The freemium business model: giving away pays
by Dries Buytaert
I've recently been thinking a lot about the freemium business model. For those unfamiliar with the freemium business model, it was first articulated by venture capitalist Fred Wilson in 2006:
"Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced value added services or an enhanced version of your service to your customer base."
I've been thinking about the freemium business model because, inspired by Drupal and Open Source, both my companies, Acquia and Mollom, use a freemium business model. (Technically, Acquia uses an Open Source business model which is different from the freemium business model, but there is plenty of overlap and similarities -- pointing out the differences could be a blog post and discussion on its own.)
At Acquia, we currently provide community subscriptions for free -- people that want help with Drupal installation and configuration can get free support from Acquia's Drupal experts. While our free support is limited to certain channels (i.e., forum only), certain support questions (i.e., no module development help and no security best practices) and comes without response time guarantees, we have people on staff whose full-time job is to help you (example customer story). Further, we invest heavily in Drupal and give those contributions away for free.
Similarly, at Mollom, our basic spam filtering service is available for free to sites with limited post volumes. Our free website protection service provides all the features of our commercial Mollom Plus product, but is limited in the number of posts it will protect each day and in its access to our high-availability back-end infrastructure. The great majority of our Mollom clients are using our free filtering service with great success.
There are a number of things that attract me to the freemium business model. The first, and certainly foremost, is the opportunity to do “good” and “well” at the same time. It’s a great thing to help people build quality websites with Drupal, and it’s a great thing to provide Mollom to help deal with spam. Second, I believe a company is better off with a large install base than a small install base, even if the majority of clients ride free. A large install base translates to direct and indirect network effects, including efficient marketing, greater brand awareness, the collective intelligence of your users, and faster product adoption. And, last, I strongly believe that a successful company built on the freemium business model is simply a stronger and more defensible business in the long run.
The freemium business model is relatively new because it didn't become a serious option until the internet gave us a low-cost distribution channel. Ultimately, I can't help but think the freemium business model is the business model of the future for the sole reason that it puts the customer first. With the freemium business model customers only have to pay when they get significant value from the software (i.e. they have reached the limits of the free version). Compare this to the current model where people have to pay to get access to the bits, or where people have to pay before they got enough value from the software (e.g. most shareware software).
That all sounds great but you have to make the freemium business model work first. Getting free users to convert to paying customers is hard. Conversion rates of less than 1% are not uncommon. Free is often “good enough” and only a few people choose to pay for additional features and services. You have to put enough value in the free version to drive adoption (so that you get the scale and the network effects that derive from it), while providing enough incentive for people to pay for premium features or services. The marketing and sales funnel is really wide at the top, and very narrow at the bottom. Plus, you have to make sure that the paying users subsidize all the free users.
Achieving the right balance between free and paid customers is difficult and requires close attention to a number of variables. As a result, I've been trying to answer questions like: how much should we invest to acquire additional free users? How do you estimate the value of a free user? What is the cost of a free user? How long does it take for a free user to convert to a paying customer, and how many will do so? What are the triggers that convince free users to convert?
For example, in Mollom's case, one could argue that we get thousands of dollars worth of value from free users already. We currently have more than 3,000 active users that use Mollom for free. Say each user spends on average 15 minutes a week moderating his site's content and reporting classification errors to Mollom. Mollom learns from this feedback and automatically adjusts its spam filters so that all other Mollom users benefit from it. At a rate of $10 USD/hour, we get $390,000 USD worth of value from free users a year -- 3,000 users x 15 minutes/week x 52 weeks/year x 10 USD/hour = $390,000 USD/year. If these numbers hold up, the value of a free Mollom user could be estimated at $130 USD/year. And that doesn't include the marketing value they add. That said, the value of a free user probably declines as you get more of them and the business becomes stronger.
Both Acquia and Mollom have just opened for business so we have a ton to learn. It will be interesting to look at the different variables and questions a year from now, and to see what we have learned. I hope we can make it work so we can do good and well at the same time ...