Business Software and the Freemium Business Model

As a previous post indicates, I am a fan of the freemium business model and I believe it is an customer acquisition strategy worth considering for start-ups, not just in the Web consumer services world but even for those developing business software. Yesterday, however, I had an epiphany in terms of what type of business software offerings it may -- or may not -- be suited for.

Until yesterday, I was of the mindset that the freemium business model could be applied to most business software offerings and it was a matter of coming up with the right packaging to determine which features should be offered for free and which should be offered as premium, for-pay features. I am now of a different mindset.

In the business software world, I think the freemium business model is ideal for the following use cases:

• Offerings that are targeted at an individual and where no organizational decision making is required to decide whether to use the offering or not. LinkedIn is a good example of this.
• Offerings that involve small workgroups and where its initial usage is not part of a business-critical workflow (i.e., its usage does not require high-level authorization within an organization). Wikis, I believe, are a good example of this type of offering. Within organizations, wikis can initially be used by small groups of people for purposes that are not business critical.

Perhaps more importantly, I think the freemium business model is NOT ideal for offerings that are a part of business-critical processes and require high-level authorization within an organization. Organizations are leery of using a "free" solution for an important function. For this type of use case, I believe the "try before you buy" approach used by companies like Salesforce.com are more appropriate.

Marketing and Sales in a Freemium World

I am currently consulting to a couple different start-ups (Pathworks Software and Radar Networks) and they are both planning to enter the market with a freemium type of business model. A term coined by Fred Wilson, Wikipedia defines "freemium business model" as:

The freemium business model works by offering basic services for free, while charging a premium for advanced or special features. The word freemium is a portmanteau created by combining the two aspects of the business model: free + premium. The business model has gained popularity with Web 2.0 companies

In the business world (versus the consumer world), LinkedIn is a great example of a freemium service. Users can use many of LinkedIn's features for free but if you want to take advantage of premium features, like posting a job opening, you need to pay a subscription fee.

From my perspective, the freemium model is very similar to the open source model and is an effective method for start-ups to build their user base; however, the model also forces marketing and sales organizations -- especially those who are used to enterprise selling -- to rethink how they run their functions. In particular...

• The freemium model moves the "sales funnel" into the service being offered.
• The marketing function can now be measured in a quantiative manner.
• The sales function becomes transaction oriented, rather than relationship oriented.

Let me expand on each of these points.

The "Sales Funnel" Moves Into the Service

With any sales funnel, there are multiple steps a prospect takes before becoming a paying customer. Historically, marketing was responsible for part of the funnel (generating qualified leads) and sales was responsible for part of it (closing the deal).

With a freemium offering, the service itself plays a role in the sales funnel. As users use the free version, the service must move them through the sales funnel and entice them to pay for premium features. For this to be effective, the service must include "features" that highlight the premium features.

For example, if you providing an online document management service, one of the premium features might be extra storage. If that is the case, the amount of storage a "free" user is using should always be highlighted and as the user approaches their maximum "free" allotment, visual cues should be provided that encourages the user to sign up and pay for additional storage.

The Marketing Function Can Be Measured Quantiatively

Anybody who has been in the marketing function at a technology company has heard all of the lines -- "how do you justify that marketing budget?", "you are just overhead". It goes on and on. To some extent, it is difficult to argue against some of the underlying messages. In the past, it has been very difficult to quantitatively measure the effectiveness of marketing. Sure, there are some elements that can be easily measured (direct marketing being a good example) but it is difficult to do so for many of the functions within marketing (PR is a good example).

In a freemium model, the entire sales funnel, and therefore the marketing function, can be quantifiably measured. The number of people who visit the website, the number of website visitors who signup for the free service, the number of free users who become paid users. These are all metrics that marketing can greatly effect, and should be held accountable for.

In fact, when taking this metrics-based approach to measuring marketing, I would encourage marketing executives to take a fresh look at how they organize their department. I propose there should be one person (or group) held accountable for each of the metrics.

The Sales Function Becomes Transaction Oriented

The tone of this post thus far could lead a person into thinking that the sales function is no longer needed with the freemium model. That is not the case. The purchase decision making for any service used by a group of users is still an organizational one and it still requires some prodding. I believe, however, that the freemium model dictates a difference in how the sales function should be managed.

Unlike the direct sales model where reps are selling six-figure deals into enterprises by using a relationship-based selling approach, the freemium model encourages much more of an inside sales, transaction-oriented approach. Typically in a freemium model, the size of the early, seeding transactions tend to be small and cannot justify the expenses associated with direct sales. Over time, as a company grows and starts selling larger deals, direct sales can be layered into the sales function.

Summary

The use of the freemium business model is an exciting development in the technology market. It requires a different mindset across an entire company but particularly in the marketing and sales functions. Those organizations who can adopt the new mindset effectively will be ahead of those who remain stuck in the old mindset.