Part of the research that I am doing is to find out what type of experiences software companies have had in respect to pricing models as well as business models such as freemium. Wikipedia defines freemium as a “business that works by offering basic Web services, or basic downloadable digital product, for free, while charging a premium for advanced or special features”. Why wouldn’t one like this model?
There is a good paper on this topic written by Lincoln Murphy and his white paper The Reality of Freemium in SaaS. According to an article by Phil Wainewright, this freemium model has not had a good track record the past decade with many failed services or has faded away.
The concept of “free” has never really felt good to me, even with the many books that have been written about it such as Chris Anderson’s book Free: How Today’s Smartest Businesses Profit by Giving Something for Nothing.
The things that Mr. Wainewright advices in his article for not relying on a freemium model is as follows:
- Vendors do not invest in proper access controls: most services do not have multi-user access control to the application and this model does not fly in enterprises. Wainewrite gives a good example of MailChimp SaaS solution that he used for a recent EuroCloud UK collaboration effort. MailChimp does not give multiuser access to the account, whereby multi-user identity can’t be managed.
- The vendors do not invest in instrumentation: the vendors do not monitor usage patterns and services levels as there is no incentive to do it.
- There is no such thing as a free lunch: when have you run a business successfully without getting paid? I know, there are a few that have eventually been able to make some money, but that is a misnomer and not a norm.
- It restricts choice because only the big guys can survive: smaller companies can’t afford taking this route as big vendors with similar service can pretty much shut down the operations of the smaller vendors.
What we tend to forget is that smaller businesses without a sound revenue/business model can’t build its operations on the concept of “free”. Having done research in the SaaS field and compared it to the traditional software licensing model, I am becoming very skeptical that a company can be built of the scale that it needs to be to be able to survive in the long run without a considerable investment. In the past, in the traditional model, one could build a business by consulting during the days and programming during the night. In this model, one assumed that the software licensing fees would eventually pay off. In the SaaS model, it will take time until the company has revenue that keeps the lights on in the company without having to scramble for money.
Wainewright refers to venture capitalist Bill Gurney’s statement about Google’s announcement of free turn-by-turn navigation in tis Android mobile operating system as “less-than-free business model”. It can be disruptive, but the more users that use the “free” service get, the more spending the vendor has to do. I just recently read about the astronomical spending that YouTube has taken from Google due to its popularity. For anybody to be able to run YouTube kind of large-scale operation has to have deep pockets. Finally, the article claims that start-ups that want to achieve disruption have to have a 9 figure investment to be able to really scale. After having reviewed some pretty well known SaaS vendors and their financial statements, I no longer wonder why.
I have been evaluating SaaS pricing models for a long time. I think freemium can work if there is a very strong incentive to upgrade. I think monthly fees work okay but my favorite model is transactional pricing, which is difficult to implement but can be very lucrative.
Jussi Mononen says
You raise some good points, Petri, but I don’t think the picture is quite as simple as this.
You treat freemium as monolithic model, while e.g. Chris Anderson whom you refer to, divides freemium into more manageable submodels: Feature limited, Time Limited, Capacity limited, Seat limited, Customer Class Limited. This added granularity gives a more realistic view of freemium and also lets a potential freemium provider have more control over its own offering.
The four points raised by Phil Wainewright are interesting but perhaps not very rigorous.
Points #1 and #2 are really more about implementation failures than about failures of the underlying model.
Point #3 is really a circular argmument: free cannot be successful because free cannot be successful. Furthermore, the point overlooks the paid part of the business model: freemium is not about giving everything away for free.
And, finally, we come to point #4: big guys can shut out small guys. Yes, they can. Actually, they can do that despite the business model. Yet, there are companies out there like MySQL, 37 Signals, Dropbox, etc. that have quite successfully challenged some very big guys using some variety of freemium licensing.
Freemium is certainly no panacea, but I do not believe it is quite the dead end you seem to suggest, either.
Jussi Mononen says
One thing I forgot from my comment above: aren’t you in sort of a freemium business yourself, too? This blog being the free part and for-fee consultation being the mium part 😉
Jussi, thanks for the very good and valuable comments and you are very correct in our statements…. I think the point that I want to make is that you have to be very, very careful of how you position your company, the solution that you offer etc… I just read an interesting article yesterday from a SaaS company CEO that they had a Freemium model and the positive side was that they got good feedback for developmment, but the bad side was that they got users that were not exactly in their target group.
If you look at SaaS companies, specifically start-ups, they will have to get larger initial investment compared with the traditional models.. somewhere between 35 to 50% more… to cover the initial burnrate to get the solution implemented and the recurring revenue model happening…
And yes, Jussi, I have probably been in the Freemimum model quite a long time…. with books, advice etc.. so I guess none of us can really avoid it…
@Surge, I agree what you are saying about the upgrade path and I have done that myself in some cases such as http://www.librarything.com SaaS service etc… As long as the SaaS company understands the revenue model and get the right type of clientele… it is a business model as good as anything else…
Thanks for your comments!
Nice blog post. You are right in that it takes a lot of money in order to successfully scale a freemium model. Freemium does provide one advantage if you do not have money though. In today’s age of technology, it is very inexpensive to develop and launch a Web based company. Freemium allows money strapped entrepreneurs to test their ideas in the market and if the initial tests are successful, they can then seek funding. When they seek funding, it will become more apparent if they have a viable freemium business as VC’s will be able to quickly assess the business and the numbers.
Freemium has the ability to dramatically reduce the sales cycle – here’s a good article on the topic by David Skok, who is a VC himself.