Only five percent of respondents would choose to pay for news, if their favorite news site suddenly begins charging for content, according to a study by market research firm Harris Interactive, commissioned by PaidContent UK. The vast majority, 74 percent, said they would "find another free site."
But can giving away most content to gain a small percentage of paying users ever be profitable for a company? “Freemium” advocates say “yes.” In fact, that’s what the freemium business model is about: Most customers get basic services for free, while a small percentage pay for premium access.
There are two main principles behind this: 1) free marketing, 2) economics of scale.
Wired editor Chris Anderson wrote the book Free on the subject. He says on his blog: “Free is not a business — it’s zero-cost marketing for a business. And it works best at the largest scale: a small percentage of a big number is a big number.” As freemium uses the near-zero marginal cost of online distribution to reach the maximum possible audience, converting a small fraction of them to paid users is not only possible, but a smart strategy, says Anderson.
The success of some companies has validated this idea for some products. For example, a survey by mobile advertising agency AdMob shows that Android and iPhone users download approximately 10 new apps per month, according to Cellular News. Of users who bought paid apps, the top reason cited for their purchase decision was that they liked the free version of the app.
Another example: When Random House’s Del Ray imprint offered the first book of Naomi Novik’s Temeraire fantasy series for free, sales for the other Temeraire novels increased by more than 1,000 percent, says The Associated Press. And it’s not an isolated case: the AP notes that the top three Kindle sellers – that is, the most downloaded e-books on Kindle – in recent days have been free e-books.
But perhaps the best examples can be found in the virtual gaming world. For instance, The Guardian reports that Club Penguin, which targets child gamers, was said to have 12 million users, of which 700,000 were paid subscribers, when Disney bought it in 2007. At a rough average of $5 monthly subscription at the time, the site was estimated to be generating $42 million in annual revenue. “About 80 percent of the site is free,” Anderson told Journalist Charlie Rose at the recent MIXX advertising conference in New York. “Eventually, young users will ask their parents for a credit card and say, `I want to buy a pet for my penguin.’”
Freemium may in fact be necessary for the Web, says Ranjith Kumaran, CTO and co-founder of online file transfer and e-mail service YouSendIt. Because “without traction, it doesn’t matter how good your product is or how much you spend to market it,” he tells BNet.
Of course, success based on freemium is not certain, nor easy. In fact, YouSendIt still needs more premium subscribers before it will become profitable, notes BNet. Currently, the company has 10 million registered users and 100,000 paid subscribers, not including corporate accounts or pay-per-use. While the overall conversion rate from free to paid is over 3 percent, for the company to turn a profit, around 5 percent of all customers will have to be “paid.”
So when is freemium a good idea and when is it not? Michael Mullany, VP of marketing at online hosting company Engine Yard, tells CNet News that companies should consider the following four factors: Cost of marketing and selling to a user in a paid model, cost of serving a free user, cost of acquiring a free user, and how successful you are at converting users from free to paid.
CNET reports that the highest freemium conversion rates fall anywhere from 2 to 8 percent. Mullany notes that for the freemium business model to make sense, your cost to serve and acquire a free user must be from between one-twelfth and one-fiftieth the cost of acquiring a customer under an alternative paid model.
Non-online companies that have to physically package or ship products should beware, however. Freemium will likely not work for you because of your actual costs. You won’t enjoy the Web-based near-zero marginal cost model. As Anderson says, “You can't mail a brownie to everyone in the world on the hopes that a tiny fraction of them will come back for more.”
