account to a paid account, they must be incented to do so. Finding that hook in your product will be key to your success.

What’s in a price

Now that you have an idea of what you’d like to charge for- what do you charge your customers? Is there a direct, measurable cost to you for user activities on your site? An example would be Dropbox which offers users online storage syncing. New users get 2gb of storage for free- but to use more than those 2gb costs the users a fee. The cost of those initial 2gb of storage is a loss leader for the Dropbox team, but one that clearly is offset by users upgrading to a more premium level of support. The hook for offering the initial 2gb of storage it build buzz or “virality”- which drives new customer signups. With a free to paid conversion rate remaining constant, more free users means more paid users.  To help decide how to best price your product, construct cost models that can demonstrate where your break even point occurs. This will help guide you in putting together pricing plans that can easily fit into a freemium model.

Looking at competitors solutions can give you some guidance, but don’t let the pricing models set by others limit you. Now why would someone upgrade if they’ve already gotten something useful for free? See Om Malik’s post on this topic to get a great illustration of why a user might make the jump to a premium pricing tier.

Freemium models aren’t the magic answer to all revenue model challenges, but with the right product and the right mix of free, you could turn a handy profit.