Wired Magazine Editor in Chief (and Long Tail author) Chris Anderson has a short post on his blog exploring ways in which a ‘freemium’ business model might be applied to “one of the biggest software-as-a-service companies.”

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.

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