Over the next 6 months I expect to see many of the Web 2.0 companies add a freemium model to their product in search of profitability. Will this model be the solution for the group of companies that have been focused on customer acquisition while delaying monetization?
The short answer is that Freemium is just a marketing tactic combined with a subscription business model. The free marketing tactic creates distribution, the premium subscription service makes the money. So, to reach profitability freemium requires a large user base that's inexpensive to support and converts well to a killer set of premium features. For many companies, freemium may not be enough. For these companies, take a lesson from players like Linkedin which have reached profitability by executing on 3+ different lines of business...each of which contribute equally to the bottom line.
Freemium Requires A Large Funnel that Converts Well
In a recent post by Don Dodge, he notes the following conversion rates at various startups employing a freemium model:
"The companies presenting at DealMaker Forum are seeing 1.5% to 5%, with most of them averaging around 3%. Doesn't sound like much but they are reaching tens of thousands of users...sometimes well over 100,000. Do the math. 100,000 free users convert to 3,000 paid users. They pay between $10 to $50 per user per month."
Lets use $10/month as an average premium user fee. For the 3,000 premium users that is $30K a month or $360K per year. A decent revenue stream for companies that typically have 3 to 5 employees.
But is it enough to reach profitability?
Can You Cover the Cost of the Non-Premium User?
This may sound elementary but freemium models are built on the assumption that premium users cover the costs of the non-premium users. Better do your math because not all web service costs are the same. Rich media streaming and storage add significant costs.
Building on the 3% conversion rate example above:
If it takes 32 free users to get 1 paying customer, you definitely can't ignore the costs. If it costs you about $2/year to support a customer, that means the 97,000 non-paying users are costing you $194K per year. That means you're making $166k per year (360K-194K). Barely enough to cover the salaries of the 3-5 folks working on the project.
Explore other Business Models Beyond Freemium
I personally like the freemium model as one type of revenue stream but I'd also be looking at exploring others to reach profitability. Take Linkedin for example. In a recent article in the New York Times, Linkedin discussed 3 of its revenue streams:
"LinkedIn will get only a quarter of its projected $100 million in revenue this year from ads. Other moneymakers include premium subscriptions, which let users directly contact any user on the site instead of requiring an introduction from another member.
A third source of revenue is recruitment tools that companies can use to find people who may not even be actively looking for new jobs. Companies pay to search for candidates with specific skills, and each day, they get new prospects as people who fit their criteria join LinkedIn.
LinkedIn is set to undergo a radical shift in strategy to find other sources of revenue. Instead of catering primarily to individual white-collar workers, the site will soon introduce new services aimed at companies."
Which business models are you focused on to reach profitability?