For Freemium to work, it comes down to the numbers and that starts with a massive addressable market.
There continues to be interest in what companies like Evernote are doing with Freemium and how they are making a lot of money with the majority of their userbase not paying a dime. Lets be very clear here; Evernote has found a strategy that works well for them. One of the keys to the Freemium marketing tactic working for Evernote is that it has a very large potential audience; essentially anyone in the world with any sort of device connected to the Internet is a potential user. That is much different than the new tool you created for the Health Club industry in the United States.
On the flip side, Ning, a very well-funded company with another very large potential audience, announced this week that they will kill the free version of their service because, well, they weren't making any money from the free users. Why? It could have been that they gave too much away for free or even more likely: they attracted the wrong audience. Ning likely had millions of "owners" of various "social networks" that created those networks without ever intending to 1) use them or 2) pay anything. So much for the theory that free users are a large pool of potential customers, right? So now Ning is going to focus on something businesses for centuries have traditionally sought... paying customers.
So what does this mean for the "Freemium model?" Like most marketing tactics, some will find success with it and others will fail miserably. If you understand that it is simply a marketing ploy and don't build your "business" around Freemium, when it doesn't work, you will be in a better position to recover. If you spend all of your time, money, and resources up front attempting to collect some "critical mass" of users thinking that you'll convert them later when you "turn on the revenue tap" you might have a big, negative surprise waiting for you.
Something that I presented at the Freemium Summit that seemed to be very popular was what I called my "back of the napkin" formula for figuring out if you have a large enough market for Freemium to work. Essentially it says, are there enough people/companies/potential users of my app for the "numbers game" that is Freemium to work. If not, then Freemium is not for me. You don't even need a fancy calculator for this one.
The formula is dead simple and until now was buried in the slide deck from the Freemium Summit. Since the brief renewed interest in Freemium this week, and the fact that I've seen some people talk about the formula, I thought I would extract it from the deck and talk about it here.
The Formula is simple:
Here is the example that we'll break down below:
Lets look at each element:
Addressable Market: Anyone who might potentially be interested in what you have to offer. To be realistic you should consider actual companies and/or users in this number and not the monetary size of the market. I used the Health Club industry above and in the slide deck so we'll stick with that. In the United States, there are 30,000 health clubs according to an Industry Association.
Reach %: In the context of SaaS or Web Apps, we'll say this is the percentage of the market that you can actually attract to your website. We'll use some amazingly generous numbers in our math so we can end up dealing with whole, positive numbers. We'll say you have some amazing Rock Star marketing folks who can get 30% of the market to your website, or 9,000 health clubs.
Sign-Up %: Of the 30% of the market that you were able to attract to your website, you get your even-more-Rock Star conversion queen to work on the problem of getting them to sign-up for the "Free" part of your Freemium offering. Sure enough, she pulls it off and gets you a sign-up rate of 4,500 health clubs. This is truly amazing.
3%: This is the average rate of conversion from Free to Premium for SaaS or B2B Web Apps. You can replace this with whatever number you want, but just keep in mind that 3% is average in B2B SaaS & Web Apps; some do better but many also do worse. This is backed-up by recent research from Softletter.
Potential Paying Customers from Freemium: So the answer is, after all of that hard work of getting 30% of the market to visit your site and 50% of those to sign-up for the free version, you are left with only 135 paying customers. 135.
From a Revenue Model standpoint, you need figure out how to:
1. Make a TON of money off of the converted 135
2. Monetize your 4365 free users (through the other 6 Revenue Streams)
From a Marketing / Business Strategy standpoint, you need to figure out:
1. If you are giving away too much for free (no reason to convert)
2. If you are attracting the wrong users (who will never pay) and if so, why
3. If your users think your product is terrible and are just using it until something better comes along and will never pay you a dime
But overall, the reality of getting 30% of the market to your site and 50% of those to sign-up is a long shot and shows how unrealistic the notion of Freemium is for small industries or niche products. As I said at the Freemium Summit, in these markets, your best bet is to:
Freemium Works better for "narrow band" horizontal products that solve a very specific business problem across all verticals, can leverage a land and expand strategy, can be pulled into a company by the individual users, etc. Think of companies like ThreadBox, Yammer, Xobni, Box.net, and YouSendit.
These products literally have every business as their possible customers. They have a big enough addressable market to make the formula work, even with realistic reach and sign-up percentages.
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