The Future May Revolve Around "Freemium" Products

In one of Jeff’s previous articles he expressed antipathy about the company LogMeIn (NASDAQ: LOGM), because the vast majority of its users opted only for the free service. At face value, it seems like he’s right: 10% monetization doesn’t look like a large number, not when physical products have numbers like 100%.

The thing is, that 10% is out of 70,000,000. Even if they only charged a dollar, that would net them $7,000,000. Not too shabby, assuming that the 10% of 70 million is an accurate number. (This is only an example. I’ve seen a stock chart that puts the price/earnings ratio of LogMeIn in the negatives, which isn’t a good sign. I’ve also seen charts that put it in the positive, which is a good sign. I’m not saying you should go and buy up their stock.) The point I’m making is, you can’t just jump at a number. Even in online industries people are slow to come to grips with the new business models that are coming out.

In the future – heck, even now – most services will be based on a free-to-premium model, where the primary, entry product is free, and a certain percentage of these free users are switched to the monetized premium product. “Downloads” does not equal “Sales Lost,” and many people would do well to remember this (I’m looking at you, RIAA). Just because 90% of your users are using your free product, it doesn’t mean that you’ve lost 90% of your paying customers. You may have lost some, like 10%, but in the information age that’s inevitable.

What needs to be looked at is: a) how well are you monetizing that part of your market that’s paying; b) is that percentage expanding; c) if it isn’t expanding, is your total market share expanding; d) what’s the total financial burden of supporting that free user base? With something like YouTube, d can be a lot, since it entails reserving video-sized server space (though if they’re smart, YouTube will solve this with cloud computing in the future). If your free product is just a downloaded program, it’s just costing you development time and some bandwidth, and that program is – hopefully – the base of your premium product, so you’re still getting compensated for the development anyway. Even if you only monetize at a steady 10%, if your total market share is growing, that’s 10% of a growing whole. Also, just to point out: most companies can’t even get that high a percentage. The best most companies can possibly hope for is 20%, unless they’re especially ingenious. 10% is a good number.

Psychology at $0.00 levels is very different from priced levels. Studies have been done that show how irrational we can become at the concept of “free” (I’m thinking Dan Ariely here). The great thing about the internet is that, having such low structural costs, free becomes possible everywhere, so learning to deal with using it is something everybody should master.

For example, there are times when it’s bad for your marketing to give things away. iPhone Apps that are free get downloaded more, but are retained less. This makes sense: most free Apps are just downloaded for curiosity since the price barrier is 0, and if you can download it again later, why waste the space? This is a problem, since the primary ways to monetize free Apps are through advertisements and micro-purchases. In this case, it may actually be better to charge for your App, even if it’s just $0.10. On the other hand, when something is limited release, “free” actually makes people irrational. People will actually chose the option with less utility as long as its free, and they can’t just get if for free later. There are plenty of examples of this in use. (How many times have you seen “free shipping and handling”?).

The game industry is really ahead on this, and I’ve thought so ever since I first heard of the “free to play” model, which is basically a micro-payment system. The advantage here is from the MMOs, where such social pressure helps drive up sales of silly things. (This happens in the physical world as well, and the utility of creating social necessities out of products is a key concept in marketing. Remember Tamagachi?)

This whole model of “free” based business has been called the “freemium” model by Chris Anderson, who does a much better job of talking about this topic here. This is an important concept to remember, because it leads to jumping to conclusions about data, based on schemata of the old school of monetization. It’s affecting the news industry as we speak, and it will be of vital importance in all future years. So, I suggest you get on reading, because you’ll need it.