Show me the money

Over the past two weeks we have delved into the workings of Sramana Mitra’s virtual accelerator, One Million by One Million where she describes her programme of getting one million startup businesses to each generate one million dollars annual revenue. If successful, the programme will assist these startups in driving enormous job creation of 10 million jobs globally and wealth generation of a trillion dollars for the businesses. The focus this week is on the all-important tenet of monetising the business idea.

What is monetisation?

Monetisation refers to the conversion of an object into money, which means that it is generally accepted as a medium of exchange. To monetize is to convert an asset into or establish something as money or legal tender. The term monetise has different meanings depending on the context. It can refer to methods utilized to generate profit, while it also can literally mean the conversion of an asset into money. For example, the U.S. Federal Reserve can monetise the nation's debt; this involves the process of purchasing debt (treasuries) which in turn increases the money supply. This essentially turns the debt into money (monetisation). Another example are where metals are monetised as coins once they are standardised in weight and accepted as money.

This principle may be applied in the startup space where monetisation refers to converting a business idea or product (the object) into revenues (money) for the business.

A simple example comes from websites monetising their content. Many are set up to earn money through advertisers. When people who browse the particular site click on one of the advertisers' links, the owner of the website earns a small amount of money (this is known as pay-per-click, or PPC advertising). If the website attracts enough visitors, the small amount paid by the advertisers for each click can add up to substantial monetisation. 

Of course, the counter-intuitive method of giving away free product also works, if executed properly.

The freemium model (a portmanteau of “free” and “premium”) has been gathering steam since 1994 when Esther Dyson, a prominent technology analyst, envisioned a world where intellectual property would cost nearly nothing to distribute. Back then, most providers of “creative content” had to shell out substantial sums to reproduce and deliver each additional copy of their products. Indeed, the Internet has all but eliminated those so-called marginal costs—increasing overall supply of stuff like software, media and advice, and driving consumer prices to zero. Meanwhile, pesky fixed costs like equipment, buildings and people remain.

Freemium has become an increasingly important business model among internet startups and smartphone app developers. Users get basic features at no cost and can access richer functionality for a subscription fee. If you’ve networked on LinkedIn, shared files through Dropbox, watched TV shows through Hulu, or searched for a mate on Match, you’ve experienced the model first-hand. It works for B2B companies as well with examples including Box, Splunk, and Yammer.

Several factors contribute to the appeal of a freemium strategy. Because free features are a potent marketing tool, the model allows a new venture to scale up and attract a user base without expending resources on costly advertising campaigns or a traditional sales force. The monthly subscription fees typically charged are proving to be a more sustainable source of revenue than the advertising model prevalent among online firms in the early 2000s. Social networks are powerful drivers: Many services offer incentives for referring friends (which is more appealing when the product is free). And freemium is more successful than 30-day free trials or other limited-term offers, because customers have become wary of cumbersome cancellation processes and find indefinite free access more compelling.

But despite its popularity and clear benefits, freemium is still poorly understood. It has inherent challenges, as demonstrated by the many start-ups that have tried but failed to make it work.

And so the debate rages on: How to attract customers with free content without going broke in the process? And while there are many advocates for the freemium model, there are just as many that are opposed to the idea. The entrepreneur has to formulate a clear strategy with the task of the freemium model defined in terms of exactly what is free, what is to be charged and the timelines or triggers to be used to pivot from using this particular marketing model.

The 7 Types of Freemium Models

A good place to start the strategy is to establish what type of freemium model is to be used by the startup according to following categories:

1. Traditional/Classical Freemium

  • Free-forever feature-limited-but-usable version of a premium product
  • The one that started it all
  • The one that most people know
  • The one with the major penny-gap issues
  • Expectations that most users will never buy by both the vendor AND user

Examples include OfficeDrop, Dropbox, LogMeIn and it should be noted this type of freemium rarely exists beyond early-stage (and heavily-funded) startups.

2. Land & Expand

  • The up and coming model
  • Free to acquire by users
  • Monetization at organization level
  • Adopters & Users are often kept out of buying process
  • Where the user and buyer are the same, the model uses a lock-in model to gain a foothold within an organisation
  • Expectation by vendor is after x number of users in an organisation, they’ll pay

Examples: Yammer (Acquired by Microsoft in 2012 for $1.2B), Xobni, Amazon Web Services. Yammer is the most successful example of this model within pure-play freemium organizations. AWS uses this model a bit differently, offering their proprietary technologies as freemium in an effort to get companies to invest in integration and thus make switching costs too high.

3. Unlimited “Free Trial”

  • Not really a “Free Trial” as the vendor likely doesn’t understand the true dynamics of freemium which will likely come back to haunt them
  • Free-forever feature is actually a crippled version of the premium product
  • Expectations by the vendor are that the user will convert/upgrade
  • Expectations by the user is continued-forever use for free
  • This seems like a risky type of freemium to adopt since it is mixing the elements of a free trial with the psychological aspects of freemium.

Examples: Echosign and Basecamp

4. Freeware 2.0

  • Free-forever, fully-functional product
  • This is their main product or a completely new stand-alone product line within a larger organisation
  • No expectations of  conversion or cross-sell by MOST free users
  • Monetisation is through add-ons for the free product created by the company itself

Examples include Evernote, Skype and AVG. Evernote, for example, is Freeware 2.0 because it is 100% usable for free, forever, and the expectation is that most people won’t pay and the same applies to Skype.

When users do pay they are paying for extra storage and additional features or add-ons, but the base product is good enough so that few people will pay for the upgrades.

5. Alternative Product Strategy

  • Similar to Freeware 2.0, but from a company with an existing premium product line of which this is a discrete subset.
  • A free-forever product with no direct up-sell path to premium version
  • Often used as a foot-in-the-door strategy
  • Goal is to cross-sell other offerings from the company

Examples here include Autodesk’s SketchBook Pro for iPad, (a product of LogMeIn), and SolarWinds.

6. Ecosystem

  • A free-forever base product
  • Monetisation occurs through revenue share with third parties, like add-ons by third party developers

Examples: iTunes and Google Apps. ITunes is included because the software is free, creating the base-platform that the user can use forever to manage their own music without ever paying Apple anything. Monetisation occurs via a marketplace revenue-share with third party content creators. Google Apps has a premium version, but monetisation around the free version occurs through its ecosystem play.

7. Network Effect

  • Monetise eyeballs and aggregate behavioural data.
  • This is the notion that if you aren’t paying for the product, then you ARE the product. Or you’re creating the product through your use of the system.

Examples here include Wave, Spiceworks, Google (advertising), and (revenue share from offers). While Spiceworks has over 5 million users, they only have a few hundred customers and those customers are the advertisers.

User Beware!

Avoiding the four mistakes outlined below won’t guarantee success, but it will reduce the chances of failure and will probably be helpful to apply during a pivot in the organisation.

Mistake #1: Picking the Wrong Market

Mistake #2: Offering No Compelling Reason to Upgrade to Your Paid Product or Service

Mistake #3: Tracking the Wrong Metrics (Or None at All)

Mistake #4: Not Guiding Prospects down the Path

While freemium is certainly not the right model for every company, when used wisely, it can be an extremely powerful tool. But before starting the next great freemium company, remember that all startups should begin by creating a world-class product or solution that solves an important pain point for users. In most cases, Freemium is merely a part of the marketing strategy and the economics of the model has to be understood!