When to Go Freemium?

“Freemium” has become the default pricing model for every new startup. After all, today a startup’s user acquisition rate is the metric that primary decides the number of zeroes at the end of its valuation. And Freemium definitely offers un-throttled user growth.

But beyond the startup phase, is freemium always sustainable in long term? When is it better NOT to use Freemium? I asked Ash Maurya this question on Twitter and he replied:

(don’t use freemium) When either the marginal cost per user is unaffordable and/or no quid pro quo from free users

This makes sense but needs to be discussed in more detail, given the brevity of his tweet. Put differently, Freemium makes sense when:

Life Time Value (LTV) from a free user > Life Time Marginal Cost (LTMC) of retaining a free user

This condition ensures that each free user brings a net positive value to the business over his/her entire lifetime. To put this to test, I took up the case of Dropbox (recently valued at $10bn) to see how things stack up for them. 

Life Time Value (LTV) from a free Dropbox user

There are three sources of value a free user brings to Dropbox:

  1. Upgrade value: If a free user upgrades to a paid plan at some point in future. Assuming an average order value of $250, (assuming $250 mn revenue from 1 mn paying accounts). Assuming that 0.1% of free users upgrade and will have a lifetime of 3 years, this is worth: 0.1% of $250 * 3 = $0.75/year.
  2. Cross-sell value: If one uses other Dropbox services (such as Mailbox). This is too new a stream for Dropbox, but given that Dropbox will surely add more services in future, let’s assume a random value of $0.05.
  3. Strategic value: The “notional value” of each customer relationship. This is a $ equivalent of the brand, influence and all other potential future sources of revenue such as selling ads, using usage data etc. For a very “display” service such as FB this value today is close to $7/year (based on its $7.12 bn revenue from a 1.2 bn customer base). Since Dropbox is less “ad friendly”,  let’s scale this down by 1/10th to reach a value of $0.70/year or $2.1 for the life time.

Hence for Dropbox, the LTV of each additional user: $0.75 + $0.05 + $2.1 = $2.80

Life Time Marginal Cost (LTMC) of retaining a free user

Each free user that comes along, adds following type of costs for Dropbox:

  1. Cost of Service: Dropbox provides 2 GB free to each user. Based on my cloud storage experience, I’d assume that:
    • The actual storage used by an average customer would be about 0.5GB. At a price point of $0.15/GB-year, this would be about $0.22 over the customer lifetime of 3 years.
    • The other costs of servers, bandwidth, etc won’t be more than 1/3rd of storage cost.
  2. Indirect costs: This will be largely the employee costs. Now, Dropbox has 552 employees today (source: Quora), which in the silicon valley is equivalent to a cost of about $80mn/year. For 200 mn users, this comes out to be about $0.4 per year or $1.2 for the customer life time.

Hence LTMC of each new Dropbox user = $0.22 + $0.07 + $1.20 = $1.5

Since each free user represents a value of $2.80 but costs only $1.50 over the life time of 3 years, it does seem that Freemium model is a “balanced business model” for Dropbox, as David Skok drew up in his post here:

image

Further Observation:

Out of all sources of value, it seems the “strategic value” of a user ($2.10) is what is tilting the balance for Dropbox today. If not for this value, Dropbox would be forced to reconsider its freemium model or at least tweak it to either increase revenue or reduce costs.  (Update: This is exactly what SugarSync, a Dropbox competitor did –  it recently quit Freemium model. The same was done by LogMeIn a few months ago).  For instance, I do think that the upgrade rate for free users (assumed 0.1% above) is too little, given that Dropbox pro plans are not very expensive. Its fencing between free and paid plans is rather weak and gives away too much value away for free.

This “strategic value” is hinged on the hope that Dropbox will someday be able to monetize users better to achieve a higher life time value. For a well funded and quality team such as Dropbox, this may be very much real. But for teams that are not, it may be just an illusive dream.

Have something to say? Please weigh in with your thoughts!

Pricing your product or service? Don’t forget the softer side of pricing!

The more I think about it, the more awe-struck I get with the idea of pricing. There are many decision areas for a firm but pricing is perhaps the single most important one. After all which other parameter can answer varied and important questions like: 

  • How will your financial numbers look like – revenues, profits, margins, investor returns, etc.
  • What type of customers you will get? High income, low income or somewhere in between?
  • How many customers you will get? We need to remember that beyond the revenue impact, this question has wide implications for the overall “design” of the firm.  A bigger customer base means a bigger stress on your Customer Support, HR, Purchasing, IT and other support departments resulting in higher costs and higher complexities in running operations.
  • How will your product/service be perceived by customers? In short what will be its “positioning”?
  • Will your pricing model be amenable to future expansion with the help of channel partners, franchisors etc? 

Above questions are no doubt important and typically make the foundation of a pricing strategy. However, in my (admittedly limited!) experience of deciding and then operationilizing the pricing of cloud backup products, I have realized that the above classic marketing analysis is important but not sufficient. When it comes to finalizing pricing, there is a “softer” side which one must factor in too.

The softer side of Pricing

This simply means that the pricing should:

  • “Sound” right: This basically means that there is no dissonance in your pricing story. The pricing dimensions make sense, numbers sound reasonable and consistent with what your prospects expect to see. For example, if you are positioned as a “cost leader”, pricing one of the services higher than the competition will cause some dissonance. Another example – if you are offering an “addon” service on top of an existing service, people don’t expect to pay a higher price than the underlying  service. For more food for thought, you can refer to the second paragraph of this excellent article by Eric Sink: http://www.ericsink.com/bos/Product_Pricing.html
  • Be easy to communicate: It is no secret that attention spans are increasingly getting shorter in our fast paced world. The high levels of competition and ambient noise mean that if your pricing page is not able to drive home the point in first 10 seconds, you are going to miss the “selling window”. The idea here is simple, choose a simple pricing model and find a concise way to communicate it. The more words you use (red flags for conditional words such as “if”, “however” etc.) the more you need to rethink.

Simple pricing model:

There can be several dimensions in which your service might be adding value to customers. But choosing pricing dimensions which a customer finds  easier to understand and control, is generally a better bet. For instance, think NetFlix. As a customer, would you want to pay for each movie you watch or the size of streamed data a movie requires? 

Concise description of pricing:

Let’s take an example. I won’t go too far – we introduced a new version of our cloud backup product recently and here is the pricing page we came up with:

zcbg_pricing

Though this is more text that what I’d call “ideal” but still it serves my purpose. The text in red boxes indicates the main points. You can see that we have chosen a single pricing dimension (GB storage) and have explicitly made it clear (the box at the bottom) that that is indeed the only dimension we are going to charge for.

Let me take one more example here. In fact a comparison. Here is what the pricing page of the popular DropBox service looks like:

dropbox_pricing

Notice how they have also decided a single pricing dimension (again GB storage) and neatly laid out their different plans. Each plan has a catchy description (again, within 10 words or so) and they have managed to even insert slightly “advanced” items such as “billing frequency” and an optional feature without adding any more complications for the customers. Hats off to simplicity!

On the other hand, let’s look at the pricing of Google Drive, a service which aims to compete with DropBox:

gdrive_pricing

See the red boxes above? The “geek” writing this pricing page seems to have gotten almost everything wrong – the page is verbose, has many conditional sentences, talks about other non-core services (that likely won’t be of interest to most targeted users) and has complex pricing exclusions in place. 

The trouble is – this kind of pricing not only makes life difficult for your prospective customers, but also for your own sales team. I have seen so called “strategic meetings” that begin with pricing and end with it.

  • Be easy to operationalize: While this looks like it, but this really shouldn’t be an afterthought since certain things look good in paper but fall flat in the real world. Some of the challenges here can be:

Setting up your billing processes: You need to provide the agreed upon service while enforcing agreed upon limitations. For doing this, the billing process needs to be accurate, polite, responsive and user friendly. A complex billing processes will open up different cases you may not have imagined, leading to different operational challenges. In the above case of Google Drive, for e.g. a user may want to know – “ I have no interest in Gmail, Picasa et al. Can I just buy storage for the sync service?”

Preparing your sales team and channel partners: Your sales team needs to know not only the pricing but also the rational behind it. They will need this more than anybody else, since they will be the ones facing the fire in the actual market.

Also, if your service/product is going to need a lot of active selling then you also need to bake in the sales commissions in your pricing.

Likewise, the channel partners need some motivation too. One suggestion – always have some room for discounts or promotions in your pricing. You may be convinced that your product will literally fly off the shelves due to your aggressive pricing,  but you never know. Some additional leeway for incentivizing the channel when needed, can come handy.

  • Be future ready: While it is impossible to do this 100%, one should at least try. At least consider the long term trends. Some of the potential mistakes here:

Choosing a strictly “derivative” pricing model: Suppose you are building a “call a cab” service and plan to charge your customers a 10% fee on top of the actual fare. This pricing model is advertised to be derived from the cab fares and hence vulnerable to all risk factors that affect the same. Suppose due to competition from alternative modes of travel, cab fares go down. Since your pricing model locks you down to a % value on top of this fare, it would essentially mean that for the same value addition to your customers, your net income could be much lower. This obviously is dangerous.

Over reliance on multiple sources or pricing dimensions: So you are lucky to find multiple sources of revenue or charge for multiple pricing dimensions? Here is an advice – do not add all these streams up to finalize your pricing numers. Have a clear idea of what is the main revenue stream and which ones are secondary.

Let me try an example. Suppose you find are running a platform where two kind of users (say suppliers and customers) meet up. And instead of charging a single group a hefty amount, you decide to charge both of them a little. After-all when you add up these two revenue streams, your numbers look healthy so why make a section of users unhappy?

But suppose in near future, market forces dictate that you can longer charge one user group (say customers). To meet your goals, you will need to hike the fee your charge the other group. But is that really an option once you have set a reference price for your customers?

The easy thumb rule – try to charge users for the value addition you are making to them. Why leave money on the table?

What are your experiences with pricing your products or service? Did you experience any of the above or are your experiences different? I would love to hear from you in the comments section.

A few essential ideas for aspiring entrepreneurs

Startups, entrepreneurship and building new products has been a big interest area for me. I might have been sucked into it not by native interest, but by sheer survival instinct of wondering if my job would be available next morning or not. After all,  I have spent 5.5 years in dynamic and exciting world of startups.

I came across the startup specialists from the bay area – Steve Blank, Eric Ries, Sean Ellis, Ash Mourya etc while digging for information on how to get the new product fit the market needs adequately to realize the dream of startup success and have been reading their posts regularly. They have pioneered the concept of “customer development” and “lean startup” which are worth reflecting on. For the benefit of uninitiated, thought of collecting a few random ideas in this post. Would strongly suggest future entrepreneurs and would-be top execs in startups to read the full theory on Steve’s Blog, Steve’s videos and Eric Ries Blog.

Wikipedia defines “customer development” as:

Customer Development is a risk reduction methodology for early stage startups. Its premise is that startups are not smaller versions of large companies. Instead these early stage ventures require new tools and techniques. Key tenets are: constant contact with potential customers, continual product iteration by shipping as early as possible for product refinement based on customer feedback.

This short story by Steve exposes the oft-repeated story at high-tech startups:

http://steveblank.com/2010/02/11/it-must-be-a-marketing-problem/

There are many posts by Steve which turn the conventional wisdom on its head. Take competitive analysis for example. Do you think it is a great idea? It can backfire if you let tour focus move away from customer problems to the competitors and their (existing) products. In words of Steve:

Instead of optimizing for a minimum feature set (that had been defined by customers) a competitive analysis drives a maximum feature set.

Most marketers are happy to build feature comparisons. But customers don’t buy features, they usually buy something that solves a real or perceived need.

Ash Mourya has adapted Steve’s customer development model for web-startups and  http://www.ashmaurya.com/2010/02/customer-development-checklist-for-my-web-startup-part-2/

Eric Ries, leanstartup is a movement in itself with frequent idea-sharing sessions organized at many locations in the US. The idea is simple but profound and marries perfectly with Steve’s idea of customer development.  Here is the idea of lean startups:

I also stumbled on to some interesting links recently:

1. A host of innovative inbound marketing tools : http://www.hubspot.com/

2 . If you are into SaaS model, then getting the economics right is important. David Skok spells out what metrics one could/should use here:

http://www.forentrepreneurs.com/saas-metrics/

3. And if you do get to the point of launching a new business, with butterflies in your stomach and bugs in your offering, you may want to read up this while presenting yourself to the outside world:

http://blog.asmartbear.com/youre-a-little-company-now-act-like-one.html

The author makes a point that one shouldn’t try to impersonate a big company when you are a new kid on the block. The chances are much better with just that image – fresh blood, novel thinking and a cool solution. Or in words of the author:

Be human. Stop hiding. Be yourself.

So true!

High-tech Product Marketing: Charms and Challenges

One of the primary triggers for my joining the bschool was the desire to make high tech products successful in the market. I had worked in some pretty innovative high-tech startups which made stuff such as network secure switch, cloud bases services and city wide WiFi network deployments. An example of innovation was the Tropos WiFi gear that powered cool solutions such as automatic electricity meter reading, forest fire sensing, monitoring water pipeline flow for leakage etc. In these startups, we grappled with the customer related issues daily and I gradually ended up being besotted by the charms and challenges of marketing such cutting edge technology products.

And since I stepped inside XLRI, I have been trying to orient myself towards this direction. I have taken to marketing in particular and have been trying to understand the concepts better. But at the same time, I also find sort of a dissonance(again a marketing jargon!)- all the marketing literature is largely skewed towards conventional products such as FMCG, consumer durables, etc. Of course, high technology products are not alien and share a lot of features with such conventional products but many a time I realized that they present specific challenges for marketers.

Before moving on, let me define what I mean by high tech startups here:

1. The product is based on a new technology/idea which is not well shaped yet. Cloud computing, Hadoop, etc were here in 2007.

2. The technology is fast evolving and different players trying to gain upper hand over each other. 

3. Customers, specifically the Enterprise customers, understand the technology and are primarily driven to such products to reap significant benefits.

Here are a few things relevant to this which come to my mind right now:

1. Weak product: If your company has not done a great job with the product design and development, the chances of you being able to market them are drastically less than conventional products. And before you say this is too obvious, let me remind you- in technology space it is pretty common for products to become misaligned with the current flavor of the market.  So, if your company has not been at its toes from the concept stage to the delivery stage and has not looked at where the market is going, then the conceived product tends to fall misaligned with where the market has moved to. For eg. WiFi gear was selling like hot cakes in 2004 timeframe but how with increased adoption of 3G and WiMAX, how do you sell it now?

The problem is that in conventional products, the other 3 Ps viz price, place and promotion can offset this weak product disadvantage to some extent. So you have a regular mp3 player(Philips Go! player comes to my mind), you can still market it to some customer segment in a place where there is less competition, using shops which the segment trusts or by using consumer promotions.

The problem is highlighted even more when the customers understand the technology. For example, it is difficult to sell a weak high technology product to enterprises which are coming to you only because they have a technology vision.

2. Benefits and perils of Internet distribution: If your product is available for download from internet then there are certain challenges you should be aware of. Internet is a great enabler and helps you reach to a totally unexpected market. At the same time however, Internet is also a common platform shared by all of us. Now, suppose your marketing program worked and a prospective customer wants to buy your product. Cool. But when he comes to internet to buy your product, he can be exposed to different ideas which can make him change his mind. He might discover products from competition or he might discover a new product category itself. He might be confused by competition and delay his decision. The threats are endless.

3. Intangibility of software: All said and done, a software is intangible, a commodity like soap is not. This is good and bad. Marketing loves intangibility as it can be “riskified” and sold at a higher margin than a tangible commodity(If this needs explanation then think – would you pay Rs 100(3x) for a soap? No. But how about paying Rs 300 for a coffee which is organic and has reduced caffeine? You probably might go for it as there is intangibility in play now).

At the same time, for software, intangibility comes with a challenge.  A potential customer can’t appreciate the real value of the product upfront and hence one needs to devise solutions to effect the purchase. Now, you can do one of:

a. reviews, customer forums, demo videos so that potential customers know your product works.

b. give them free evals, demonstrations, etc.

Option a is lower cost and applicable for “easy to use" products but option b is what you would have to do if your product is complex, high tech and  new on the market. And that might cost money and effort for each potential customer. You also need to highlight your support SLAs here.

4. Company’s credibility: This, most often than not, is the deciding factor. The company needs to position itself as an honest, stable and tech savvy company. The reasons are:

a. Honest: Remember Tangible Vs Intangible point above. If the software doesn’t work the customer would want money back. Also, he would want to ensure that you are not a malware/data stealing company.

b. Stable: More true for continuous involvement products. For eg. if Google is not stable, would you do emails with gmail?

c. Tech savvy: Customers need to make sure that the bugs will be fixed on time and improvements will be done as technology world changes. This is where the halo effect is important- i.e. if you have people from Google, MS in your company it helps. CEO blogs, press releases all help to build this image.

I would try to keep on editing/updating the above text as my understanding improves. For now, if you are aroused you can read this interesting write up on Ten Reasons High-Tech Companies Fail

Heck, why dint I think it before? Aha-moments at XLRI..

It keeps happening every now and then in class. The profs keep coming with statements which make you wonder why we didn’t think it before. Here are a few I remember(the list will keep on getting updated):

Class Context Aha-moment Message
Marketing How stupid customers can be. When you buy “Mint with the hole”, you pay for the hole and get mint free! Marketing fooled you with giving less for more. And we all thought it was such a cool product!
Marketing How companies use the “emotional” appeal to goad you to buy their products. Prestige pressure cooker punch line: “Jo biwi se kare pyar, wo prestige se kaise kare inkaar”(English- one who loves his wife, cant say no to prestige pressure cooker). Marketing wants to target husbands to buy the product for their wives. So when a customer buys Prestige, he is not really buying cooker, he is buying love for his wife.
Marketing How the marketing effort goes beyond what we generally think. Parry’s punchline: “ Bathroom is a room too”. In 1980s, when Parry wanted to market their bathroom fitting products, they realized that Indian customers put bathroom at the last of their shopping list. The culprit was the low visibility of bathroom to house visitors. So, Parry marketing effort also focused on trying for greater significance to bathrooms in average customer’s mind.
Human Behavior Setting goals in life A man’s reach should exceed his grasp, or what the heaven’s for?  
Marketing Consumer behavior We value our  losses more than our gains While making buying decisions, consumers want to reap the benefits they have been reaping till now. You can offer something new, but they value it less than what they end up losing.
Financial Accounting Profits and Cash Topline is vanity, Bottomline is sanity, Cash is reality! Profit is an opinion, an idea. Cash is hard, bare  fact.

Challenges of one year executive MBA

Going for an MBA program itself has many challenges.  But a challenge unique to one year MBA programs run by IIMs, XLRI, ISB, SPJain, etc is the alignment of 4 potentially conflicting things- long term goals, short term goals, your intellectual interests and you desired life style. For illustration, assume that:

a. you want to become a VC, entrepreneur or want to go into marketing strategy area in long term.

b. Since it is difficult to land a job in placements which can directly lead you to achieve above long term goals, you need to form differet short term goals. For instance, Product management or pre-sales.

c. You were always interested in understanding equity markets or foreign trade.

d. You want to have a decently active campus life, which means beers, parties, eat outs, sports etc.

Now think yourself. In a 11 month course, with same contact hours as a two year MBA program, how you can do all of the above efficiently? The key, of course, is to set the priorities straight and do good time management. But this is only as useful as saying to a layman- “just keep your body in balance, head straight, look at the ball and there will go your straight drive to boundary just like Sachin’s”. Isn’t it?

I like to read my readers with something more emphatic than the endings of my posts. So here goes today’s multimedia bite(from Steve Blank):

Open-source business model generates heat..

I have been seeing a lot of analysis on opensource business model off late. Blame it on Oracle vs MySQL vs EU controversy. I thought it would be good to note all these discussions going on. Here are the links:

Open source remains elusive

Gigaom discusses and amends the above article

I haven’t read these two links yet, but I was thinking aloud yesterday on this topic. For what ever its worth, here it is:

1. the comparison of market share Vs revenue numbers is not correct in case of open source. For eg. some people say MySQL’s market share, with 60000 downloads each day, was about 40% in terms of installations but in dollar terms it was just 0.2%. And hence they deduce that open source as a biz model is doomed. I just think that a better comparison, like with most things in life, is:

Efficacy of business model = Value derived (Enterprise value) / Money invested

And on this count, MySQL will score at par to the big boys – Oracle and MS.

Efifcacy = $1000 million / $ 100 or $200 miilion
= 10 or 5 times.

which is as good as most successful high tech startups, financially. The reputation and good will you get, is totally matchless.

2. Open source will undergo a lot changes which will see its revenues/installations ratio improve.

3. Calling open source a bloated, impractical industry just because the ROI is less, misses an important point. The founder(s) of an open source company never wanted to earn insane amount of money. They generally go open source as they choose good will over money and and want to see the world as a better place. So why judge them on a purely ROI basis?