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The freemium business model: giving away pays

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 ...


Posted on by Joseph Bachana.

I think that while many people will abuse the right to use services and products freely under the 'freemium' business model, most will feel beholden to purchasing goods and services. Ultimately, peoples' good nature will lead them to reach into their wallets in gratitude and awareness that good things take resources to create and support.

We'll see that develop nicely over the next 12-24 months with Acquia as a perfect example.

Joe Bachana
1560 Broadway
New York, NY 10036

Posted on by charlesfrean (not verified).

Another case in point ...
I've recently launched a site, targeted initially (but not exclusively) at 'people known to me', that offers free help and support for their Mac, iPod and iPhone questions. I've been providing this kind of help for years, both informally (free) and formally (now as a paid consultant and some months ago as an Apple employee).

My motivation for building the site was partly to learn Drupal and to see how Drupal could enable me to make a better, more dynamic site than an earlier static, Dreamweaver-derived site; it was also partly to test the 'freemium' model, (without my having heard that term until I read Dries's post!)

I would like very much to agree with Joe Bachana that "peoples' good nature will lead them to reach into their wallets in gratitude and awareness that good things take resources to create and support". We'll see! I suspect there are several factors that need to come together appropriately to make the freemium model work. In my case, the list would include:

  • Quantity: Is the scope of the content of the service broad enough that a large enough pool of potential users exists?
  • Quality of Content: Is the perceived value of the free service sufficiently high to attract enough users from the pool?
  • Quality of Delivery: Am I reaching that pool of people where enough will choose the premium (paid) services?
  • Duration: Can I maintain the service long enough to reach the 'tipping point' when it begins to pay for itself?

There are clearly other factors at play, but that's a start.

Charles Frean

Posted on by charlesfrean (not verified).

"Why $0.00 Is the Future of Business"

This article by Chris Anderson, editor in chief of "Wired", on why the future of things is “Free” may be of interest. It mentions Fred Wilson's "Freemium" article.

He states "we are entering an era when free will be seen as the norm, not an anomaly ... a generation raised on the free Web is coming of age, and they will find entirely new ways to embrace waste, transforming the world in the process. Because free is what you want — and free, increasingly, is what you're going to get."