how free pays

This blog post does not advocate free products/services.  Chris Anderson sockpuppetry may be found elsewhere.

This blog post does not trash the freemium model, either.   Instead, it looks at business realities – cost of customer acquisition, revenue per customer, growth and scalabaility – advocating a large strategic toolbox and a careful selection, informed by hard data.

Businesses dig holes – they invest in developing and expanding products and service – so they seek ways to fill in the hole and then some.  Some were surprised to learn that the World Trade Center’s foundations sunk over 100 feet – clear down to bedrock.  The highest structures have the deepest foundations.  If you want to grow big, you have to dig deep.

In business, digging deep means borrowing – from investors, in the form of equity; from lenders, in the form of secured debt; from grantors, rich aunties, unsuspecting spouses – you get the picture. And those investors and aunties – anyone who takes a risk – they want their money back, with a premium, fast. This is just one of many reasons why speed of execution is so important.

Back to the construction metaphor, once you dig a hole, it starts filling with water. Then the whole job site gets muddy. So best get that roof up – fast!

Apple goes to the superbowlGrowing fast means acquiring customers fast. Attracting, converting and retaining customers is expensive – leading to any number of marketing gimmicks: spam (oops, AOL), virals, bounties (oops, Amazon), artificial scarcity, bundling (oops, Microsoft) – because not everyone can afford a superbowl ad (oops, Apple, GoDaddy, HP, IBM).

Pricing gimmicks are nothing new – Hammurabi, Jesus and Tecumseh all complained about them. Sale pricing, promotional pricing, free pricing, e.g. generate artificial urgency around a value proposition – or in the case of “free,” to remove the proposition altogether. Something for nothing. A free lunch. A windfall, pennies from heaven – Barnum had a name for his target audience.

A recent NYTimes analysis shows jut how the freemium model works – its not Web 2.0 lottery math or intangible network effects – it’s real cost accounting, the kind that investors demand:

  • cost per customer acquisition
  • ratio of conversion from Free to Premium
  • cost of customer retention
  • revenue generated per customer

Few businesses have the financial savvy to account for all these costs, let alone founder’s time. Those that do, can win at this game. Those that don’t, can’t – they’re playing darts, blindfolded – gambling with their investors’ stakes.

Sure, it’s hard to divvy up every fixed and variable cost, and apply it consistently and dispassionately – that’s what a good Business Model does. But it’s even harder to dig that hole and watch it fill with water because you didn’t grow fast enough.

That’s called “taking a bath.”

The freemium model is a pricing tool and a marketing gimmick, nothing more. As a means to execute a business model, its relative value is not open for debate – it’s right there, in the spreadsheet. It works when conservative customer base forecasts are consistently met. And if they can be met without giving it away, so much the better.

It’s tempting to try to recoup sunk costs on incremental sales, but that hampers growth. It’s just as tempting to drink the Kool-Aid and give it away, but only if you can capitalize on growth. Work the numbers.  Free can pay, but only if you’re disciplined enough to stick to your Business Model.

Did Jesus have an affiliate program?A good busines model is not a panacea, it’s just a rational basis for an irrational decision: Create something wonderful. Give it away. Maybe Jesus was onto something…

Tags: Coaching · Economic Development · Marketing · Strategy