Freemium technical-view-of-an-emerging-business-model


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Short paper about the value of the so-called Freemium business model that is based on selling 2 forms of a specific product, one for free and the other for a positive price. The first one basically creates a market for the second, while at the same time providing the producer with valuable feedback that can be used when optimizing the second product.

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Freemium technical-view-of-an-emerging-business-model

  1. 1. Freemium: attributes of an emerging business model Nicolas Pujol, author Pujol Enterprises LLC, Kirkland WA; DRAFT – 01 December 2010 Quantity differentiation is the most ancient: product samples have long been used in pre-sales situations,Origins and types of freemium representing the zero price version of its commercial complement, the full product. Samples are a form ofAn umbrella term for new and old freemium with quantity limitation, in terms of volume. The digitization of the economy throughcommercial practices media, software and network services has given riseFreemium is a term increasingly used in commerce to to another type of quantity limitation: time.designate a business model using two products or Nowadays, web services can be activated andservices, or a combination of products and services. terminated within a defined time period through trialIn such combination, one item is provided at no programs that serve as demand generation during pre-charge while a complementary item is sold at a sales cycles. Variations of the time differentiationpositive price. Unlike what economists call tying, the concept also gave birth to maturity: beta, immaturefree and commercial items are softly connected: the versions are often made available to a subset of a usercomplement is not indispensable. The practice has population (for example, developers of softwareexisted for a very long time, although it carried programs) or the entire user base with disclaimersdifferent names and forms. The name however was that such product is unstable and unsuitable forcoined by venture capitalist Fred Wilson in 2006 and general purposes. Other distinctions includeis gradually becoming a model that businesses enthusiast versions, which contain new features thatidentify with. Freemium relies on a free version of a have not been time tested. In other words, the valueproduct or service, and by nature this version is from the asset comes from the quantity of time that itlimited. Commercial transactions happen outside the has been used, which reflects the amount of userslimitation. The delta between what is free and what is having tested its reliability. Customers pay forpaid is generally called differentiation. maturation of time.Freemium is sometimes confused with two-sided One variant to the time differentiation paradigmplatforms, but is not the same concept. In two-sided includes data release. This is particularly relevant forplatforms, a company deals with different groups of time-sensitive data such as financial news andcustomers on each side, and each side is statically generally media-related information. In this model,established. There is no transition or conversion from vendors provide the data at no charge over time, butone side to the other. In freemium, free and paid release it first to paying customers gaining a timeusers may constitute one general group. Each free advantage over free users.user can become a paid user, and vice versa.However, we’ll see that even if not a platform, Feature differentiation separates product functionalityfreemium may have similar attributes to two-sided and levels of service between a free and commercialmarkets. set of offerings. At the core, one finds either a product that is limited in functionality (the free core)Types of freemium and another that includes advanced featuresThere are three differentiation strategies: by quantity, (premium core). From this epicenter, adjunct servicesfeature, or distribution. may be added and target either the same user as the free product or a different one within the
  2. 2. organization. Feature differentiation can be packaged software that includes a user license. Thechallenging as it requires trade-offs between growing license, open source or commercial, dictates the usethe free user base and generating revenues. This is cases where the product may be used at no chargethe reflective competition dilemma in a book to be and those that require a commercial right. Dependingpublished early 2011. how the end user obtains the product and what she does with it, it is free or it costs money. For example,Another type of freemium may allow a commercial software may be free to use but not to re-distribute ormodel through differentiated distribution and use embed. Alternatively, it may be free for non-cases. The split between free and commercial models commercial purposes or require a fee-based license ifoccurs in the way the product or service is the end user utilizes it for commercial purposes.distributed. This scenario is mostly found today in Figure 1: 13 "free vs. paid" scenarios in freemiumThe nature of freemium is a form of demand party, no requirement to purchase now or later.generation. Given such demand generation is attained Viewing the transaction this way would leave thethrough a product or service and not a traditional tangible benefit for the provider ignored: the useradvert (banner, catalogue placement, generally, a pays for the free good with an alternative currency,message), freemium is often seen as a product which is mind share. Mind share is the developmentstrategy with a zero price, an odd transaction where of awareness for the provider’s brand and thethe recipient receives a free product without counter consideration for purchase of future commercial
  3. 3. products and services. It is in itself a seed of brand exchange. Sales cycles in freemium scenariosequity planted in the recipient and not a currency therefore have two steps, representing two discretewhen the recipient is provided a message, and a transactions. The free product plays a dual role: first,message only. Mind share becomes a currency in the that of a product (playing in a market) at a zero pricecontext of recipients being provided more than a in step 1, and that of an advert for a relatedmessage i.e. the value of a product or service, commercial offering in step 2.monetarily “free”. It becomes the currency of Table 1: comparison of traditional sales cycles with freemium Pre-sales TransactionTraditional sales cycle Advertising (banner, ad words, Sale of commercial product or message) – step 1 service – step 2Freemium sales cycle (step 1) Free product or service wins on Free product or service is sold at basis of zero price, value proposition price of zero. Currency: user’s mind and viral marketing share.Freemium sales cycle (step 2) Free product acts as the advert for Sale of commercial product or related commercial goods service. Currency: money.Freemium as a multi-sided marketMulti-sided (often simplified as two-sided) markets Software platforms: end customers purchaserepresent a business relationship where a company computer devices in large part because of thedeals with different groups of customers that are applications that are available on the device. As adependent on one another (Hagiu, 20091). This result, platform companies must court applicationinterdependence between one group and another is developers to work with them while at the same timecalled indirect network effects. The presence of promoting and selling their effects and the distinct separation of onegroup of customers versus another, are two factors Freemium does not involve a platform to operate.that define multi-sided markets. In academic Furthermore, free users and paying customers belongliterature, two sided markets are often referred to in to one general category. By these two characteristics,the context of platforms. Schmalensee and Evans the model does not fit the standard definition of two-(20072) list four types of multi-sided platforms: sided markets.Exchanges: the platform company puts buyers and However, a look at the real world reveals a differentsellers in contact towards a transaction. reality. We can take the example of open source software: models in this industry do require distinctAdvertiser-supported media: the twentieth century sub-groups of users in order to function. Forradio stations, newspapers, televisions and newer example, early adopters and technically savvy usersbusinesses including internet search, making content are often knowledgeable enough to never have to relyavailable at no charge to users while generating on outside services or tools that facilitate the use ofrevenues displaying ads. the products. We can refer to this group, or side, with the letter A. In return, these free users deliver valueTransaction systems, such as credit card companies to the provider by testing the product, creating adealing with consumers and merchants. brand, and sometimes contribute code or bug reports.
  4. 4. A different group of users is more conservative in represent users, unlike platforms where the twonature, and often defined at the business or customer groups are distinct by nature.commercial segment of the market. This segment thatwe can call side B is the one using commercial In addition to being distinct, the two sides ofservices and/or feature upgrades from the free freemium show interdependence: risk averseproduct. customers value the fact that early adopters have battle tested the software while providing the vendorSides A and B have distinct demographics, behaviors positive brand equity that will help it sustain itsand needs. They are sometimes playfully represented business over time. Conversely, free users benefitby the photo of a Computer Hacker (a technically from the presence of commercial customers in theskilled software professional with an early adopter, ecosystem: the latter provide vendors the financialtrial-and-error bias) and a corporation’s Chief resources to produce more free software and shareFinancial Officer (pragmatic, more risk averse and more code. This interdependence mirrors the indirectlooking for commercial relationships with software network effects seen on platforms.providers). Their commonality is that they both Figure 2: transactions in freemium1 Andrei Hagiu: Note on multi-sided platforms, economic foundations and strategy (HBS, 2009)2 David S. Evans and Richard Schmalensee: The Industrial Organization of Markets with Two-Sided Platforms(2007), available at