Thoughts on Free Powered Business Models and Why Time Beats Features

I spend a lot of time thinking about what it means to offer products that are free or basically free to users on the web. I try not to get religious about free – there’s nothing inherently right or wrong about choosing a business model that incorporates a free component so long as you understand what you’re getting yourself into and have a plan for how to make up the revenue somewhere.

With so many social media companies rushing to discover and implement a business model that will work for their service and community, I think the discussion of free sometimes gets convoluted. I think there are some really important distinctions between a model that incorporates a perpetually free version with a premium upgrade and a model where there is one (or few) offerings that users can fully enjoy for some period of time before having to make the pay vs not pay decision.

I want to make the case for more companies tinkering around with the “free trial” approach as opposed to the model focused on a neutered version of the paid product being offered for free with the hope of eventual upgrades.

I can think of two sensible ways to offer a free web product whose ultimate aim is not to be ad-supported:

1. Perpetually Free with a Paid Upgrade Option – Under this model, you build a product that has a perpetually free version that is a degraded version of the paid product. The onus is on the company to properly delineate the free and paid offering such that the basic offering is sufficiently useful to the free audience and the premium offering is sufficiently valuable to those who choose to pay.

2. Free Trial with Pay or Quit Option – Under this model, you build a product where the user can consume the full version of the product but only for a limited period of time. At the end of the trial, the consumer must decide whether or not he/she likes the service enough to continue paying for it.

For now we will ignore a more nuanced approach that blends both of the generic strategies above.

There are a lot of social media people today who are trying to figure out a freemium model for their product or service. We’re already seeing models that combine a perpetually free offering with a paid upgrade option work pretty well in the free-to-play gaming space (you can see my earlier post on virtual goods in the United States as a reference). As a basic rule, I think freemium can work really well for products in which the free and paying users can peacefully coexist or where having more people engaged using the service actually makes it more useful for paying and free users. It’s still worth noting that the “free trial” approach in gaming still generates a lot of money (see World of Warcraft or any other successful subscription MMO).

There are a few things about the perpetually free with a paid upgrade approach that I think are worth considering before heading down this path:

It is very difficult to properly segment users and features such that you provide enough value to both paid and free audiences. For example, an email service that provided a 10 MB of storage for free and 1 GB for the paid version would have a hard time surviving – the basic offering isn’t sufficiently compelling to get people in the door. Conversely, a service that offered 2 GB for free and 10 GB for the premium service might be giving away too much value in the free product to expect a large audience of people to upgrade. And that’s just one product dimension. Adding more dimensions just makes it that much more difficult to figure out the features for which users would be willing to pay.

Going with a free trial can be much simpler. You offer one product that users can fully consume for some period of time before they have to decide whether or not they want to pay for the product. It’s more important to figure out how much time a user needs to experience your product before he / she is ready to make a purchase decision rather than which features should be exposed to paying users vs free users.

Offering a perpetually-free product is a framing event for your customers. Offering a product free with no prospect of a paid offering can be a sticky decision. Customers begin to think of your offering as free and attempts to introduce paid offerings can rile the community. It doesn’t match with what customers thought they were getting into when they signed up for the service.

Introducing any kind of monetization can generate backlash within a community. But the longer the ethos of free is allowed to become an expectation within your customers, the more difficult that conversation can be. I think it’s a much easier conversation to have with customers when you’re explicit up front with the fact that at some point they will have to make a decision as to whether or not the product is sufficiently valuable to warrant payment.

Price is a signal and there is value in sorting between customers who you can afford to keep and those who you cannot.For customers for whom your service is not sufficiently compelling at the price point you’ve offered, you have an opportunity to tweak the offering. If people aren’t biting at the price you’re charging, that’s a meaningful market signal. And that’s information that’s better learned sooner rather than later.

Under the free trial model, it seems to me that testing alternative hypotheses is easier. You have the features you have and all users get to use them. You can increase the length of the trial, decrease the price, or do both. But what you don’t have to do is to go back through your segmentation of features and figure out if you sorted properly.

At the end of the day, I think it’s good to figure out whether the business model you have in mind works. The sooner you find it out, the smaller the stakes and the more time you have to fix it.

  • http://www.facebook.com/profile.php?id=690068237 Brian Hayashi

    Great thinking on the freemium business model.

    I'm reminded of the old adage on learning to fail fast. The Internet allows us to do an incredible amount of market research in literally hours, allowing us to determine whether our assumptions are valid or not. Of course, all of the market research in the world won't save a business manager who willfully sees things the way they want to see it, facts be damned.

    Most web services are based on capturing a lion's share of a certain type of user interaction, such as taking mobile photos of travel destinations or entering reviews about popular recipes.

    The Forrester social market profile data, available free, helps web entrepreneurs compare their assumptions against validated user behavior. This allows them to construct the most elegant offering by ensuring the freemium offering meets the key needs of their most important user group. The Forrester tool enables businesses to determine how likely their targeted demographic will engage in the desired behavior. For example, if your service depends on seniors that chat while playing videogames at the same time, you might have a tougher time.

    http://www.forrester.com/Groundswell/profile_to

  • http://www.charleshudson.net chudson

    Hi Brian,

    Thanks for the kind words. I'm a big believer in failing fast – it either helps people figure out which of their assumptions weren't true or to move on to something else where they are likely to be more successful.

  • http://www.facebook.com/profile.php?id=639480676 Nabeel Hyatt

    Charles, great points and I can understand why you advocate using a Free Trial mode versus separating by features. However, as soon as the trial is over a Free Trial mode inevitably turns away a large set of users which would never pay you. Most would say that's a good thing, except that a well architected dual currency model is designed to get around that.

    This isn't the right space to go into the vagaries of dual currency, Daniel James, Matt Mihaly and others have spoken well on the subject, but essentially by allowing for a currency more or less tied to time spent, and another tied to dollars spent, and floating the exchange, you enable your entire user base to be more or less monetized without having to barrier off some large set of the users.

    Just a thought, keep up the great posts.

  • http://www.charleshudson.net chudson

    Hey Nabeel,

    Yes, I agree that for games, the FTP model allows you to do things along the lines of what Matt and Daniel are already doing. And it's clear that the subscription paywall does restrict the audience for games and that you can radically expand reach by making a game free.

    What I'm struggling with, however, is whether there is an FTP equivalent for non-entertainment web products. I haven't come up with the dual-currency silver bullet equivalent for web products that are not games.

  • vpatel

    Another advantage to the free trial model is that it helps create focus for a startup by cutting down on noise generated by users who will never convert.

  • http://kissmetrics.com Hiten Shah

    Speaking from experience with Crazy Egg (a non-game web product), we recently removed our “free” plan all together and implemented a “30 day money back guarantee” on all of our plans. We attempted this because we were unhappy with our conversions from free to paid, so we figured that our free plan was a bit too generous. The change led to a significant decrease in the number of daily sign ups and a dramatic increase in revenue. We are now toying with the idea of providing a free trial for some of our future products. I think there is a lot to explore and test here and agree that businesses should consider trying free trials over perpetual free plans.

  • http://www.charleshudson.net chudson

    Hiten,

    Thanks for the real world example. Your experience matches what I would expect to happen – some users will never cross the “penny hurdle” and I'm glad to hear that making that change worked for you.

  • http://500hats.typepad.com davemc500hats

    nabeel or charles, can you link to the other articles referencing “dual currency” models? i'll also search for them myself… sounds interesting.

  • http://500hats.typepad.com davemc500hats

    ok, never mind found it here on jeremy's LSVP blog:
    http://lsvp.wordpress.com/2008/02/06/using-dual

  • http://500hats.typepad.com davemc500hats

    other interesting related piece here:
    http://www.brokentoys.org/2008/09/25/how-to-sto

  • christof.lapd

    I used a free flickr account for quite a while till I got a paid account. When I had a full account for 30 days and had to make the descission after this time I wouldn't have got a pro account. So I think #1 this is the better option (For my personal use)

  • pwb

    Emphatic disagreement. Free trials are completely lame. When trying out a product, no one needs the full version. It is actually very easy to delineate free/paid feature sets. It's silly to think the free version is a degraded version of the paid version. If you can get traction with a free service, the features that people will pay for will become obvious. The moment you ask someone to take out their credit card, 99% of the people are gone.

  • http://www.charleshudson.net chudson

    It looks like we'll have to agree to disagree, then. I don't think all free trials are lame – they give you a good sense for what the product is, how it works, and whether or not it's worth paying for. My real concern, though, is that I've seen relatively few companies who are skilled at converting free users to paid users. If your goal is to build a big company with 90% free 10% paid pyramid as its structure, then there's a case for carrying free users. However, if you want to build a business with an opposite pyramid (a large share of paid users and a smaller tail of free users), I continue to have some questions as to the value of having a perpetually free offering as part of your plan.

  • http://wishli.st DHS

    Interesting post!

    Chris Anderson was on BBC Radio 4 recently discussing business models with a free aspect:
    http://www.bbc.co.uk/radio4/news/inbusiness/inb

  • http://ridgepartners.com Build a Business

    Good read. Very well put together. Good Luck!

  • Aswan

    Very interesting debate. It's a tough call as with the current investment climate, a lot of companies are being pushed to monetize ASAP. The Trial-to-Pay approach presents a problem to services still in BETA that are trying to beef up their analytics and collect enough usage data and feedback to make informed product improvements. Further, there's the issue of being able to demonstrate enough value in the trial term to compel users to convert. For sites with a more long-term value prop (say LinkedIn), this wouldn't fly – hence their freemium model. But then again, that doesn't seem to be going too well for them either. Eek.

  • http://www.charleshudson.net chudson

    Aswan,

    If you're in beta, I think it's probably a good idea to spend more time working on features while you hash out the business model. But you still need to think about life post-beta.

    As for LinkedIn, I think freemium is working well for them (I think it has more to do with audience segmentation – they charge the users who see value in paying for broad access and offer a good free version of the product to their general users. This makes sense because having the free users actually makes the service more valuable for those who are paying to access the network). They're doing 10s of millions of dollars in revenue, so they must be doing something right!

  • Aswan

    Agreed.

    I was always a little suspicious of LinkedIn's revenue though; I was under the impression that only a small fraction of users were paying and that (among other things) was the reason for the CEO swap. I certainly could be wrong. I am curious what their ad revenue looks like though.

  • http://Yolto.com Alex

    Dear Charles,

    The shareware model that you are describing and tend to favor proved to be THE MOST efficient for the software mass-distribution over the past decade. In my opinion it happened because it feels equally fair to the people in cash-based cultures and credit-based cultures.

    By the way, we created a group on LinkedIn lately fully devoted to Game Payments and distribution of digital and virtual goods. I sent you an inmail with an invitation there but probably you missed it. The group is here: http://www.linkedin.com/e/gis/1192457 That's exactly the type of topics we are discussing there, I thought you might be interested to join too.

    Regards

  • http://www.twitter.com/dremoran dremoran

    I think LinkedIn makes the bulk of its money from recruiters who want access to the userbase. The company poses a huge threat to executive search companies.

  • http://www.instigatorblog.com Ben Yoskovitz

    Charles – great post and interesting comments that follow. I think it's also important to understand a company's sales model and strategy in conjunction with the business model.

    If you find that sales are generated more successfully through a higher touch model (i.e. demos, etc.) then offering anything for free is a challenge, because you have to exert more energy to make a sale but the sale brings in $0. I think of http://www.hubspot.com as a good example. No free trials. No free version. And the sales process involves a demo. That's a high touch model where it would be silly to offer the product for free.

    So beyond just the business model and whether some form of freemium works, companies need to evaluate how they're going to market and sell the product as well, and understand how their market wants to be sold. That can impact the business / revenue model.

    (Incidentally, I found your site through http://www.startupcfo.ca where you left a comment.)

  • http://www.b-unique.ca/ Adrien O'Leary

    Hi Charles, as a freelance, I'm a big fan of 37signals products. They offer both a 30-day Free Trial and a free version for most of their solutions. I started using their contact management system – Highrise – in September with the free version. I knew from the beginning I would have to switch to the paid version when I would have added 250 contacts. That happened after 2 months. And I can tell you I didn't hesitate because I had the chance/time to use the software with all the features and it was perfect for me. So I believe there is always a similar way to offer both a free version and a full-features 30-day free trial.

  • http://www.charleshudson.net chudson

    Hi Adrien,

    I too use Highrise and I like it. I too started off with the free version, but I knew that I would have to upgrade pretty quickly. I think the 37Signals guys are probably some of the smartest when it comes to versioning.

    At the end of the day, though, I would have been just as happy starting with 1 month free of Highrise Solo edition as I was starting with the perpetually free version – it became clear to me fairly quickly that the product was worth the cost.

  • http://www.charleshudson.net chudson

    Hi Ben,

    Thanks for the comments and I appreciate you contributing to the discussion. I agree that this issue is pretty much moot when you have a high touch model. In those cases, it might make sense to have a free trial period to let the enterprise try out the product – many enterprise software companies do those. But a perpetually free version? Unless it's an open source product, that's a tough way to go with a direct sales model.

  • http://www.facebook.com/profile.php?id=604372773 Scott Fasser

    Hi Charles, excellent post. Question about using advertising as a lever for free vs premium. We're contemplating a product offering in which free includes ads and premium has no ads as the sole differentiator. I don't believe that is enough of a distinction, but my colleagues disagree. I realize it depends on how disruptive the ads are and what types of ads, etc. but I think a service level distinction would be more compelling.

    Your thoughts?

  • http://www.charleshudson.net chudson

    Hi Scott,

    I tend to agree with you – unless the ads are really obtrusive (which is an issue in and of itself), I've never been terribly convinced that removing ads as the primary value add can move the needle.

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  • http://www.rivalmap.com Andrew Holt

    I think the choice between free trial and free version (or both) depends entirely on the product and the target audience.

    If a product has features that clearly have value associated with them, yet it's possible for users to get a taste for the product without those features, then offering a free version can be logical. For instance, WordPress allows anyone to cretae a blog for free, but charges when it comes time to map the blog to a domain or customize the CSS. Any serious blogger will want, and be willing to pay for, those features. There is a clear upgrade path for a target audience, and their pricing has a correct (in my opinion) cost/value ratio.

    Free trials, on the other hand, can make a tremendous amount of sense if the target audience most likely has a budget for the product, but needs to be convinced either of the category (that they need *any* type of similar product) or your particular product. For enterprise software, it's almost a requirement that companies be allowed to try out applications as a part of the sales process. If the product offers real value, companies will be able to perceive the value within the time allotted and be more than happy to pay if the price is right. It's trickier when companies aren't yet convinced of the category value, but a good sales person can usually work through this during the free trial.

    Now, the trickiest situations usually arise when the target audience varies, and the product's total value won't necessarily present itself to the adopting user. BaseCamp falls within this category. Users can range from independent contractors and small startups to enterprise customers with big budgets, all of whom will need some time to use the product with their colleagues. BaseCamp's model works very well for them, since the upgrade to paid plans will only be required in two scenarios: 1) a consultant/contractor grows to more than 15 clients, by which point the product has presented a lot of value and a budget has been made available, or 2) the customers already has a large number of projects, and project management software will present immediate value once the group gets on board. So those that started free will upgrade when the time is right, and those that already need paid plans get the chance to try them for free, with no commitment. Those that have no reason to pay are not asked to do so.

    The price/value structure is definitely the trickiest part of planning a business, but once you figure out the “will pay for” features, choosing between a free trial, free version, or both, should be easy.

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  • http://www.charleshudson.net chudson

    Wow, thanks for the great comment!

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  • http://rafer.tumblr.com rafer

    edited down version of http://rafer.tumblr.com/post/308370414/1-perpet

    I find it fascinating how differently we approach freemiums. I don't find it to be at all a problem to “properly segment users and features such that you provide enough value to both paid and free audiences.” I think content people and commerce people see freemium opportunities in entirely different ways.

    You see the free version as the bastardized, “degraded” version” of the real, “paid product.”

    Instead, I want to support users for Love or Money. I see the premium version as a tax on the 2% to 5% of the user base that abuses the free service. Any freemium I work on is free first and premium after because I want volume. The broadest adoption net is one that offers value for participation and attention and values the free users beyond their likelihood of conversion.

    It’s not just an attitudinal shift. I think we also design our services and organizations differently. Most importantly, the 80/20 focus on earned media versus advertising is reversed. Earned media isn’t free, and it requires just as much forethought — and a completely different set of testing — as a great CPA plan.

  • http://www.charleshudson.net chudson

    Scott,

    I read your full post and your comment. I agree – it's hard to paint all freemium businesses with the same brush. I think there are two different cases:

    1. A product with mass-market appeal where you have enough reach / audience potential that a small, concentrated audience of buyers is enough to support the entire audience of non-payers without offering two different products. I would put the social gaming and free-to-play gaming spaces in this category. A small percentage of payers can carry the audience. There's one key thing to make this happen, though – there is no cap on what a “power payer” can spend. If you had a F2P game model where you capped what top spenders could spend, I'm not sure it would work.

    2. The second model is one where all / most paying customers pay the same price (a subscription or an a-la-carte consumption path where most people pay the same regardless of utility or consumption. These businesses are different. In that case, figuring out how to convert free users to paid customers when they're consuming key functions is a much different calculus.

    If you look at a lot of the big companies in freemium today, they fall into category #1. Allowing your whales to spend as much as they want to or can afford allows them to cover many more non-paying users. Under model #2, the balance between paying and non-paying customers is much more important as your paying users will deliver a fixed amount of revenue.

  • http://rafer.tumblr.com rafer

    Once again, we hold different world views. In my world your #2, is the first premium step, is pretty obvious to figure out what should be taxed, though price can be very tricky. After the simple premium is well established (and the enterprise is likely at least CFBE), a _hopefully_though_not_necessarily_ variable superpremium should be introduced to the mix.

    At some unpredictable point along this progression, sales of a proprietary ad unit — and hopefully also a proprietary advertorial unit — work well.

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  • http://www.sheeparcade.com Free Games

    Yes, like you have said before I think it’s good to figure out whether the business model that we have in mind works. Like right now I'm still figuring out which business models is the most suitable one for my product/

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  • abhitam

    I agree with Andrew. Freemium entirely depends on what the perceived value is. And whether to give a free trial or offer a free offering is not mutually exclusive. Take YouSendIt for example, we have a free offering that is restricted on what size of files you can send and some other features which provide certain basic value. Beyond that, if you need to use the product on a more regular basic (a.k.a. power user), you can try the Pro version for a limited time. If you like what you see, you can enroll in a subscription plan. If you don't, you always have a choice to move back to the Free version with a more limited feature set.
    And, in my experience, I have seen certain segments gravitate towards a certain offering. Enterprises have specific needs around having multiple seats or more power features and thus gravitate more towards free trials. On the other hand, more single seat users or individual sole proprietors may move between free and the lower priced SKU.

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