Box.net's co-founder Aaron Levie is something of a freemium evangelist. In September, his lecture at the Web 2.0 Expo in New York—titled "6 Reasons You'd Be Crazy Not To Give Your Software Out For Free"—detailed how his company embraced the model in 2006 and saw sales spike 1,822 percent within three years.
Despite the flashy moniker and such stunning results, the freemium formula is actually quite simple: give customers a basic product for free but charge them for extra features or services. It’s a natural progression from the age-old practices of giving away teasers, promotional material, and free trials. The idea is to spread a product to as many potential customers as possible so that some of them will come around to paying.
Before turning to freemium, Box.net had been a paid-only software service providing file storage online. But then Levie and his partner, Dylan Smith, decided they wanted to go after a bigger market. To do so, they started delivering a free version of their service, offering 1 GB of space with an option to upgrade to a 10 or 25 GB product with added features. The results came almost immediately: "The two months after the switch were the most profitable in the company's history," Levie said, signing up close to 500 times the amount of new users each month.
The success, to Levie and Smith, demonstrated that freemium wasn’t so much a sales strategy as it was a marketing tool. The free version spread naturally among users with basic needs—all the while exposing the product to businesses and high-need customers willing to pay. As long as Box.net had enough pay users, it could support a version scaled to the limited needs of its free ones.
But it’s the possibility of an excessive number of free users that worries freemium’s detractors. Inc. columnist and 37Signals founder Jason Fried recently wrote that the idea of giving away products is "truly insane," and that he'd much rather serve a smaller, pay-only customer base than a large, unwieldy—and possibly unprofitable—one. By taking on a massive amount of users, he writes, his company might not be able to sustain its level of quality and success.
Doing such a cost-benefit analysis is essential. And even if it doesn't make up a large portion of your business, done right, freemium can give your online marketing efforts a big boost. Here's how to make it work for you.
How to Make Freemium Work: Coordinate Your Team
While many like Levie have rushed to embrace freemium with open arms, its history remains a cautionary tale. The biggest problem companies run into is that they stake too much in freemium without coordinating all the parts of their business.
Take Helpstream, for example – the Silicon Valley software company that provided free customer relations applications. Even though freemium works for many software-as-a-service (SaaS) companies, it failed Helpstream because of a fundamental misunderstanding between marketing and sales. Helpstream's former CEO Bob Warfield acknowledged as much when he wrote on his personal blog, "Sales was not particularly interested in any of the goals the CEO had set forth," namely using freemium to spread sales. The sales staff contended the strategy was taking away commissions. What sales failed to realize, Warfield argued, was that even if it didn't make money initially, freemium could bring in a ton of potential customers.
Levie, despite his success with freemium, acknowledges what a tough sell it can be with a sales team. "On one hand sales will love you," he said during his presentation. "But on the other hand sales will hate you because you have to sell against something that people can use for free.” Indeed, Levie admitted in an interview that, “The No. 1 competitor we lose business to is our free product.”
With that in mind, you’ll need to clearly lay out the benefits to your sales team and make sure they’re on board.
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How to Make Freemium Work: Keep Support Costs in Check
When it comes to the product you give away for free, keeping costs down is obviously essential. Ideally, the only costs would be the initial money or time invested to create your product. That’s where technology and software companies have an advantage when it comes to freemium.
"The technology can exist and support itself," says Lincoln Murphy, founder and director of Sixteen Ventures, a Dallas-based firm that develops business strategies for SaaS and Web app companies. "The best strategy is to take a subset of your core product and make it free."
For Sixteen Ventures, Murphy realized his potential clientele were mostly Internet companies considering freemium and so he put together a 23-page digest called "The Reality of Freemium in SaaS.” In it, he explored both the benefits and pitfalls of the strategy. More importantly, it served as an entrée to the company's services. "It didn't take me long to write, since I had most of the research anyway," Murphy says. Soon the paper was getting tens of thousands of views and downloads online, in large part from his target customer base.
Murphy likens his tactic to accounting firms that offer tax preparation technology and services like 1099 forms for free to customers. Though such services cost very little, they create valuable interaction with potential customers.
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How to Make Freemium Work: Make a “Sticky” Product
For freemium to pay off, you need a market with a high number of users of which you can conceivably acquire a big share. That’s because you might only get one pay user for every 10 free users—though often the results aren't even that good.
"It can totally be leveraged by high potential companies," Levie says. He considered Box.net to have high potential because of its ability to spread within businesses willing to pay for more capacity and features. Employees used the free version to demonstrate the software's practicality and in the process won over the businesses themselves. This, Levie notes, allowed the product to "spread virally in ecosystems we normally wouldn't have attracted, such as energy and entertainment industries."
Levie also notes that scaling the strategy to meet the needs of that many users required a lot of research and funding. Like many other freemium start-ups, Box.net turned to venture capital investments to cover customer support and acquisition costs early on while pay customers staggered on board.
"We've spent a disproportionate amount of time and energy and resources on making sure our product worked perfectly and was super easy to use," Levie says. This served a dual purpose in reducing the support customers would need in the long run and overcoming the "friction" – often called the penny gap – in getting people to upgrade.
Ultimately, freemium comes down to designing "sticky" products. After it sticks, meaning the user has an ongoing need for the product, you can experiment to see what it takes to convert that person to the pay side. "You never really know until you get out there," says Scott Raney, a partner at Redpoint Ventures, a Silicon Valley venture capital firm that has invested in a number of online, freemium-based companies like Expensify and Scribd. Once you start embracing it, Raney says, you can tweak the numbers to figure out just how much you can give away and still drive conversion.
"It has to be easy for an end user to discover, understand, and implement on their own," Raney says. "If you do that, get them sucked into using, then there's a good chance you're going to be able to convert them into some form of paid user."
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How to Make Freemium Work: Don’t Give Away the Farm
At this point we've seen two different freemium options. There's the Box.net strategy that stratifies pay customers and free users, which requires you to go after a large market and likely needs a lot of funding and experimentation.
Then there's the less complicated second option used by Sixteen Ventures, which is little more than an online marketing strategy. It’s so simple that many companies may be practicing it without even knowing it. You offer a small subset of your products or services for free with the goal of attracting a pool of pay customers. This can take the form of a free trial, a "try before you buy," or even an advice pamphlet. But giving too much away, to the point where you can't sufficiently convert your free users, will only come back to hurt you.
"It's very tempting to make a quick buck early on, and then shoot yourself in the foot in the long run," Murphy says. In general, he advises start-up, bootstrapped companies to be leery of taking on freemium as a core strategy early in the game, because success varies from company to company and market to market. "It's human nature to follow people that are successful," he says. "It's not so intuitive to understand that they aren't an analog and not everything they do will work for you."
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