Wired Magazine

The concept of freemium has gained widespread acceptance amongst consumer-facing Web 2.0 companies, enabled by the low incremental cost of adding each new user. In an online and near-global market, a freemium approach to acquiring users can be a powerful and cost effective adjunct to more traditional sales and marketing processes. Anderson has discussed this topic before, notably in an article for Wired, and it will no doubt figure in his next book.

Wikipedia defines freemium simply, as;

“a business model which 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 and premium. The business model has gained popularity with Web 2.0 companies.”

In a useful ‘Taxonomy of Free’ in his Wired article, Anderson wrote;

“This term, coined by venture capitalist Fred Wilson, is the basis of the subscription model of media and is one of the most common Web business models. It can take a range of forms: varying tiers of content, from free to expensive, or a premium ‘pro’ version of some site or software with more features than the free version (think Flickr and the $25-a-year Flickr Pro).

Again, this sounds familiar. Isn’t it just the free sample model found everywhere from perfume counters to street corners? Yes, but with a pretty significant twist. The traditional free sample is the promotional candy bar handout or the diapers mailed to a new mother. Since these samples have real costs, the manufacturer gives away only a tiny quantity — hoping to hook consumers and stimulate demand for many more.

But for digital products, this ratio of free to paid is reversed. A typical online site follows the 1 Percent Rule — 1 percent of users support all the rest. In the freemium model, that means for every user who pays for the premium version of the site, 99 others get the basic free version. The reason this works is that the cost of serving the 99 percent is close enough to zero to call it nothing.”

Returning to his blog post, Anderson outlines four broad approaches that he feels best apply to this particular company’s situation;

1. Time limited (30 days free, then pay. This is the Salesforce model)
2. Feature limited (basic version free, more sophisticated version paid. This is the WordPress model)
3. Seat limited (can be used by up to some number of people for free, but more than that is paid. This is the Intuit QuickBooks model)
4. Customer type limited (small and young companies get it free, bigger and older companies pay. This is the model used by Microsoft’s BizSpark, where companies less than 3 years old and under $1 million in revenues get Microsoft’s business software free.)

Of these, he suggests a preference for 3 and 4, explaining that;

“They allow you to reach the largest potential market with the most useful product, and then convert the ones that are likely to be the best, most committed customers.”

For those used to the practices of consumer-facing companies such as Flickr, WordPress and others, Anderson’s recommendations may appear strange, but objectives, costs and opportunities are quite different when enticing business customers and his thinking reflects this. Commenting on the post, Ben Watson offers further useful insight from the perspective of a business user.

As an individual, I bring very different motivations to testing a new application than I might when fulfilling some corporate role. I am more inclined to play, and expending personal time playing with various possible solutions may well be perceived as ‘cheaper’ than buying in to a market leader. As an individual, too, I am often well placed to anticipate my own changing needs, and to compare those with premium features that purchasing a product would unlock. My free usage of the site is unlikely to be at volumes sufficient to incur significant cost for the provider, and may be largely offset by advertising revenue and any consumer evangelism in which I might indulge.

In the workplace, on the other hand, new products are often evaluated by putting them to work on a particular – real – task. Any trial has to be conducted with a product that is as close to the real thing as possible, and has to run for long enough to see the task through to completion; will the product do the job? Does it have training or support implications? In that context, the time- and feature-limited options that Anderson rejects are unlikely to entice the majority of prospective customers.

For the company seeking to apply freemium models in attracting business customers, though, the up-front costs are likely to be high. Trials may involve significant quantities of data and heavy use. More expensively, there may well be an expectation of (or requirement for) support in testing and integrating the product, and cautious businesses will doubtless look for something approaching an SLA before letting information onto distant servers over which they have no control.

Freemium can work in business as well as in the consumer space, but the calculations for viability will be very different and it’s unlikely to offset traditional marketing spend in quite the same way. Dan Farber noted the proportion of Salesforce revenue devoted to sales and marketing back in 2007, for example, writing;

“[Salesforce CEO Marc Benioff] addressed his company’s quest to reach a billion dollars in revenue and why he spends more than half of salesforce.com’s revenue, which was about $500 million for the year ending January 31, 2007, on sales and marketing. He responded … that a significant investment in worldwide marketing and distribution is required to meet demand.

…

In part, the big spend on sales and marketing is a remnant of his heritage, growing up professionally in Oracle with Larry Ellison. He apparently believes that to take on Oracle, SAP and Microsoft, you have to have a differentiated solution with clear benefits–in this case a pioneering on demand application and platform–and to spend on marketing and sales like his much bigger rivals. And we thought on demand software and Web 2.0 was more about self-service and word of mouth marketing–not if you want to go through  the front door of the Fortune 1000.”
(my emphasis)

What proportion of business customers need to pay in order to support those who are getting something for nothing? Is it even close to the 1% rule Anderson proposes in the consumer space? 

See also this video of Chris Anderson speaking at Nokia World last year.

Related articles by Zemanta

• Finding a Freemium model that works for you
• Chris Anderson Tells You A Thing or Two About the Long Tail and Free
• Exemplar or exception?

Facing the real prospect of significant disruption to the mid-range part of their business from the lower costs of relative newcomers Salesforce, NetSuite and others, it certainly made sense for SAP to ape Salesforce’s success and pursue a strategy that would see the German company able to offer their smaller customers a cheaper hosted solution, rather than continuing to rely exclusively upon the expensive purchase, installation and upkeep of hardware at customer sites.

However, as ZDNet’s Larry Dignan reported back in April, the company was forced to slow the roll-out of their Business ByDesign solution, and Phil Wainewright was quick to spot the opportunity that the company had handed to its competitors;

“By announcing its own SaaS product for the midmarket late last year, SAP put its stamp of approval on the on-demand model. Now that it has said customers will have to wait another year or more before they can buy it (due to scaling problems, no less), the company has created the worst of all worlds: it has validated a market and then vacated it, giving competitors a free run.”

So what went wrong, and are there broader lessons to learn from SAP’s mis-steps? As Vinnie Mirchandani notes, both Salesforce and NetSuite have been characteristically swift in publicly rubbing salt into wounds, and most companies would naturally be keen to avoid handing the competition such an easy target.

In a tightening economic climate, and with Dennis Howlett reporting customer disquiet at rising maintenance costs for SAP’s existing installed product base, the company must surely regret not having a good news story to tell about a product that requires no hardware or upgrade investment on the part of their customers. Zoli Erdos at CloudAve reports that NetSuite has jumped on this opportunity too, claiming a total cost of ownership comparable to 50% of just the annual maintenance component of SAP ownership. It’s worth noting that Dennis responds to Zoli’s post in the comments, describing the premise as;

“pure hubris and you know it.”

Unfortunately, and as SAP are discovering to their cost, moving an existing deployed software solution toward on-demand hosting is not simply a matter of moving the application from one data centre to another. Costs rise rapidly at the provider’s end, too, as they take on previously delegated costs for networking, power, maintenance and more. Software designed for single tenancy installation is either expensive in wasteful under-utilisation of numerous single tenancy servers, or technologically inefficient in the way that it operates across multiple tenancies and virtual machines. In either case, these new – and rising with every ‘successful’ sale – costs must be borne by the provider rather than the customer. Whilst SAP’s incremental costs in shipping each new software package to a customer site are very close to zero, every new SaaS tenancy brings costs that SAP must plan for and bear; space in a data centre, hardware, power, cooling, bandwidth, etc.  All too soon costs begin to spiral out of control, and if the economics are not carefully optimised ‘success’ runs the risk of very quickly becoming self-defeating.

Purely in terms of the corporate balance sheet, the shift from installing software to deploying it can be too painful to endure. Rather than a sizeable up-front license payment supplemented each and every year by an up-front annual maintenance charge and intermittently by hefty upgrade fees, software companies transitioning to provision of SaaS face the prospect of no more than a monthly or quarterly subscription payment. The ‘upgrade’ gravy train makes little sense in a SaaS environment, where customers have been led to expect continual incremental improvement. Even where customers could be persuaded of the value in some notional upgrade, the economics again become self-defeating as the software vendor rapidly finds themselves maintaining a plethora of legacy versions to their software and absorbing the resulting overheads in support, equipment partitioning and the rest.

That secret money machine of the enterprise software business – consultancy around implementation and customisation – is undermined by the Model T Ford plainness of much SaaS too, adding significantly to the woes of CFOs at traditional software companies who are trying to balance the books on a move to the Cloud. SaaS products today tend to target the low end, rather than competing head-to-head with the feature-bloated behemoths at the top of the software foodchain. The nature of SaaS products means that ‘trials’ are a couple of mouse clicks away. Even signing up to take the full product tends to be quick, painless, and priced at a point well within the budgets of middle managers and even individual professionals. Salesforce was one company to make significant headway in this fashion, infiltrating the enterprise via individuals with just enough budgetary authority to close the contract without having to negotiate the complexities of an ‘enterprise sale’ or compete directly with the incumbent system or the biases and politics of the C-suite.

Whilst perfectly capable of matching or exceeding the value of license and maintenance components over the long term, especially when the savings inherent in running a single version of the core software package in a controlled and manageable environment are taken into account, this retrospective trickle of utility rental funds requires a significant realignment of a company’s finances and metrics. All of an organisation’s carefully optimised profit and loss models need to be completely rethought, and tenets at the heart of the corporate DNA stand every chance of directly impeding any serious move toward a utility computing model where individual short-term margins will tend to be far tighter than before.

Although not directly addressing the utility computing market by name, the lessons in Clayton Christensen‘s The Innovator’s Dilemma and Innovator’s Solution are writ large here for all to see. What traditional provider of locally installed software can successfully cannibalise their own business and reimagine themselves fundamentally enough to succeed in the Cloud? SAP are certainly trying, but it’s not clear that they’re even close to succeeding.

The SaaS success stories tend to be SaaS from their foundation. Marc Benniof could not have produced Salesforce whilst at Oracle, and even Larry Ellison had to facilitate NetSuite at arm’s length to his main business.

Can traditional software providers ever make the transition, and are the major obstacles standing in their way technological or financial?

Recent advances in the business of Cloud Computing form just such a picture, and reach out to encompass previously unrelated aspects of Web 2.0, the Semantic Web, Platform Computing, Software as a Service (SaaS) and the economics of Disruption. Not merely some game of buzzword bingo on an unprecedented scale, it is becoming increasingly easy to see the opportunities for a significant shift in the way that we access computational resources; and to recognise that the walls separating organisations from their peers, their partners, their competitors and their customers will become ever-more permeable to the flow of data upon which those distant machines will compute.

There is much to understand that is already known in related fields, and much to discover that only becomes possible in this space. One early challenge is in carving a discrete niche for the place toward which we are moving with such rapidity. Far more than ‘just’ the Cloud; an evolution on from the playful flippancy that diminishes so many of Web 2.0′s poster children; and difficult to relate to the mainstream misconceptions of the Semantic Web’s complexity. Yet this new place is the sum of these parts, and far greater than they can ever be alone. So do we extend the already ephemeral notion of Cloud Computing? Do we appropriate the ‘next big thing’ label of Web 3.0? Or do we need a healthily fresh attitude to business computing’s apparently insatiable desire to apply labels?

First, though, let us consider the shape of this thing that is taking on more substance with each passing day.

Reporting on last week’s Web 2.0 Summit in San Francisco, CNET’s Dan Farber notes that

“The cloud was omnipresent,”

before going on to close his report with;

“cloud computing won’t be very compelling without what is variously called Web 3.0 or the Semantic Web.”

Indeed.

For too long, the emphasis in Cloud Computing circles has been almost exclusively upon provision of rapidly scalable and ad hoc remote computing on top of cost-effective commodity hardware. The Cloud play from Salesforce, Amazon’s EC2 and the rest has been dominated by the implicit assumption that these Cloud-based resources are an extension of the corporate data centre; a way to simply reduce the costs of enterprise computing.

There is value in this business, but there are bigger opportunities.

Nick Carr is amongst those to fear that a small number of players may come to dominate the provision of Cloud resources. He outlines many of these arguments in his latest book, The Big Switch, and more recently has been involved in an interesting discussion with Tim O’Reilly on the topic. Justin Leavesley shares some of Talis‘ views on the economics behind all this over on Nodalities, broadly agreeing with Tim O’Reilly;

“It’s pretty clear that utility cloud computing is highly capital intensive so it should come as no surprise that there are powerful economies of scale to be had. But the bottom line is that you are talking about plant and power. These are rival goods, scarce resources that are created and consumed. This is not different from many utility industries with one exception: the distribution network has global reach, already exists and is very cheap compared to existing utility distribution networks. It is a lot cheaper to access a computing resource on the other side of the planet than it is to send electricity or gas across the globe… [So] what is to stop economies of scale turning this into a global natural monopoly?

Actually, unless there are some large network effects, quite a lot stops single companies ruling entire industries. For a start, without network effects, economies of scale tend to run out: the curve is usually U-shaped. Telecoms, Gas, rail companies have strong network effects from their infrastructure-it makes little sense to have duplicate rail networks or gas networks in a country. Utility computing does not have this advantage because the distribution network is not owned by them.”

Continuing the conversation, Carr captures the usual widely held perception of Cloud Computing nicely;

“The history of computing has been a history of falling prices (and consequently expanding uses). But the arrival of cloud computing – which transforms computer processing, data storage, and software applications into utilities served up by central plants – marks a fundamental change in the economics of computing. It pushes down the price and expands the availability of computing in a way that effectively removes, or at least radically diminishes, capacity constraints on users. A PC suddenly becomes a terminal through which you can access and manipulate a mammoth computer that literally expands to meet your needs. What used to be hard or even impossible suddenly becomes easy.”

This is quite true, but continues and further entrenches the misapprehension that the Cloud is little more than an adjunct to the corporate data centre; a misapprehension that we shall get down to challenging in a moment.

First, though, there is a growing recognition that today’s market leaders will inevitably need to become more interoperable if this business segment – and they – are to grow. The proprietary nature of their offerings today may allow them to innovate ahead of the standards process (that will be shaped in large part by the lessons they learn), and the relatively high cost of switching to a competitor today may give each the critical mass upon which to invest and grow, but the characteristics of the current market are clearly the characteristics of a nascent market; computing’s new Wild West. As so often before, standardisation, true competition, mainstream adoption and commoditisation will all follow as we move toward phases 2 and 3 of Gartner analyst Thomas Bittman‘s intriguing ‘evolution of the Cloud Computing market.’ Similarly, Erica Naone offers a useful overview of Cloud Computing’s open source component in Technology Review this month. None of the projects she covers are a significant challenge to Amazon’s EC2, Microsoft’s Azure, Salesforce’s force.com or Google’s App Engine… yet. But together they help to keep these commercial entrants honest, and remind all of us that switching costs can be brought very low indeed if the pain of the status quo becomes too great.

Writing ‘Welcome to the Data Cloud?‘ for ZDNet last month, I began to explore the important role that data could and should play in the Cloud;

“Just as ‘we’ used to duplicate and under-utilise computational resources, so we do something very similar with our data. We expensively enter and re-enter the same facts, over and over again. We over-engineer data capture forms and schemas, making collection exorbitantly expensive, whilst often appearing to do all we can to limit opportunities for re-use. Under the all-too-easy banners of ’security’ and ‘privacy’ we secure individual data stores and fail to exploit connections with other sources, whether inside or outside the enterprise.

In a small way, the efforts of the Linked Data Project’s enthusiasts have demonstrated how different things should be. The cloud of contributing data sets grows from month to month, and the number of double-headed arrows denoting a two-way linkage is on the rise. Even the one-way relationships that currently dominate the diagram are a marked improvement on ‘business as usual’ elsewhere on the data Web; even in these cases, data from a third party is being re-used (by means of a link across the web) rather than replicated or re-invented. Costs fall. Opportunities open up. Both resources, potentially, improve. The strands of the web grow stronger.“

It is here, in the use and reuse of data, that the potential of the Cloud will be realised. Back in the previously cited conversation between Nick Carr and Tim O’Reilly, O’Reilly himself came very close to saying so;

“In short, Google is the ultimate network effects machine. ‘Harnessing collective intelligence’ isn’t a different idea from network effects, as Nick argues. It is in fact the science of network effects - understanding and applying the implications of networks.

I want to emphasize one more point: the heart of my argument about Web 2.0 is that the network effects that matter today are network effects in data. My thought process (outlined in The Open Source Paradigm Shift and then What is Web 2.0?, went something like this:

1.  The consequence of IBM’s design of a personal computer made out of commodity, off- the-shelf parts was to drive attractive margins out of hardware and into software, via Clayton Christensen’s ‘law of conservation of attractive profits.’ Hardware became a low margin business; software became a very high margin business. 
2.  Open source software and the standardized protocols of the Internet are doing the same thing to software. Margins will go down in software, but per the law of conservation of attractive profits, this means that they will go up somewhere else. Where? 
3.  The next layer of attractive profits will accrue to companies that build data-backed applications in which the data gets better the more people use the system. This is what I’ve called Web 2.0.

It’s network effects (perhaps more simply described as virtuous circles) in data that ultimately matter, not network effects per se.”
(my emphasis) 

Talis CTO Ian Davis would appear to agree, commenting;

“People need to be  investing in their data as the long term carrier of value, not the applications around them… the data is more likely to persist than the software so it’s important to get the data right and take care of it.”

Salesforce CEO Marc Benioff, too, used his Dreamforce User Conference this month to move a company long associated with the ‘data centre extending’ Cloud firmly in the direction of embracing data and the network. As Krishnan Subramanian noted on Cloud Ave before the keynote,

“Till now, the Force.com platform served business users to develop apps that can be used internally within an organization. They have to tap into Force.com APIs from outside platforms to offer customer facing web apps. With the new initiative, it becomes easy for customers to allow the internet users to “interact” with their data.”

Over on VentureBeat, Anthony Ha had more;

“Salesforce.com wants to become an even big player in the cloud computing market with a new service called Force.com Sites, which allows companies to host public-facing web applications in the Force.com platform. That means Salesforce — nominally a maker of customer relationship management (CRM) software, but also an increasingly important platform for business-related applications — is moving closer to direct competition with cloud giants like Amazon Web Services and the Google App Engine.”

Locked away within an organisation, and only accessed by that organisation’s applications, data cannot be put to full use. Much of the value in each individual datum lies in comparing it to other measurements, in delving into detail and in pulling right back to observe the bigger picture.

Organisations believing that either the big picture or the detail reside within their own systems alone are woefully misguided. Even the most specialised, the most proprietary, the most confidential of data only reveal their true value when placed in context, and that context is all the richer when informed by numerous perspectives.

Cloud Computing, and the various *aaS movements, have finally brought us to a place where the fiercely guarded and tightly delineated boundaries between the organisation and those outside it may become permeable in ways that should benefit the organisation rather than threaten it. Data is just a resource. In the terminology of Geoffrey Moore most data is often mere context, and there are savings to be made both in reusing the data of others or in re-selling necessary context to those prepared to pay. Some data, of course, is core to the business, and this may continue to receive the same reverence and protection that we misguidedly apply to the entire database today. Even here, though, the opportunities afforded by (controlled?) sharing may outweigh any desire to maintain data protectionism.

The language of Groundswell offers opportunities to go further, to embrace and to exploit the behaviours and the motivations of customers and the wider Web.

There is clearly far more to write in clarifying this view of both the components and the whole, but as it passes 2,000 words this particular blog post has perhaps gone on long enough.

For now, then, I should conclude by asking what role the Semantic Web has to play in any of this.

The Semantic Web, with its unadulterated recognition of the primacy of the web’s hyperlink? The Semantic Web, designed from the outset to convey context and relationships derived from data spread across the Web? The Semantic Web, supported by technologies that operate openly and at Web scale?

Isn’t it obvious yet?

Returning to the Web 2.0 Summit with which this post began, another presentation was from Kevin Kelly, founding editor of Wired Magazine. As I wrote this post, I referred to Steve Gillmor and Nicole Ferraro, from whose reports I inferred that Kelly had built upon an earlier presentation (that I greatly enjoyed), in which he argued;

“You have to be open to having your data shared… which is a much bigger step than just sharing your web pages or your computer.”

Fact-checking before hitting publish, I notice that last week’s video is now up, here, and Kevin’s championing of the primacy of data in the cloud resonates with every word I’ve just written.

Yep. Here we go, on a journey toward Kevin Kelly’s “World Wide Database.”

In subsequent posts I’ll explore some more of the detail, and I hope you’ll stick around for the journey.

Storm Clouds image © ‘shidairyproduct‘ 2008. Shared on Flickr, and licensed with a Creative Commons Attribution License. Converted to a jigsaw by Big Huge Labs.