My Favorite Business Model

Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc, then offer premium priced value added services or an enhanced version of your service to your customer base.

Examples:

Skype – basic in network voice is free, out of network calling is a premium service

Flickr – a handful of pictures a month is free, heavy users convert to Pro

Trillian – the basic service is free, but there is paid version that is full featured

Newsgator – the web reader is free. If you want to synch with outlook and your mobile phone, that’s a paid service

Box.net – you get 1gb of virtual storage for free, but you have to pay for more than that

Webroot – you can get a free spyware scan, but for full protection you need to pay

This business model has been around for a long time.  Shareware always used a model like this and there are many successful software companies that have been built with this model.

It works even better with web native services.  A customer is only a click away and if you can convert them without forcing them into a price/value decision you can build a customer base fairly rapidly and efficiently.  It is important that you require as little as possible in the initial customer acquisition process.  Asking for a credit card even though you won’t charge anything to it is not a good idea. Even forced registration is a bad idea.  You’ll want to do some of this sort of thing once you’ve acquired the customer but not in the initial interaction.

Don’t require any downloads to start.  Don’t require plugins.  Support every browser with any material market share. Make sure your service works on various flavors of Windows, OSX, and Linux.  In short, eliminate all barriers to the initial customer acquisition.

And make sure that whatever the customer gets day one for free, they are always going to get for free.  Nothing is more irritating to a potential customer than a “bait and switch” or a retrade of the value proposition.

The best examples of this business model are when the customer implicitly understands why the paid service has to cost money.  More storage costs for photos or virtual storage are good examples. Termination costs on other carriers networks in the Skype model are another.  When it is just additional features that don’t carry an incremental cost to offer, it may be harder to convert free users to paid users. But if your free service is loved and you do a good job articulating the value that comes with the paid service, you can convert to paying users with good results.

I would like to have a name for this business model.  We’ve got words like subscription, ad supported, license, and ASP, that are well understood.  Do we have a word for this business model?  If so, I don’t know it.

Comments

[kosso]

spot on. and I love the word 'freemium'!

[Michael Parekh]

I think Freemium wins.

[Arantius]

I believe the word for this business practice is loss-leader.

[Charlie]

Free++ (free-plus-plus)?

[Pankaj Kumar]

How about calling it "Web 2.0 Model"!

[cityhippy]

Funnily enough I am leading a team launching a web service in June that pretty much follows the model you outline above.

What would I call this model...? I guess we think of it as the 'community-led' model meaning that we are going to build a service/tool for a community and then add in relevant (and potentially community-led) value-add premium services for those that wish to use them.

One similar example you missed is Ebay. Let people sell stuff for a tiny cost and then add in premium services for those that need 'em.

If its good enough for eBay then it's good enough for me.

Namaste

Al

[Hooman Radfar]

How about "Digital Foot-in-the-Door?"

See post:

http://hoo-ville.blogspot.com/2006/03/classic-web-20-business-model.html#links

[Rishi Khaitan]

I agree, this model is time tested and has been proven effective in a variety of businesses.

Isn't this model implied by the term "Premium Services". Offer a free service, hook the user by fulfilling a need (and ideally make the cost of switching to a competitor high), and then upsell premium services.

If you want to be picky I suppose you could call this model "premium services upsell". I'm pretty sure any that hasn't had their head in the sand for the past 20 years will understand what is meant by that.

[Tom Blossom]

What is your favorite model for selling services and/or software to businesses and not consumers? I think there is too much focus on the consumer market when people talk about internet services.

[Nik Cubrilovic]

Great tips Fred - this is by far the most common model at the moment, the problem sometimes is that companies make products free without a clear plan as to what they will do from that point. Also this model has set the mindset in most people that common utilities on the web should all be free - so it does have a broader impact.

This is a 'loss leader' strategy as somebody mentioned, because you are selling a product at below-cost (ie. free) to attract sales in profitable areas. The differential (free - cost) is part of your customer acquisition cost.

Attempting to monetize only part of that free user base as opposed to all of it is also more effective. I would like to hear more from others about conversion ratios in common apps - I think 4%+ is excellent.

In planning financials and forecasts you need to look at a potential conversion ratio, if you estimate 5%, then your real cost of customer acquisition is 20x the cost of a free account. Add to that the costs in getting the free customers in (it is never zero, there is always at least some effort).

I think a lot of companies fail because they don't think this through.

[Mike P.]

My suggestion:

"Build the Skill/Bill the Skilled"

Enjoy your blog.

[Olifante]

Differential? Upgradable? Pay some money for more things, get your kicks for free?

[Pete Cashmore]

One more vote for Freemium.

[Peter Cranstone]

Here's the first problem - building something "good enough" but not too good. Anybody will use free, getting a premium requires something special... and usually it's 1% or less than the current userbase.

[Rick Burnes]

I'm sold on freemium, but I have two questions:

1) The way you've described freemium it seems like Times Select = A Big Freemium Experiment. Yet you're not a big TS fan. (Who is?) Does freemium work for content? Why does it make sense to wall off network calling on Skype, but not Nick Kristoff's columns?

2) How do the numbers work for the six examples you cite? Does the 'mium' pay for the 'free'?

[ron k jeffries]

I love Jim GRovernor's FREEMIUM term.
http://blog.eronj.com/2006/03/23/freemium/

[Ivan Pope]

You say 'The best examples of this business model are when the customer implicitly understands why the paid service has to cost money.'
I'm not sure this is really the case. I would guess the trick is to understand the exact point at which a wonderful free service just gets better with an easy to handle subscription rate. Thus, I get to use and love the service, and I convince myself that if I just had those extra features/bandwidth/ability it would be so much better. So I pay up. Am I right? Doesn't really matter, because I love the service, It's almost a self fulfilling prophecy. I upgraded my Flickr account because, well, just because I liked the idea of having that little 'Pro' logo next to my name. Sometimes it's no more complex than that, it appealed to my vanity!

[Giordano]

I alway think of it as "drug dealer" or "mouse trap" model. Here, smell the tasty, free cheese (give us your data, move your activities on the system). Ops, now you're stuck :)

[Patrick Dodd]

My vote is for Freemium as well. I'm about 2 months away from launching my own Freemium service and its nice to see this business model validated on your site.

As an aside, your photos of Sun Valley brought back some great memories. I've spent a lot of great days there. Some of the best skiing in the world IMHO.

[Dan Entin]

Two comments:

1. While I think you did a great job of explaining this business model I don't understand WHY it's your favorite? Is it because it has big upside? is low risk? is consumer-friendly? is easy to execute? Etc.

2. I don't disagree that it's a good business model in theory but also very curious to know how financially successul this has been for the above-mentioned companies/products. Two other recent internet services to consider in this group are Plaxo and LinkedIn - the latter has done a better job of creating a compelling premium offering.

[Brian Puckett]

Freemium has a nice ring but bit off in the description. Sounds like there is a minimum to amount that is free.

I prefer staight forward freeorfee model as there is no ambiguity; both free and fee are included with equal emphasis.

[Jeff Jarvis]

works in services, not content, i'd say.

[Maria Palma]

I can't think of a name off the top of my head, but I can say that everyone does love that word: "Free". It's the magic word in advertising.

[ospimato]

I like "Freemium"

[护士出国]

护士要出国,
到这里来宣传一下.