Fred Wilson of Union Square Venture is a big proponent of the freemium business model on the internet. He recently reiterated that when it comes to delivering media on the net, freemium is a great way to go. Fred originally endorsed Freemium back in March of 2006.
I have a tremendous amount of respect for Fred. I don’t know him well, although we have met a few times. And I read his blog pretty regularly so feel like I know his views. I can’t say that I was not enticed by Fred’s arguments. At the time, Phanfare was growing nicely but marketing costs were high. It seemed that if we created a freemium business model and allow everyone to use Phanfare in some basic form that it would help us prospect for customers willing to go for paid upsells.
But I also had my concerns which I wrote about in May of 2006 in a post entitled Why is there no free version of Phanfare. At the time, I was concerned that there were few network effects to Phanfare and hence the value of having a large community of free users was not that high. I was also concerned that as a differentiated provider, we would be hard pressed to make money with the load of the free users.
But in 2007, we embarked on changing Phanfare to incorporate a free version. The thinking at the time was that our calculus had not considered the cost of marketing, which is lower if you can prospect by attracting people with a free version. We thought having some network effects to Phanfare were important, so we also added social networking. We thought that people would connect to their friends on Phanfare and expose them to the system.
We offered 1GB of storage to free users and unlimited storage to paid users. Classic freemium.
Here is what happened.
- We saw a surge in registered users.
- We saw drastically reduced margins. Customers with less than 1GB but paying our full subscription fee were our most profitable customers. With those people at the free level, our margins were down significantly.
- We lost the ability to effectively use CPC search marketing (google). When we had a free trial, it was easy to see which clicks were worth paying for. But with freemium, the conversion funnel was so long (average of nearly a year before the person needed more storage) that any attempt to optimize price per conversion was hopeless. (Try adjusting the shower temperature with a 12 month delay between knob and temperature change and see how it goes for you. In control theory parlance, this is known as introducing a delay in the feedback loop)
- We lost our position as a premium provider. People perceived Phanfare as “free” and it was hard to describe ourselves as a paid service for those who care about preserving their full size originals and displaying them in a better way.
- There were few network effects to Phanfare. People who were our customers did get their friends to register for free accounts, but the rate at which those people became Phanfare participants was very low. We did not have a social network; we registered the audience.
Another issue is that storage is the driving cost factor for Phanfare. The page views per bytes/stored is so low for us (we are an archival service storing full size originals) that advertising, even if it was welcomed by our user base, would not pay the bills.
Fred Wilson estimated that Facebook might have $.25 revenue per user per month. Phanfare could never survive on that.
In the end, freemium is not a good model when the cost of delivering service to free users is high. But more fundamentally, I reiterate my position that freemium is a bad marketing plan for any premium business that hopes to be the differentiated provider.
Freemium makes sense when at least one of the following conditions are true
- Free users have zero marginal cost to the company. True for Skype and other P2P services that get participants to volunteer infrastructure.
- The value of the product to a prospective customer depends on their being a large network. True in dating, Skype, Facebook, Ebay and Twitter.
- The business can be run ad supported. That means that the business has reach and attention that scale along with costs and costs are low enough that ads pay the way. (At Phanfare our page views per byte stored are so low that advertising does not work well). Any ad-supported business can consider paid upsells. At some level they are running freemium. Or put another way, they are using their reach to pitch their own products.
Not a single one of these conditions is true for Phanfare. Moral of the story: trust your instincts.