The Thing About Freemium

By Bryan Mezue
[Freemium is like a Samurai sword]…Unless you’re a master at using it, you can cut your arm off.
Rob Walling (HitTail) being interviewed by WSJ [1]
 
One of the interesting arguments proposed during the course of the LTV class is that the freemium model has been highly under-appreciated, when in fact it could help many startups unlock masses of value in customer acquisition savings when used effectively.
I think there is a fascinating question to ask about why this is the case. In my own startup, an online marketplace similar to oDesk or eLance, we are targeting customers in a dispersed market where freemium may in fact be the answer to all our customer acquisition headaches. Yet my partner and I are divided on the benefits of the freemium approach. How does one make freemium work in an online marketplace? Is it even possible?
In a detailed article on TechCrunch, Jules Maltz of IVP lays out some best-processes for deciding when to use freemium[2]:
  • Start with the product. Make sure that your product is appealing whether your customer is paying or not
  • Align your choice to what you’re selling. In some categories, e.g. babysitter services, paying a fee to play is actually a good indicator of quality, and freemium just does not work
  • Ensure that freemium users actually create value. This could either be by converting into paying customers, or by attracting paying customers (or both, in the case of DropBox)
  • Make sure the math works in your favor. The amount you invest to acquire and service ‘free-loading’ customers should be counter-balanced by the value they create
  • Measure relentlessly. Cohort-analysis can be a powerful tool in tracking and adjusting strategies towards the freemium approach
In our own marketplace context, there are a few additional complications. A freemium approach potentially takes away the incentive for the supply-side to participate (i.e. they don’t get paid for their services). Even with a prove-yourself-first-model, where each supplier must provide a pre-set amount of free services before getting paid for new services, the mismatch of incentives could break down the fundamental dynamics of the marketplace. On the supply side, we could end up attracting only low-quality suppliers, because the high-quality ones don’t want to wait through a trial period. In addition, on the demand side, most users are incentivized to keep using the effective ‘free trial’, and if the flow of new suppliers still in their trial phase dries up before demand, the users will stop finding marketplace useful.
The answer no doubt lies in testing many different models to see what sticks. But it certainly seems that “freeconomics”[3] may not always be the answer to every startup’s customer acquisition problem.

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