Enterprise Freemium Magic
Freemium can be magical for enterprise software, but has some tricky downsides
Thanks for reading the ProductFix newsletter. In this edition, I turn my attention to the marvels of the marketing strategy known as Freemium.
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Enterprise Freemium Magic
On March 23, 2006, Fred Wilson wrote an article on his blog entitled “My Favorite Business Model”. This crystalized and catalyzed the Freemium business model for the software business.
Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc, then offer premium priced value added services or an enhanced version of your service to your customer base.
Fred Wilson, AVC blog (Mar 23, 2006)
Fast forward 15 years later to today and we find freemium pervasive in our business and consumer software products. It didn’t start with Fred Wilson’s blog post, but this model certainly accelerated in the years that followed. No doubt aided by digital transformations and the shift toward cloud services as the back-drop.
When there is no Magic?
The buying process in enterprise software is long and drawn out. It is not uncommon to have 9-month or longer average sales cycles in many product categories. Why does it take so long? It is not because the software provider wants it to take a long time. It is because of many factors, including:
High Cost - Enterprise software can range from $50,000 to $millions per year in the license, maintenance, support, and/or subscription fees. Further, implementation, transition, and organizational support costs may be a multiple of the software itself. These costs are generally justified by increasing revenue, decreasing costs, or better managing business risks. Such large items often need to be budgeted for months in advance of selecting a solution.
High Risk - Enterprise software creates high-risk for the organization making the purchase. Is it the right solution? What if it fails to deliver the expected value? Who is to blame if outcomes aren’t as good or better than expected? What if it touches sensitive data and mission-critical activities? Individuals making these buying decisions are putting their reputation and, sometimes, their job on the line.
Complex - Once a need is identified and potential solutions are found, they are never identical. Understanding the variations in options, how to weave it technically and operationally into an existing business is not easy. Typically, buyers want to understand how these risks will be mitigated before signing anything.
Many Stakeholders - Unlike consumer products where you often have just one key person to focus on, in enterprise software we need to deal with procurement, the budget owner(s), the people with the problem to solve, influencers, potential blockers, and ultimately the users. All of these roles represent a tangled web that sales teams must navigate through a long journey toward closing a contract.
Traditionally, we tackle all of these challenges in the buying process by hiring a large sales organization. They take the ball as soon as marketing efforts create some qualified leads.
When successful, after shepherding prospects over many hours of phone calls, webinars, product demonstrations, in-person meetings, collateral exchanges, draft project plans, stakeholder turnover, proposals, and contract red-lining through gauntlets of procurement and legal professionals - they become a customer.
Now, the fun begins. Handover to Customer Success to get the new customer onboarded as fast as possible. This often involves engaging with whole new teams both on the customer side and vendor that were not part of the buying decision.
Don’t forget to train the end-users and get them excited about having to learn a whole new system to do what they were doing differently yesterday.
Now for some Magic
Users start by solving their own problems
What magic does Freemium bring to the table? As I outlined above, the traditional buying process is a long and arduous journey. Both for the vendor and the customer.
In Freemium, the user is empowered to solve their own problem with limited financial risk. If the product provides anticipated value usage of the product should spread throughout the organization. The users become the buyers, influencers, and users all rolled up in one.
As the usage of the freemium product expands, so too should the value of that product to the organization.
Hubspot - A user with an unmet need can start simply by maintaining their own contacts list. Before you know it, the value can expand to full CRM, sales, and support management across multiple user functions. With each new user and function added the lock-in deepens but the business value accelerates faster.
Slack - Gains increasing value with wider communities able to have short asynchronous communications.
Google Docs - Gains as more users collaborate around the same office productivity documents, spreadsheets, and presentation files.
Mailchimp - Gains as distribution lists increase in size, creating more touchpoints for marketing and sales.
Trello - Simplifies project and task management as more team members work from a single set of facts. Before you know it, hundreds of people can be collaborating, keeping work visible, and reducing unproductive status communications.
So now the enterprise is receiving a clear business value that can be quantified removing a great deal of organizational risk in the buying process.
Enterprise Freemium Magic:
Users become the Decision-Makers, Influencers, and Buyers all-in-one.
Users are motivated and derive value through self-training
When users switch companies or organizations they can start using these freemium products again without waiting for a buying process to start or finish
All led by highly scalable, low-touch marketing efforts
No sales executives and no sales engineers involved
At some point, the value proposition becomes clear enough to justify the cost of paying for the premium (aka paid) tier of service. Either the limitations in the paid tier become unacceptable under widespread use (like no backup, limited history, no change controls, enterprise security policy gaps) or the premium features prove compelling (such as more features, limits removed, branding).
A sponsor steps up to allocate some of their scarce budget and procurement closes the deal.
Enter the Sales Team
When the magic conversion step does not happen on its own - sales is called in to help.
Unlike traditional enterprise software sales where lead quality is frequently in question, prospecting to closing a deal may take months — freemium leads are of very high quality, can be recognized immediately upon closing, and you know you will have happy customers.
All smart freemium vendors collect product analytics, user demographics, and firmographics against their historic conversion rates to premium tiers. This data provides excellent predictive data on who is most likely to convert with sales engagement.
Sales focuses their attention on those opportunities most likely to convert.
The Downside of Freemium Magic
All of this magic is not without its perils. If it were so simple, everyone would be doing it. So here are the primary obstacles to unlocking freemium magic.
It Doesn’t Work for All Categories
Freemium has entered into more product categories than could have been imagined 10 years ago. However, it still does not work well in those areas that it takes an all or nothing approach to run in the business.
Examples unlikely to be freemium:
An HR employee trying out a new payroll service.
An industrial engineer choosing their own MRP.
A security admin deploying their own Biometric Solution for mobile apps.
While these users may review, test, and even set up a limited trial in these examples, many enterprise software usage decisions are beyond the ability of a rogue individual to make.
Further, most experts say you want a product that has potentially millions of users. So if your category has only a few to a few thousand potential customers, you probably don’t have the scale to make freemium economics viable.
Your Product Better Be Great
First, unlike traditional enterprise software that is purchased primarily on the value, aka ROI, the business can estimate with limited regard for the users, this selection process is entirely driven by the users. Users that can independently decide to use software can also decide to drop it. Happy users create more users through their influence.
Freemium products will typically follow the product-led growth model as well. This means they will be hyper-focused on increasingly satisfying user needs, usually supported by robust research practices, product analytics, and iterative design.
Picking the Premium Dividing Line is Critical
It is easy to get stuck delivering a great product to a growing user base stuck on the free tier. Through careful analysis and a bit of luck, freemium products need to craft a dividing line carefully between the free tier and the premium tiers. Enough value in free to create high demand, real business value, engagement, and influencers. Yet, clear and attractive additional value gain by opting into a paid tier.
Within each category applying freemium, this dividing line is where products can uniquely distinguish themselves from alternatives.
Zoom attributes a lot of their early adoption success and ability to convert to creating a simple 40-minute limit to free use.
MailChimp switched to freemium and set an initial dividing line at 500 contacts to an email list. In just one year, they increased their users over 5x, increased paying customers by 150%, and profits by 650%. It worked so well, they have gradually increased the key dividing line to 2000 contacts.
Evernote, by contrast, found they set their dividing line poorly and, in 2016, had to adjust it to push more conversions into premium territory. Feature by feature they decided free or premium and over-time it got muddled and limited clear added value for upgrading. So they made the big decision to potentially lose some free users to gain a higher percentage of paid users.
Your Marketing Expenses will Explode
With a freemium marketing strategy, you will create some segment of your users that are permanently going to stay on the free tier. A business needs to budget knowing that this is simply the cost of engaging in this practice.
Be Comfortable with Forever Free Users
At Evernote, they once had just 0.5% converting to paid tiers. At Slack, it was estimated at 30% conversion just a few years ago.
Why is this important? Regardless, of being on a paid or free tier of support, there exist costs for support, hosting infrastructure, and personnel that must be accounted for. Under a freemium model, all of those costs associated with free users get accounted for as a marketing expense. By contrast, all paid users have these costs listed as a part of the Cost of Goods Sold.
The impact is that the Gross Profit Margin may seem somewhat inflated since a lot of infrastructure expense is not factored into Gross Profits. The bigger challenge is that, from a planning perspective, it is very difficult to predict your marketing spend in this model.
In traditional enterprise sales marketing is a fairly predictable and routine expense tied to external services, campaigns, and events. Under freemium, a spike in activity can cause similar spikes in new free users.
Take Zoom, for example, who witnessed millions of new users during the COVID-19 crisis, driving them to acquire more cloud infrastructure resources from Oracle.
Breaks Enterprise Control Protocols
The last potentially negative side to the freemium model is that it works because it specifically removes slow-moving stakeholders from the initial selection process. Procurement loses control. Information Security and Compliance teams are out of the loop. These organizations exist for good historical reasons, and freemium circumvents them which may cause some backlash.
If this is severe, they may make it difficult for these organizations to convert from free to premium tiers of service.
Conclusion
I think that the Freemium Marketing Strategy is simply amazing at what it can do. In categories where Freemium offerings exist now, it is difficult to compete without offering a free tier of service. When it comes time to decide to buy, it would be very difficult for procurement to open the selection process up if a viable free tier product is already delivering proven value.
The huge advantages gained by Freemium do not come easy. Your product must be awesome. Users must love it beyond the business value it creates. It affects your business model and sales approach plus is only viable in certain product categories.
Not many established enterprise companies have transitioned to freemium offerings — but even Microsoft Teams is giving it a try.
👍🏼Recommendations
Blog: AVC by Fred Wilson. Drops of insights on a daily basis from the co-founder of Union Square Ventures in NYC.
Medium Article: The Top 10 Videos to Watch for Product Managers of All Levels by Alex Mitchell. Couple good oldie videos in here like “20 Years of PM in 25 Minutes” and “Agile Product Ownership in a Nutshell”. Enjoy!
Follow: Nick Finck (@nickf). Some UX Design thoughts from experience.
🍺Overtime
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