First, a quick quiz…For this quiz, time is important as we want your gut instinct so you only have five seconds to answer before the submit button goes away. It’s multiple choice, there are only two options and you simply need to select one.
When you’re ready, go take the quiz and make sure to return here…
Pricing, Business Models and Virtual Goods
The topic of free and freemium pricing models is a regular one in startup land.While I’m sure it comes up on occasion in more traditional businesses, I have a feeling it’s much less the case. I don’t recall Mark pondering the option of offering free drinks and meals for the first six months at OX Restaurant. Or Beth considering just giving sweatshop free clothes away for the first three months at Grey Rock Clothing.
“When something is FREE! we forget the downside….we just can’t resist the gravitational pull of FREE!”
Over in startup land, it’s almost universal that first time founders plan to launch their product initially for free. While the free excuse list is almost infinite, a few samples include….
- We really want to get people in and using it, get them hooked on the app before we start charging.
- Because this is such a new innovative way of doing things, we can’t charge them, they just won’t pay until they use it.
- Once we have enough users, we’ll start monetizing through ads but we can’t sell ads until we have the users.
To be clear I’m not advocating against free or freemium models. In some cases they make great sense, however those cases are rare. What I am advocating is that you make that decision explicitly and can back up your reasoning. I have yet to speak with a new founder who plans on offering free initially AND has a good reason for it. Someone who’s explicitly thought it through and has clear, sound reasoning why they’re starting with free.
Making an Economic Choice
In new product development, what is much more important than free users are the hard no’s. What’s a hard no?
“Here’s a pink stuffed animal I made, do you like it?”
“Yes, it looks awesome, you’re a lovely human being, let me hug you…”
“Will you buy this pink stuffed animal from me? Will you please give me 20 of your hard earned dollars for this pink stuffed animal I made?”
“You want me to give you 20 bucks for this crappy stuffy you stitched together? Are you mad?”
There, that’s a hard no. It’s someone saying no, I don’t see enough value in this exchange for me. Hard no’s are money in the bank for startups, if you leverage them. You have to chase down every hard no and ask why, why, why? Why don’t you love me anymore? Why doesn’t my value proposition work for you? Would you pay $10? What if I included a lifetime warranty? What if it was $5 plus a lifetime warranty?
Starting with free removes your ability to get to those valuable hard no’s almost entirely. Now rewind the above conversation…..
“You want me to give you 20 bucks for this crappy stuffy you stitched together? Are you mad?”
“I’m just kidding, we’re giving them away for free as part of launching our new company, here it’s yours!”
“Thank you! I love you again, that was a close one”
See the difference? Few people can resist the power of free. You feel great about your pink stuffed animal, love is in the air, everybody happy, happy, happy.
What happens to the pink stuffed animal? The same thing that happens to most free software apps, it’s neglected and dies a slow quiet death in a dusty basement. Dad never says “hey, why aren’t you loving that pink stuffed animal? I paid $20 for that you know?!”
Here’s the thing you must realize, free is a reality distortion field of it’s own. We can’t control ourselves around free. Remember the quiz at the top of this post? I’m quite confident that greater than 75% of you chose the free option even though it’s not a rational choice. A $30 giftcard for $5 offers you $25 in value. A free $20 giftcard offers $20. That doesn’t matter since we go bonkers around free!
“Zero is not just another discount. Zero is a different place. The difference between two cents and one cent is small. But the difference between one cent and zero is huge!”
Clearly the rational choice is the $30 giftcard but free messes with our minds. In the book Predictably Irrational: The Hidden Forces That Shape Our Decisions, the author Dan Ariely digs into the details of how we tend to apply either market norms or social norms in these situations. Free confuses your customer into applying social norms instead of market norms. This will certainly increase your user count but if you’re building a business you need to iterate to a value proposition that works when customer’s apply market norms to them.
If it makes good sense, free it up! Just be aware how powerful free can be. Depending on how you use it, it can help or hinder you. Offering free prevents your customers from applying market norms to your offering. Having customers applying social norms can distort your offering in ways you may never recover from. Good luck selling those $20 pink stuffed animals six months from now!
I firmly believe that you need a direct business model if you want to build a “real” business. Period.
well then there’s that, you won’t find me arguing with you. My hope is that more people get to your view quickly!
What is this business model thing the kids are talking about these days?
I like ‘free’ models. Where I think founders go wrong is in A) identifying (pre-launch) which features to limit in order to prod users to move up to a paid service and B) knowing how to price those tiers according to the user’s estimation of their value. C) realizing that an a la carte menu is how people buy things in the real world (apps with dinner, to borrow from your restaurant analogy)
I’ll give you an example: I use the freemium version of insight.ly, a cloud CRM. It isn’t perfect, but it integrates with Gmail and does a good enough job that I don’t look elsewhere. I’d actually like to move up to the next tier so that I can add other employees, but the monthly cost doesn’t align with my expectations/budget – and the features of that tier are not useful to me at all.
I don’t recall insight.ly asking me why I don’t move up – despite adding and deleting users several times (surely an indicator of someone who is bumping into the user ceiling?) and I can’t simply add a user for $10 a month. Another failure.
Bottom line is, free got me using it, and it isn’t ‘free’ that’s stopping me from paying for it.
sounds like a good example/usage of free, I’m going to check it out. Have you seen streak.com as well?
no idea to be honest, @startupcfo:disqus mentioned it…I was just bluffing and following along…
I can give you a compelling case for FREE.
I’ve got two android apps that do exactly the same thing.
The free one has ads, the paid one does not.
The free one makes 4x the revenue as the paid one, and it does it monthly rather than a one time sale.
There will always be people willing to pay a little to get a better product, and I want to accommodate them because I am one as well, but it turns out, to my surprise, that my bread and butter is based in the FREE world.
I have run into that same problem numerous times with “cloud tools” that I use for work. Freshbooks is a good example, Zendesk is another, and there are many others.
The issues is always one of scale economy, where the jump to the next level can’t be justified by the amount it will cost. Incremental fees as much easier to swallow, but they can’t be too high.
In the end, these companies should be charging what the market will bear, and their free accounts are loss leaders anyway, but I know from being a consumer that you’re likely to get more out of me, in small increments, over time, than large fees all at once.
I hope it was clear that I wasn’t suggesting free has no place in software? Look at this blog alone with wordpress, disqus and likely every other piece of software involved, clearly free is entrenched in software. One of the core messages I hope comes across is that free is powerful, use it to your advantage and make sure it improves your business not harms it.
Thanks for sharing a positive case for free!
No, no, that was very clear :)
I actually find it a bit distressing that its working as i describe however.
I attribute the success of the free with ads model to a combination of demographics, but most importantly on mobile: a) you can attract all the kids with a smartphone but no credit card. b) Some people feel that they should not have to pay for the software they use. c) some try it out and don’t mind the ads enough to pay for them to be gone.
Regardless, it’s unfortunately in my interested to encourage them to use the free version because the ads are worth more, particularly re-occurring, than an outright purchase, which I am then obligated to support. At this point I have the choice to be more philanthropic about it, except that I do this for a living ;)
Actually, i guess this is a good time to paraphrase that saying, that I can’t attribute without looking it up: “if you think its free, then you are the product”.
Interestingly prior to our grand opening we individually handed out hundreds of cards (to a targeted audience) that said: bring this back in the weeks after we open and get a free t-shirt if you spend more then $50 and we had about 5 people redeem them. So free with some stipulations attached is a different thing. This year we’re giving out free downtown parking passes at Art in the Street. We’ll be telling people in the street, you don’t have to buy anything to get one, just come into the store. It will be interesting to see how that goes.
Hadn’t seen streak but I checked it out. Might use it for dealflow, which is otherwise killing me.