I had the pleasure of joining Emergence Capital and a group of executives from some of its portfolio companies for dinner a couple of weeks ago. All of the companies are selling their products in the freemium model, and the dinner was an open discussion about the model and its many permutations. The discussion was spirited as often happens when you get a group of software executives together to talk business models, but also very engaging.
So what exactly is "freemium" anyway? I suppose it has some connection to the "free trial" model that is very common with SaaS applications, but it carries the idea of free to a different level (and as the CEO's of a freemium model company are quick to point out, is NOT like a free trial). The concept is to tier the product offerings and offer an "entry" level product with low barriers of entry (free). Besides the free product there are any number of enhanced products and/or features that the company tries to use as enticement to move to a paid edition. All of the freemium model companies had that much in common, but beyond that the details are very specific to the product, market and target customers. Noted VC (and EverNote investor) Fred Wilson talks about the model here.
The least complex freemium product offering usually involves 2 editions, free and premium. The free offering has enough of the feature set to provide customers with the genuine user experience but not enough features that some of (and hopefully a lot of) customers would not eventually feel the need for the premium product. The free version has to be as pain free as possible to encourage sign up, no long profiles to fill out and no credit card needed. Asking for more than basic customer information should wait until you have established the relationship and started to build some trust. Often the free product is ad supported as well, generating some revenue for the company, and possibly providing some additional incentive to move to the ad free premium edition. Companies using this simple version of freemium include popular note taking app EverNote, NewsGator, InsideView (an Emergence company, SaaS sales intelligence with 3 versions, free, Pro and Team), Box.net (storage / file sharing, 1 GB free, $ for more), Yammer (an Emergence Company, internal microblog, pay for administrative features) and social network LinkedIn. The model can be expanded beyond this simple 2 product tiers to include additional versions or even add ons like bandwidth, storage, etc.
The next permutation of freemium is what I'd call the viral extension model. The idea is to offer a product / service that has at its core a way to draw in new prospects as a part of its process. This method of gaining customer share was pioneered by Hotmail in the 1990's and is still used by Yahoo, gmail and others...basic is free, pay for more services like PoP access or more storage. Expansion comes from the free advertising that is on the bottom of every free email sent. A couple of the Emergence portfolio companies fall in this model, EchoSign (electronic signature and contract visibility, the contract is the viral vehicle) and Yousendit (just like the name implies, sending, receiving and tracking large files...the file is the viral vehicle of course).
The model has several benefits, most importantly lowering the cost of customer acquisition. The freemium companies are all cloud based products / services which provides an interesting benefit for the companies by making the variable cost go down as customer volume increases. This is very important in a business model where only a percentage of the total customer base is paying for the product. Conversion is of course key and the successful company is very focused on conversion metrics. They need to understand what creates the conversion event and when it generally occurs to manage the business and cash flow. Many of these companies see very high attrition rates for the free product but generally the attrition happens very early in the relationship. If a customer sticks around for very long (more than a month or so) the conversion opportunity is pretty good. Unfortunately though, at some point that conversion rate falls off. If you stay free for too long there's a much greater chance that you will not convert unless of course the conversion event is something like storage capacity or bandwidth.
There are some risks and detractors for the model as well. Conversion or more specifically lack of conversion, is the greatest risk. Finding the right balance between making the free offer compelling enough to acquire the customer but not rich enough that they never want to move up to a paid product is critical. And no bait and switch, what's free stays free, that's the quickest way to create a nasty customer backlash.
