Note: This post utilizes data from one of our customers, SmartBear Software. We'd like to thank Jeanne Hopkins, their CMO, for letting us release the gist of the findings, in order to let everyone learn from them.
Freemium has gone from an intermittent growth tactic in the software disk days of the 1980s to a strategy that every SaaS company can’t live without. After all, how do you grow a business without giving away the farm for free?
Sarcasm aside, we’ve debated the merits of freemium before in a previous post. Our conclusion is better discovered on that post, but the gist is: freemium is an acquisition tool, not a revenue model. When used correctly, freemium can be wonderful for businesses and that’s why everyone is flocking to barren tiers. Yet, with 5 million downloads of their free tools for developers, one of our customers, SmartBear Software, was thinking about the naming convention of free or lite in labeling their software offerings, positing the question:
"Does calling the free plan “free” (or “lite”, “basic”, etc.) diminish the value of the product?"
The subtext here is that free plans have become such a novelty and so poorly set up that unless your first price point is close to free ($0), you’re essentially shooting yourself in the revenue draining foot, because the delta between the free plan and the first paid tier is too high (especially in enterprise companies). To answer their question, we did what we do best: gathered customer data and determined some willingness to pay magic. Let’s explore the study, the results, and top-level findings to help you boost your revenue right away.
The study: Comparing ordinal names to regular names
Without getting too deep into our software and process (you can hear the pitch on the phone or website if you want), we make value based pricing software that gets to the heart of willingness to pay by collecting data directly from the customer. Part of our software also determines relative preference between features, benefits, or value propositions by forcing the user to make choices between them. Here's some example output from a fun pricing study we did comparing the price of time with Dharmesh Shah or Jason Calcanis:
For this study, there were a few moving parts. We first took different target customers for each SmartBear product, had them price out a full featured product based on its features and value propositions, introduced a less featured free product with the free name, and then had them price out the free tier while knowing full well that the less featured tier was free. We then calculated the difference between those two numbers, and voila we had clear trends on the value of the names. (Side note: We also ran the feature preference studies against the different names.)
In terms of different names, we tested modified names where we appended “Free”, “Basic”, “Starter”, and “Lite” to an existing name. We also introduced a non-modified new name that was branded similarly, but didn’t have an ordinal prefix or suffix. For example, let’s say we’re pricing a product named PriceIntel. For the study, we would test pricing by determing the willingness to pay for "PriceIntel" (full featured product), then price “PriceIntel Free”, “PriceIntel Basic”, “PriceIntel Starter”, “PriceIntel Lite”, and then “PriceSmarts”, which is the non-modified name.
Hopefully, everyone is with me so far. If not, comment or give us a call and we’re more than happy to walk you through everything. :)
Results: Names have impact on perceived value
The results were exceptionally telling. Essentially, “free” drove the price to pretty much free or $0. Basic, Starter, and Lite all hovered around 50% of the original value, and the non-modified name only drove the perceived value of the product down 15 - 24%. Keep in mind we tested this across some pretty nerdy segments (software engineers, software developers, network engineers, etc.), but every single segment we tested had pretty much the same results. Take a look at the aggregated results:
The relative preference results fell in line similarly, as well. Keep in mind though that this analysis forces the respondent to choose a most valuable and least valuable name, so no matter the frequency of responses, more than likely when people see “free” it’s an easy choice as the least valuable. Here are those results:
How can this help you? Non-Ordinal Names and Value Metrics
1. Skip ordinal names for your free tier
Instead of using cliche ordinal names like "free", "starter", "basic", or "lite", use a real name. Not creatively inclined? Just grab a thesaurus and get cracking. At the very least name the tier after the customer persona using the product. If the free plan is for a single person with the hope you’ll land and expand into the team, then name the tier “solo.” If it’s for small businesses, you’re also hoping to grow with, then name it the “small business plan.” I’m not a creative genius, so I’m sure there are better examples out there.
Just don’t kill your value, conversion rate, and revenue by pricing improperly.
2. Align your tiers along your value metric
A foundational principle of pricing and packaging is that you need to charge your customer for the value you’re providing them. As that value increases, you should charge more. Wistia is a phenomenal example. As you get more bandwidth and upload more videos (get more value from the product), you pay more.
If you don’t have a finely tuned throttle or proper feature differentiation between your free plan and that first tier, then you can’t move your customers up along your value. You’re just giving it away. This is especially scary in the enterprise space where the difference between a free plan and the first premium one can be from $500/month all the way to $1000s per month. As such, make sure that free plan, no matter the tier moves that customer “up the river” efficiently.
Freemium offers are only the silver bullet to a business when you’ve figured out a good portion of the big aspects of your business: customer, marketing flow, user metrics, etc. If you’re taking the free plunge or starting off with it from day one, make sure to start small. You can always add more features or increase the throttle, but it’s a heck of a lot harder to take things away. After all, if you’re not moving those customers up into greater profitability, then you’re just running a really expensive, developer ridden tech charity, rather than a growing business.
To learn more, check out our Pricing Strategy ebook, our Pricing Page Bootcamp (it’s free!), or learn more about our price optimization software and solutions. We're here to help!
This article is a guest post from Jack McDermott, Co-Founder and CEO of Balbus Speech, one of the market leaders for effective speech therapy apps and tools. Here he writes about his experience in Apple's app store.
Anyone dealing with software pricing knows one thing in particular: it’s really, really tough. Most companies struggle to find the ideal balance between price, value and user acquisition costs. Not to mention most software products come without recurring revenue—so you better make your one sale count and not leave cash on the table.
It’s even more challenging when you’re selling apps on the App Store, where nearly 9 out of 10 downloads are free apps. Price Intelligently has already written a great post on freemium here, but with well over 700,000 apps, the iTunes App Store is a pricing battleground that favors the lowest possible price: free. For independent developers, it’s sometimes impossible to stand out from all the rest. But, just like catchy marketing or a refreshing user experience, pricing is another way to attract new customers.
At my startup, Balbus Speech, we develop speech therapy iPad apps. In a specialty market like ours, prices on the App Store range from free to upwards of $99. Our apps, Speech4Good and Speech4Good Lite, are targeted at speech therapists looking to spend between $5-20—no easy feat when the entire marketplace is sunken with free to 99 cent apps. As a result, pricing our apps has been a constant evolution of “trial and error”—our prices have moved anywhere from free to $29.99. Yet through the trials (and with a little help from Price Intelligently), we have learned two key takeaways:
1. Be goal-orientated: Turn "free" into "free to download"
Your app pricing should reflect your company’s goals. With our apps, we recognized that our market is highly selective and comfortable paying for therapy resources. Yet, we also recognize that users can only improve their speech if they have access to our technology. Clearly, we need to think of our pricing structure as a combination of affordable value as well as widespread accessibility—which is evidence of our full-featured version ($19.99) and our “Lite” stripped-down version ($4.99).
On the other hand, if you’re marketing a viral game or music/video app, you may want to compete on features and user experience, not price (most are free to download anyway). Unlike special education apps, these apps have different goals: most often, free to download with restricted features or levels that require an in-app purchase—remember: “freemium” is a marketing strategy, not a pricing strategy.
2. Get creative: correct price points and targeted flash sales
It’s time to change how you think about sales on the App Store. Your goal should be minimal: what value in price do I need to portray to get a potential user to make two clicks and type in a password? This is often all that’s needed and it’s how you should think about your App Store product. In fact, by lowering our price 33% from $29.99 to $19.99, app sales increased by over 200%--making this pricing change a valuable long-term strategy.
What about getting creative with flash sales? We tend to avoid quick sales—which usually hope to spike downloads and make your app rank higher on the App Store. Our market is less elastic in this sense, as speech therapists and students typically research and compare apps before purchasing. But if you’re looking to temporarily drop your price, do it with a clear purpose. For instance, we recently partnered with “Apps for Children with Special Needs” to promote a back-to-school app sale—this way we maximized our marketing reach with a partner while also promoting an event or occasion as the reason for our sale.
In summary: Iteration in any pricing strategy is key
So with these ideas in mind, there’s only one thing left to do: try it for your app. We've been able to refine our pricing strategy so we can do less “trial and error” and make more sales. Pricing is a process just like marketing, product development or even sales. The sooner you treat your price strategy this way, the sooner your app sales will exceed your goals.
To learn more, check out Price Intelligently's Pricing Strategy ebook, their Pricing Page Bootcamp (it’s free!), or learn more about their price optimization software.
UPDATE: We clarified some of the language in an example we outline in the middle of the post. The numbers are simply samples strictly to show an example scenario that isolates the impact of freemium. If you're interested in running through the math with your own data, let us know.
On May 26, 2006 famed VC Fred Wilson posted the following about his favorite revenue model:
"Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc, then offer premium priced value added services or an enhanced version of your service to your customer base."
And thus, modern day freemium was born. Of course as Fred mentions, freemium had been around for quite some time in numerous different forms, from the free calls of Skype to the free storage of Box.net (even before the 2000s software developers have been giving away lite versions on CDs since the 1980s). Yet, at the time of this article, the momentum of freemium began to change from novel to mandatory. Everyone bought into the idea of “just get a bunch of people to sign up and drive them up the river of your plans." Revenue slowly became a secondary goal though with musings of, “we’ll figure out the revenue model eventually” or “we’re just not focused on charging customers right now, maybe in a year or two.”
The success of Skype, Facebook, Flickr, and the like didn’t help, painting freemium as the silver bullet to any entrepreneur seeking a billion dollar exit. Of course, this perspective is a bit gonzo in it’s assertion, but after mentoring some early stage companies at a number of events the past few weeks, we’ve lost touch with the one truth about freemium: it’s a marketing strategy, not a revenue model.
In an effort to clear the misconception around freemium's true purpose, let’s explore why freemium potentially kills businesses, uncover where freemium is appropriate (the big asterisk), before going through some healthy ways to implement “freemium like” strategies.
Freemium is a marketing strategy, not a revenue model
In a freemium model, a business is giving away a portion of the value they’ve created: 1. to gain as much interaction with potential paying users, and 2. in the hopes that the value in a premium tier is so enticing to a customer that they can’t help but drop their credit card digits to upgrade. Yet, pushing a customer up to a premium tier takes an extraordinary amount of intimate knowledge about their behavior and incentives, let alone a direction on who that customer is out of the different personas you could be targeting. Freemium will make your pipeline much wider, potentially leading to a flood, but if your customer and business development aren’t guiding the water through proper canals and ditches, you simply have a disaster of support, hosting, and frustration costs for customers that don’t want to upgrade.
This is why companies like Wistia and MailChimp are around for 5 and 10 years (respectively) before they launch a free plan. By that time they’ve figured out what drives their customers, at least to a point where they’re ready to step on the gas. Essentially, freemium didn’t lead them to being a good business. Being a good business drove them to freemium.
When you launch a freemium plan you should have clarity as to the purpose of that plan and how it will lead to an increasing amount of revenue across your bottom line. You should be so excited that your CTO busts out a legendary rap launching the plan (see Wistia below). It should be an event worthy of a ticker tape parade.
Enough with the philosophical stuff, what’s the data show
OK, all of that was philosophical, so I’m sure some trolls will find some exception or tautology to explain how I’m generalizing and completely wrong. As such, let’s do an impact analysis using some sample data. Let’s say you’re a SaaS company with three tiers and your software pricing as follows:
Let’s make some assumptions for this scenario, too. I repeat, we're making these numbers up to outline a scenario to show some data around the impact on freemium. (If you want to test out the impact of freemium on your own product with your own data, let us know.) You’ve done a phenomenal job marketing your $49 product and start with 100 customers (and 0 customer in the other two tiers), growing the base by 30% while churning at a rate of 10%. You’re also able to move your customers to upgrade at a rate of 5% every month from tier 1 to tier 2 and tier 2 to tier 3. (lots of numbers involved in the revenue modeling...email me if you'd like to go deeper :)).
If nothing changes, at the end of five years, you’ll have 1,095 customers and a run rate of $900k. Now imagine we drop that bottom tier to $0 and hold everything the same.
The result: your $900k 5-year run rate just turned into $380k. 42% of what you could have had.
Obviously, there are a number of factors to consider here and all of these levers can be optimized and improved. Yet, look at the real dollar impact on your long-term run rate with all things being equal, in addition to the costs in supporting and marketing to free customers that haven’t proven they’re willing to pay for any aspect of your product.
Simply put, freemium is not an insignificant cost to your business. If you're not able to optimize any of the above metrics, then maybe you should develop your marketing, pricing strategy, customer, etc. to grow into a freemium strategy. Big customer databases are only sexy if they’re ponying up cash.
The asterisk: where freemium works
There’s a huge asterisk that shouldn’t be overlooked. For some companies, freemium is viable from day one. Although, I’d really push anyone on this claim. Very few of you will be a Facebook, and even then, they haven’t figured out their ideal revenue model. If you want to build a platform, then be a LinkedIn, charging the power users of the network from day one. Social applications and other platforms like Smarterer need to grow their free user base to a point where the data is valuable to a paying user base. That’s perfectly fine, but really challenge yourself to think about creative ways you can charge right from the get go.
If you’re trying to figure out your revenue model, the answer is rarely “let’s give it away for free until we figure out how to charge.” Instead, test different revenue models. Iterate the pixeled dollar signs on the page quickly and see which maximizes cash.
Finally, tread cautiously, but if you can figure out how to embed viral growth into your free offering, go ahead and offer one. Dropbox brilliantly offered a negligible amount of storage unless you tweeted, shared, or signed up your friends for the service. All of those actions correlate to an actual dollar amount in customer acquisition spend, making the shares, invites, and tweets from “free” users actually correlate to real marketing dollars. Just be careful, because it doesn’t work for every product.
OK, I get it. What should I do though?
1. Diet freemium - the free trial: If you’re selling a SaaS product, then don’t be afraid of the free trial. They’re exceptionally valuable in giving a potential customer a taste of the value you’re creating, while not giving away everything and the kitchen sink without an upside.
2. Follow business fundamentals: If you practice the fundamentals, your freemium time will come. Double down on finding product/market fit or at least moving as close to it as possible before flooding the business. Take the time to also find out what drives the customers coming through the pipeline. Usage from current customers is exceptionally enlightening. Plus, you'll be able to optimize retention, upgrades, and costs to a point where you'll be making enough cash to seriously consider whether freemium is for you.
The goal of any business is to create some sort of value that someone is willing to buy. Whether weeks or months go into that first dollar of revenue or your cash flow begins trickling in from day one, someone exchanges cash for the efficiency you’ve created. Business at its core is that simple. If no one is buying, then you haven’t justified your value for that price to that particular customer. Of course, if practice were as good as theory, we’d all be driving maseratis right now, right? Developing your customer and your product takes time and energy. You can still move quickly, but don’t be reckless by giving away the farm. Cash is the real validating king.