What Now: Freemium or Paid?

Your company, SpiderNet, is in the final stages of defining the go-to-market model and pricing for the product. The company has spent a great deal of time debating the benefits of doing a freemium model versus paid. The product has the capability to be split along a free/paid feature set, but there are differing opinions in the company on what to do.

On the one hand, several people in the company want to charge $99 for the complete product, arguing that every installation will result in some revenue to the company. Even though the base of users will be smaller, every user is a real customer. Furthermore, if the number of users doesn’t materialize, then the company can always change to a freemium model later.

Others in the company argue that getting to a large number of users right out of the gate will help to establish the company as a leader in the space. Give the product away for free, build a large user base, and then charge $99 for additional features or capacity. They further argue that the sales and marketing costs will be much lower since the free product effectively “markets itself” through viral use. Of course, once the company gives something away for free, there’s no going back to charging for that functionality.

Both arguments make sense to you, but the company needs to decide on one model or the other. You do a quick assessment of the situation and make the determination that the proposed free product is useful to your customers, the market for your product is very large, and you have a pretty clear view of how to monetize the additional features. Given this, do you choose freemium or paid, and how do you think about the trade-offs?

What Now?
Freemium appears to be all the rage right now and my personal feeling is that companies are blindly marching into a free model without understanding key considerations. I meet with many companies who have or are proposing a freemium model. Often, when I dig into the rationale, there is no systematic thinking about why freemium makes sense or a clear view about how to generate revenue. Quite frankly, there’s a lot of hand waving going on.

There are actually some pretty simple guidelines for freemium, so let’s look at where freemium makes sense. (My thanks to my friend Uzi Shmilovici, CEO and founder of Future Simple, who has done considerable research on freemium business models and informed this post.)

The freemium model must offer…

1. Phenomenal quality, value, and usefulness
2. Access to a very large user base (millions of users)
3. A logical way to make money from the free base
4. Simple, understandable pricing and experience

Many times, one of these conditions does not exist and the company is unable to become a profitable entity. Moreover, if the first condition is not true (and the product is not phenomenal), then no one will use it to begin with. Just because something is free does not mean that someone will automatically use it.

If all four of these conditions are not true, then freemium probably should not be a core part of the distribution and go-to-market strategy of the company.

A Tale of Two Startups
Ever wonder what happened to the company Xdrive? It went out of business. On the surface, Xdrive was doing the exact same thing as Dropbox. Ever hear of Dropbox? 😉

Why did one fail and the other succeed? Against the above list of conditions, Xdrive did not have a delightful product, and it did not have a business model that ever made money (Xdrive was ad-based whereas Dropbox is capacity-based). Finally, the two products are really not the same: Xdrive was an extension of your hard drive and Dropbox is a file sharing application. The interesting aspect about Dropbox is that viral uptake is compounded by the fact that every file share requires another user to sign up for the service. While these companies may look the same on paper, they are really quite different from a user acquisition/market and pricing model standpoint.

Where Free Does Not Work
There are many cases where free may not work. Many enterprise products (whether SaaS, on-premise, or appliance-based) do not have immediate appeal to a massive user base. Often, enterprise products are targeted at smaller market segments and grown from that starting point. Also, for the enterprise market, the features of free may not be sufficient to gain viral adoption. In such a case, your company may offer something for free, but the market does not choose to use it. A small market with an un-interesting product will likely result in disappointing adoption. Remember that the driver to success is massive adoption of free such that a small percentage of paid upgrades can yield interesting revenue.

Considerations for SpiderNet
The CEO of SpiderNet has a feeling that many of the freemium conditions exist, but he really does not know. Before deciding on one model or another, I would recommend that the company do a live beta and test the thesis. If during that process, rapid and viral uptake occurs, along with a reasonable understanding of the revenue potential, then freemium makes sense. Otherwise, charging for the entire product may be a more pragmatic approach.