What do Pandora, Dropbox, The New York Times, Flickr, Hulu, Evernote, Angry Birds and Farmville have in common? They use a “freemium” business model. You may not have heard the term before, but you and your kids deal with it as part of your Internet experience.
Many web startups concentrate on becoming popular without a lot of thought as to how the resulting product can be monetized. This lack of a clear business vision as they built traffic to their site has been true of such notable sites as YouTube, Twitter, Facebook and others. After all, with a lot of visitors and engagement, advertising could always be used as a way to generate income.
You can’t really argue with this approach. Just look at the success and valuation of these sites. Google bought YouTube which was unprofitable for $1.65 billion in 2006. Internet users have accepted advertising as the cost of being able to access free content on the Internet. This approach has been the foundation of Internet growth.
This strategy allows the site owner to concentrate on getting traffic by providing good content and a good user experience. With today’s Internet, good sites get found through word of mouth, review sites, etc.
The other, long standing, Internet business model has been the subscription-based approach. Users pay a monthly or annual fee to access services or content. Subscription sites may have different subscription plans with increased access or features with higher cost subscription plans.
This approach has typically been used for more specialized content or products that users require and are more willing to pay for them. Symantec (virus detection) and Rhapsody (music) are examples of such services. In fact, many organizations that once sold their software products have turned to subscription-based licensing. Recurring revenue is a lot better than selling the product once. This model does require a lot of resources for marketing and takes a lot of time to build up a user base.
A third business model for Internet services and software exists. It’s been around for more than 20 years, but is now being adopted by many businesses. The concept is a basic, free application supplemented by a feature-rich subscription-based premium version. This “Free plus Premium” business model has been termed the “freemium” model which is an amalgamation of the “free” and “premium” terms. The power of “free” is at work with this model. See my post on the subject of "free" listed under “Related Posts.”
There are a number of freemium models. One is a simple combination of the advertiser and subscription business models. The “free” core service is advertiser-supported. The premium, subscription-based service eliminates the advertising and may or may not offer additional functionality. Pandora is an example of such a freemium service.
Other freemium services restrict the amount of “access” you have in the basic service. Dropbox and The New York Times are examples of this approach. The New York Times restricts access to a certain volume of stories while Dropbox restricts the amount of storage space available in their free, core versions.
Others offer improved features and functionality as what differentiates the free services from the premium service. Flickr is an example of such an approach with the ability to store and share users photo collections online as the premium, subscription-based feature.
The rapid acceptance of mobile devices and apps has led to an explosion of apps using the freemium business model. Game apps are a major case in point. While the game may be free, virtual goods or additional characters, features, etc. come with a price.
The New York Times reports that according to Flurry, 65% of App Store revenue comes from freemium games! This approach has even led to a class-action lawsuit against Apple by parents whose kids incurred hundreds of dollars of charges without their knowledge. This occurs because, once you provide your password to the App Store, there is a 15 minute window where one can purchase apps or features without having to reenter the password.
The takeaway is don’t hand your mobile device to someone else until 15 minutes have elapsed since you last logged into the App Store.
Those businesses that use freemium effectively do not spend a lot of dollars on advertising. They depend on viral spread of their product and can make a strong revenue stream and business case with subscription-based levels of less than one percent of total users. After all, one percent of a large number is still a large number.
What used to be a foolhardy approach to a business model (free services and low rates of subscriptions) is now a popular Internet business model. By taking advantage of the relatively low costs of today’s technology along with letting others promote the products, freemium products are thriving.
The rapid adoption of mobile devices is pressuring advertising-supported sites. The freemium business model appears to be an answer to this change for many companies.