Should startups adopt the "free value-added" model?

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Should startups adopt the "free value-added" model?

Jules Maltz, general partner of venture Capital IVP, recently wrote about whether startups should adopt the business model of "free value-added (Freemium)" and the 6 experiences that can be used in this model.

Over the past few months, the industry has had a heated debate over the "free value-added" model. Some argue that the free value-added model is a huge cost trap that will force startups to sacrifice revenue to support users who will never spend money. Others argue that the free value-added model represents the future, as bandwidth, storage, and information processing costs are constantly trending towards zero. But everyone admits that the free value-added model is very powerful. Hittail's Rob Walling recently pointed out that the free value-added model resembles a samurai sword: "Unless you are a real knife, you will accidentally chop off your arm." “

We are not IVP, but we believe that the free value-added model will be a destructive force that needs to be fully understood. Over the past few months, we have interviewed a number of leading users of free value-added models, including 37signals, Dropbox, Evernote, GitHub, HootSuite, New Relic, SurveyMonkey, weebly, and Zendesk. (To ensure simplicity, we focus on software companies that try to convert free users to paid users, rather than companies based on advertising mode.) With the assistance of these companies, we have summed up the 6-point experience of the free value-added model.

1 starting from the product

In the interview process, a topic has been discussed several times: to ensure that the product is the highest priority work. Designing a high-quality product is important to any start-up, but it is particularly critical and challenging for a company that takes a free value-added model. The perfect premium value-added products are able to promote themselves, attract new users (including free and paid users), retain old users, and automatically provide user services, all without human intervention. This can only be done with well-designed products that are popular with users.

A typical free value-added company can convert 1% to 10% of users into paid users. Therefore, free value-added products should have: a) lower marginal cost; b. Lowest Sales Marketing Cost Since most users do not pay, free value-added companies will be in trouble if the cost of product marketing, publishing, and support is too high. Products need to be able to sell themselves and attract loyal users with their own merits, without the company spending large marketing budgets. For users, such a product needs to be simple and "useful." This is not to say that the technology is not complex, or development will not encounter difficulties, it is only to make users feel that the use of products is simple.

In addition, both the free and the paid version of the product, simplicity and quality must be consistent. Many of the free value-added companies failed because the free version of the product did not bring much value, so the user could not be converted into paid users. In reality, providing users with less-than-free versions of their products does not help attract them to pay, which is not conducive to the free value-added mode of operation. The best free value-added companies should bring value to both free and paid users, and spend most of their time making free products better.

Only by developing a good product can you attract free users and paid users. Once you design and develop world-class products, you will be able to understand the user and whether the free value-added model is right for them.

2 Know your users: is the free value-added model suitable for them?

Like ordering, permanent licensing, and a service based pricing model, the free value-added model is just one of many tools designed to attract users to buy your product. Your first job is to understand the user's problems and provide solutions to the problems. Once you've done that, you can ask why they want to buy your product and point out whether the free value-added model is the most appropriate way.

If you want to determine whether the free value-added model attracts users, ask the following questions:

How complex is your product? If you are in such a market, customer questions about autopilot, registered financial planner or RF interference, then means that your product may be too complex, not suitable for free value-added mode. If you want the free value-added model to be effective, your users need to quickly understand and get started with the product without having to undergo a complex familiarity period. If users need hands-on training or technical support at the outset, free value-added may not be the right model.

Are your users really attracted to free? What would you say if a stranger offered to take care of your child for free? What would you do if you saw a free but dirty couch on a street corner? Every day, you say no to a lot of free stuff, because you know, these free things aren't really free. In some cases, you need to engage in "deadly tasks", such as babysitting and laser myopia surgery, so you'll be willing to pay for it. In other cases, the cost of time and the effort required outweigh the appeal of free.

If you are sure that the free value-added model fits the customer, then you can learn the value of free users and determine whether the free value-added model is right for your business.

3 understand the value of free users: is the free value-added model for you?

Free users make sense only if you bring value to your business. In general, the most attractive and dangerous part of the free value-added model is the relatively easy way to bring free users. Entrepreneurs will want thousands of users to use their products. However, if such users are not able to bring in paid users, it will become a hindrance, leading to the company's slow demise. If you want the free value-added model to be effective, the free user must meet the following two types:

1. Free users who can be converted into paid users

These users do not currently pay, but based on the understanding of the data, you can predict that a large proportion of them will be converted into paid users.

Key product attributes: Over time, users get more and more value from your product.

Typical company: Evernote. On the first day, new Evernote users did not store any content, and all they could do was create new content. But as users gradually build notebooks and web clips, they have more reason to reuse products and interact with historical data in many different ways. 3 years later, the value of Evernote to the user is much greater than the first day, so users are more likely to reuse it. Although the number of users for most services decreases over time, Evernote the opposite, users will use the service more than a year later. As users get more and more value from free products, some people choose to pay, which brings significant revenue to Evernote.

2. Free users who can attract paid users

These users are currently not paid and will not be paid for the future. But based on user loyalty and level of activity, your service will attract other paying customers. Through a variety of ways, these users will become marketing channels, can bring meaningful investment returns.

Key Product properties: viral propagation.

Typical company: SurveyMonkey. Online surveys are typical of viral transmission. A free user may send dozens of questionnaires. By doing so, he promoted SurveyMonkey to hundreds of potential users. With the right conversational rate, such a marketing project will become a very effective paid user access channel, even if the initial user may never pay.

In order to become a successful free value-added company, your product needs to provide more and more value over time (direct conversion), or the ability to spread virus (attract new users). Some lucky companies have both. For example, for Dropbox and GitHub, free users can attract new users on the one hand through file sharing, on the other hand, as storage files increase, they can be directly converted to paid users. This will bring the ideal free value-added products.

Once you are certain that free users can bring value to the business, you need to make sure that the financial indicators are performing well.

4 Ensure financial indicators

The free value-added model will fundamentally change the financial position of the business, which has the potential to bring both a good and a bad side. Even if you are confident that you can attract free users, you still need to understand the financial situation and ensure that the financial situation is in your interest, which will ensure that the free value-added model drives business development. You need to do two important analyses:

1. Market Size

Only when in a huge market, free value-added mode can be effective. This is why companies such as Dropbox and Evernote are targeting large levels of the market. If a portion of a product is priced to zero, the price of a paid product is not too high. In addition, you will sacrifice some potential users as a result of offering free alternatives. Since a large percentage of users are free users, you may need to attract millions of of users to create a meaningful paid user base. Most free value-added companies have a conversion rate of 1% to 10%, compared with an average of 2% to 4%. In general, users cannot spend more than hundreds of dollars a year. So if you want to make your company's annual revenue reach 100 million dollars, you'll need millions of users. If the market is not large enough, the free value-added model should not be adopted.

This model does not take into account the user's fluctuations between free and paid. This volatility means you need more free users or a higher conversion rate in the product lifecycle.

2. Return on investment in free value-added mode

In addition to the size of the market, you need to ensure that the return paid to users exceeds the cost of providing services to all users. As mentioned above, the free value-added model requires lower marginal cost of products, which means that the provision of services to new users does not entail higher costs, which is the main reason why the free value-added model is applicable to the software industry. Products with higher marginal costs, such as hardware, are often unsuitable for free value-added mode. By comparing the cost of providing services to free users and the income earned by paid users, you can calculate the return on investment in the free value-added model.

In our 3rd experience, we talked about how you can get revenue from free users, as long as they: a translates to paying subscribers; b attracts other users. If the free value added model is right for you, your 1-year ROI should be a higher positive, and more than 50% for most startups. (In some cases you can set a negative 1-year return on investment to drive market share growth, but the return on multi-year returns should still be positive.) However, this approach is risky and applies only to mature businesses that have stable performance and are easily predictable. )

Optimizing key financial indicators is the hardest part of creating a successful free value-added business. Determining product pricing and distinguishing between free and paid products will be the most influential factor in session rate, viral spread, revenue, and ROI. In the initial stages, these decisions can only be based on guesswork, as well as ongoing attempts and mistakes. However, with a better understanding of the free value-added model and analysis of the user base, you will be able to better determine the price, maximize the return on investment, and achieve profitability.

5 Measure Effect

As investors, we like the business of providing user-group data. Why? This is because user group data reflects the current state of health of a company and the potential for future development. By dividing users into groups (based on a standard registration cycle, such as one months or a week), companies that use the free value-added model can summarize trends in user access, participation, transformation, and continued use of services.

For free value-added companies, group analysis is particularly important because there may be a long lag between user registration and final conversion. In the traditional software licensing model, users will receive the software immediately after payment, the transaction is basically over. But in the free value-added model, free users are likely to pay for a few years before they use the service. The only way for a free value-added company to judge a user's conversion rate is to track long-term group behavior. It's like a wine maker can judge a batch of wines by tasting a bucket of wine.

If you can keep a close eye on and understand user group data, the enterprise will gain two advantages:

1. Understanding of user conversion and retention rates

User group data helps organizations understand valuable information in product development and pricing processes. One of the most common analyses of the free value-added model user base is tracking long-term cumulative conversion rates. Ideally, the cumulative conversion rate of free value-added companies should rise over time, and the cumulative conversion index for each group should rise.

Other time-based user group data that can help track key metrics include:

-What is the typical behavior of a user after 3 months of registration? What is 1 years and 3 years from then?

-What is the lifecycle value of free users and paid users?

-Do users from different channels have different conversion rates?

-How does product tuning affect user group behavior?

-How does price adjustment affect the user's use or conversion rate?

2. Better Predictability

With strong user base data, free value-added companies in the process of maturing will be more and more predictable. CEOs, venture capitalists, and open market investors all like better predictability. For a given period of time, the revenue from the free value-added companies came from 3:

-paid subscribers who have been converted in the previous time period continue to pay

-For the first time, free users have been converted to paid subscribers

-Instantly convert users who are attracted to the current time period

Through the user community's historical data, free value-added companies will be able to better understand how many paid subscribers will continue to pay for a given quarter and how many free users will be converted into paid users. The only sources of revenue that are uncertain are new users. Therefore, the free value-added model is more predictable than the software as the service mode.

6 Break Free Value-added mode

Although the free value-added model can bring great scale and profit, it is not a rigid pattern. Most successful software companies have gone beyond the free value-added model and tuned their business to meet user needs. They typically take multiple strategies and follow 1 or 2 points in the following guidelines:

1. Sales are not enemies

Many free value-added companies have developed Easy-to-use products that automatically convert free users to paid users, but these companies often fail to position themselves well in the sales department. For companies such as Dropbox, New Relic and HootSuite, they have a high penetration rate in the enterprise market, discovering that customers want to sign enterprise-level cooperation agreements and talk to sales people. This is a good thing.

Although most free value-added companies do not have a large sales team, smart companies will remember the 2nd experience: Know your users. If users want to buy your product in different ways, you should also adjust the sales model. Free value-added companies can build a strong sales team in a product-centric culture. Free value-added companies have a huge advantage over non-free value-added companies because they have attracted a lot of leaders who love their products. For example, Dropbox's free value-added user base brings potential customers to the company's corporate products, and its enterprise products do not use the free value-added model.

2. Free trial is also free

Companies including 37signals and Zendesk do not offer permanent free products. These companies believe that all users who gain value through their products should eventually pay. However, by offering a free trial, users can intuitively understand the product, making the product itself the best marketing tool. Similar to free value-added companies, these companies adopt a high speed sales model and therefore require a product-centric culture. They may sacrifice market share but will bring more profitable and faster-growing companies.

Conclusion

While the free value-added model does not apply to all companies, it will be a powerful tool if used in an appropriate manner. We've seen a lot of companies, including the 9 companies interviewed, that have gained huge revenues and profits with free value-added or high-speed sales. We believe that the free value-added model can also bring long-term and stable business, just as Salesforce has billions of dollars in revenue by virtue of software as a service model.

However, before building a successful free value-added company, keep in mind that all startups need to develop world-class products to solve the user's real problems. If you judge that the free value-added model is the most appropriate way to do it, hopefully the above experience will help you.

This article compiles from TechCrunch