What makes for a successful business freemium model product?

freemium

Interest in the freemium model, where the venture gives away one version of its product in order to up-sell those users to a more feature-rich paid version, has had its ups in downs in the business market. But with freemium model companies like DropBox, Zoom, and Slack going public it’s definitely on the upswing now.

With the help of the article 7 markers of a viable freemium product by venture capitalist Matt Holleran on VentureBeat.com, let’s look at what will help founders be successful using the freemium business model.

1. The user’s first experience with the product is easy and awesome

Ease of use and simplicity are paramount to keeping technical support costs to zero and eliminating one major source of friction in product adoption. If you have a complex product with a steep learning curve that requires training, freemium is not for you. And you need to launch a Minimal Remarkable Product, not a Minimal Viable Product. A remarkable product with a flat learning curve has the best chance of going viral.

2. Rely of WOM (Word of Mouth) and viral marketing

Customer acquisition is the number one variable cost in virtually all tech companies in the enterprise market. By relying on WOM and viral marketing, millions of dollars can be saved on traditional marketing, dollars which can then be spent on converting free users to paid users.

3. Your product is not single-user only

Products like Slack and Zoom are inherently multi-user, in fact the value of Slack in particular goes up with the size of the active user base. Multi-user apps have two benefits: one, they become attractive to teams and thus can charge a higher price; and two, these products, like Zoom, can be inter-company, not just intra-company, thus selling themselves as users from one company invite another.

4. The freemium model should be built-in, not slapped on

If you plan on using the freemium model you need to plan for it before you start product development. First how will you build virality into the product? Second, what features, functions or even performance will be included in the paid version but not included in the free version? This decision is the core and the art of the freemium model. If the free version is not useful on its own you will never have the large user base needed to convert to the paid version. On the other hand, if the free version is so useful most users don’t see a reason to upgrade, you won’t generate significant revenue. This is where the need for customer discovery, A/B testing, and lots of trials are investments that will pay off.

You also need to make it virtually painless to upgrade. That means keeping the upgrade to the paid version very simple; don’t confuse users with a plethora of payment plans – for a subscription offer monthly or yearly payments, period.

5. Don’t rely solely on the freemium model – it’s not a panacea

Products like Slack, Zoom and DropBox are all very solid products that filled an unmet need. While their freemium business model no doubt drove rapid adoption, these products could have succeeded with a different business model, though perhaps not as quickly.

6. Study the winners and the losers

While there is a lot to be learned, especially from public companies like Slack and Zoom that have to disclose much more about their financials and operations than private companies, don’t restrict yourself to companies that have gone public or been acquired. Since freemium companies offer a free version, your only cost of studying their products will be company time. Remember as Picasso said, Good painters borrow, great painters steal. However, you can’t simply ape a winning freemium formula from another company. Your freemium model needs to be customized to your market and its users.

7. Understand the bottoms-up sales process

The freemium model stands the typical business sales process on its head. Users first adopt the product because of its fast on-ramp and value provided to them. They then exert upward pressure on the economic decision makers to upgrade from the free to the paid version. Help them out! Provide case studies, testimonials, webinars and other ways the economic decision makers can quickly and easily see and buy into the reasons to upgrade. Don’t try the standard field sales force, face-to-face selling process with the economic decision makers – that’s the antithesis of the freemium model.

8. Establish and track your metrics

Freemium companies must set goals for upgrades – what percentage of users must upgrade for you to break even, for example. You should track actual vs. projected on no longer than a monthly basis. Collect as much data as possible and establish what is the profile of your ideal customer. What drives customer engagement? What works best to incentivize upgrades to the paid version? And be careful of churn. Winning the customer is winning the battle; retaining customers is winning the war.

Freemium is not for every company nor for every product. If you can’t follow a majority of these best practices then freemium is probably not for you.

How do you build virality into your product?

virality

The classic marketing funnel and where virality helps

I’ve posted previously about the need to build virality into consumer products, for one simple reason: any other cost of customer acquisition is just too high. But how do you go about building virality into your product? Easier said than done! Everyone wants WOM (Word of Mouth) marketing but how do you go about obtaining it? The best guide I’ve seen yet is the article by Gabole Cselle on Medium entitled 9 Ways to Build Virality into your Product. He is a partner in Area 120, Google’s internal startup incubator and a very impressive bio.

The author and I are in violent agreement: “Consumer product startups have to bake a viral channel into their product from the get-go. They can’t merely glue it on later.”

I’m not going to repeat all of Gabole’s suggested techniques, but as usual I will just comment on a few of them. But if you plan to develop a consumer product I highly recommend you don’t just read the original article, but study it closely.

1. Two-Sided Reward

You need to have a product which lends itself to rewarding both your user and friends they invite. The example given is DropBox, which initially offered up to 500 mb of free storage space to both sides and created what Gabole calls a viral loop. A more generally available value is a store credit. That costs real money, as it requires the vendor to offer both a free item to the friend and cash value to the customer. Wonder why consumer companies raise hundreds of millions of dollars? It’s simple, for marketing and sales! I would steer towards DropBox’s model which doesn’t require cash out of pocket and is intimately tied into the product – enhancing its capacity – and avoid the double reward model used by delivery services – too expensive.

Here’s a twist for you: combine the freemium model with a two-sided reward: if your customer converts to paid from free give the them ability to gift a version of your membership or subscription to a friend. Perhaps in the case of a subscription for a limited time.

2. Appeal to Vanity

As I said years ago, social media is a place where voyeurs can watch exhibitionists. Likes on Facebook, connections on LinkedIn both enable users to show off. Can you enable some sort of feature, like a counter, in your product that enables your customers to show off as well?

3. Collaboration

Collaboration is one of the most powerful drivers of virality; based on Metcalfe’s Law, the value of a network grows as the square of its nodes. Slack, which just when public with a rare direct listing, is a great example of a collaboration product that has gone madly viral. One reason that Slack doesn’t tout is that it can be used within a company for non-business use cases, like groups who like to go out to lunch together or watch sci-fi films together. By making both personal connectivity and business connectivity very easy to setup, Slack created a very powerful viral marketing effect.

5. Artifacts Shared on Social

I would title this social sharing and it’s the backbone of apps like Instagram and Pinterest.

For user-generated content (UGC) products, there exists an even more powerful viral channel than embeddable content: social sharing. If your product creates uniquely interesting content, users can be encouraged to share it on their social networks, thus spreading knowledge of your product to their network. The most successful examples in this genre is auto-shared content onto other networks.

The key phrase here is user-generated content, which is virtually free (you will have a moderation cost to keep out violent, pornographic, or other extreme anti-social content).

9. Highly Visible Hardware

This is a special case, but it’s a worthwhile one: a hardware product that is set in a highly visible location that is exposed to potential customers. The example given is Square, the store point of sale terminal.

Keep in mind, virality is not cosmetic, it’s not something you can just slather on your completed product. It must be built-in from the get-go. And be wary of viral methods like the two-sided reward which can drain your capital resources. I highly encourage developers to study all nine ways to build virality into their products well before they write the first line of code. Without built-in virality the cost of customer acquisition in the consumer market will in all likelihood sink your company.

Mapping the ecology of your market

audio ecosystem

I often suggest to my MIT mentees that they map the ecology of their market: customers, competitors, vendors, media, and other stakeholders. This is particularly useful in determining potential partners. Who will benefit from your startup? What do you have to offer a partner? Too often founders think what’s in it for them when the secret to successful business development is figuring out what’s in it for the partner.

This diagram by Andrew Quint of The Absolute Sound is an excellent depiction of the the audio marketplace. He has put the customer – consumers, not audio professionals – in the center. But beyond that Andrew has segmented the consumer audio market into three major segments.

Hardware – amplifiers, speakers, turntables, etc. is at the top half of the diagram, with “software” or “content” in the bottom half. Note that music itself has three segments: record labels, streaming and download services, and musicians – in this case including live music.

Of course any such diagram can go beyond simple connections to color coding certain elements. For example, any media campaign would target Audiophile press, Online audiophile communities, and perhaps audio shows as well.

Ecology maps should be living documents, updated as your market as well as target customers and partners, may change.

By quantifying relevant sections of your market this type of diagram can help educate investors, advisors, potential hires, et al.

Most important when you present this type of depiction is to elucidate the dynamics amongst the players. For example, what is not shown is “merch” – merchandise sold at shows by musicians: cds, t-shirts, signed photos, etc. Merchandise has become an ever growing share of a musician’s income as revenue from recorded music continues to shrink. While at the same time streaming is rapidly surpassing CDs and downloads as consumers’ preferred method of music consumption.

And, of course, market dynamics vary by country or region. For example, in Japan CDs are still the music medium of choice.

Death by premature marketing

graveyard

There used to be a saying back in the day that “the best way to kill a bad product was to market the hell out of it.” Perhaps related to the Ulysses S. Grant quote, “The best way to get rid of a bad law is to enforce it.”

The Forbes article For Even Hot Startups Premature Marketing Can Mean Premature Death by Derek Lidow is a case study of how way too much VC money enabled companies like Munchery to overrun their headlights by marketing their services before they were fully baked.

I’ve referred previously to the firm CB Insights and how they analyzed 100 defunct startups to identify the top 20 reasons they failed. As noted, “no market need” was number one. That jibes with the findings of NSF (The National Science Foundation) that the number one reason post-docs’s startups failed was because they built products no one needed. The number two CB Insights’ reason was “ran out of cash.” Spending millions on marketing to try to buy marketshare and catch the elusive “first mover advantage” is a fast way to run out of cash.

Munchery raised $120 million in equity financing and more than $11 million in venture debt financing before declaring bankruptcy. In between they pivoted so often the employees all got motion sickness.

Mr. Lidow outlines what he sees are the three distinct stages that almost every successful startup must navigate: customer validation, operational validation and scale-up. Only in the scale-up stage does marketing come seriously into play. I’ll add my comments to his three stages. However, before I do that I should point out that he skips the all-important first stage: customer discovery. Before you can validate your customer you must discover them through dozens of interviews based on your initial hypotheses. Pivoting during customer discovery costs nothing! And as you work your way through various customer types and segments you will be setting yourself up to later validate your business proposition with your target customer. Skip this stage at your peril!

Customer validation Here’s where having a robust prototype can pay off as you wear out shoe leather going back to those customers you identified during the customer discovery phase to ascertain if your solution fits with the problem you discovered that your target customers all share. As Mr. Lidow says, “Stage one ends when you can describe, with a high degree of certainty, who will buy your product or service and how you will deliver it.” Though I believe “how you deliver it” better fits in the operational validation phase. Thus I’d change this to “… who will buy your product or service and why.”

Operational validation. Too much startup literature is focused on product and not enough on process. But if you do not build the proper processes: financial, distribution. customer service, technical infrastructure and administration you will fail to scale. The canonical example of this is Friendster, inventor of the social network. Friendster failed as it never built enough infrastructure to prevent its site from crashing due to the unforeseen tsunami of users. Like changing a product, once you have launched, it can be painful and expensive to change your operations well. Before attempting to scale you need to stress test all of your operations to shore up any weaknesses you find.

Scale-up. This is why the VCs invest – they want growth. Why do they want growth? Simple, because it’s  the only path to either world domination (very, very rare); an IPO, rare but doable; or an acquisition, the most common exit for VC-backed companies. Here’s where you take your foot off the brake and hit the marketing accelerator to drive demand. If you have kept your gun powder dry through the previous three stages you will be able to go after the business holy grail: economies of scale.  Which not only drives down your unit costs, but give you a pricing advantage over competitors.

This advice does not mean you wait under launch to hire your marketing and sales team! What it means is you don’t unlock their budgets until you are in a position to scale. Before that they are participating in customer discovery, validation, and operations – working on such mundane but critical issues as pricing and returns policies, and planning the traditional media and social media pr and marketing efforts. Trying to paste marketing onto an existing product is almost as dangerous as spending money on marketing before you are in a position to scale.

The key issue in marketing spend is timing. Too soon and you waste money; too late, and you will lose customers to competitors.

 

 

 

The battle for Internet attention

attention

The one thing I always say to mentees who are targeting consumers on the Internet is that they are in a battle for attention. This amazing graphic put together by media consultants Lori Lewis and Chadd Callahan for All Access Music—really points out the sheer amount of activity vying for (or constantly stealing) our attention. The PC Mag article Every Minute Online Is a Battle for Consumer Attention sub-titled This not-to-scale visualization of what is happening on the internet every single minute of every single day this year should underscore why you have a hard time getting anything done, enables you to compare the 2018 internet minute with the 2019 internet minute. The comparison shows just about every type of activity increasing.

Note the activities are a mix of consumption (dollars spent online) and creation (2.1 million snaps created).

For founders these images are daunting pictures of all the competition for attention on the Internet. It may be enough for you to think about off-net activities. A colleague and I were interested in entering the “rating” business many years ago, so we watched carefully from the sidelines. Yelp, of course, won the battle for a standalone ratings service. We believe that one reason was that they literally had feet on the ground in areas where they planned to launch and put on events in each region for prospective users. Their competition never got out from behind their computers and probably thought that they could build the business simply by sitting at their desks.

If there is a lesson in these numbers it’s that founders may want to consider what types of off-net activities can help build their brand and generate revenue. While the events marketplace is also very crowded perhaps the right combination of online marketing, social media, and events can help a B2C company breakthrough.

I’d like to see what an off-net minute activities chart looks like for a typical consumer!

Option paralysis or the paradox of choice

 

screens

I often warn my mentees who are in the publishing, media, games, or related industries that they are in a battle for their audience’s attention. Their customers have a plethora of things to read, listen to – podcasts now in addition to music and the radio, and watch.

I am now so old that I remember when there were just 3 television channels, ABC, NBC and CBS. We got very excited when UHF (Ultra High Frequency) channels joined the three VHF (Very High Frequency) channels; though the former required a special UHF antenna and still the reception could be somewhat dodgy. UHF was clearly the minor leagues of TV, but we welcomed it any way, since their was a paucity of TV shows.

Michael Goldhaber’s The Attention Economy and the Net is essential reading for any founder who is aiming to carve out a slice of their customers’ attention. But if you would like a more up to date and easily digestible article on the problems of information overload, read The Wall Street Journal article by Erich Schwartzel Oscar in the Age of Entertainment Overload subtitled Audiences have more choices than ever before. For Hollywood, that might not be a good thing. One could say that entertainment is just a special case of information, which I believe it is, and thus the issues this article raises are just as applicable to newspaper publishing, blogging, podcasts, or even journal publishing.

What’s the problem? It’s not with the producers, it’s with the consumers!

When researchers at Warner Bros. discovered that audiences seemed overwhelmed by too many choices, they had a guess at a diagnosis. Albert Einstein had called it “option paralysis,” indecision in the face of too many choices. (It’s why Einstein opted to wear the same sport coat and trousers every day.) For advice, the studio brought in Barry Schwartz, an emeritus professor of psychology at Swarthmore College and the author of “The Paradox of Choice.”

Perhaps you recall the song by Bruce Springsteen, how totally obsolete, 57 Channels (And Nothin’ On):

I bought a bourgeois house in the Hollywood hills
With a truckload of hundred thousand dollar bills
Man came by to hook up my cable TV
We settled in for the night my baby and me
We switched ’round and ’round ’til half-past dawn
There was fifty-seven channels and nothin’ on
Well now home entertainment was my baby’s wish
So I hopped into town for a satellite dish
I tied it to the top of my Japanese car
I came home and I pointed it out into the stars
A message came back from the great beyond
There’s fifty-seven channels and nothin’ on
Well we might’a made some friends with some billionaires
We might’a got all nice and friendly if we’d made it upstairs
All I got was a note that said “bye-bye John
Our love is fifty-seven channels and nothin’ on”
So I bought a .44 magnum it was solid steel cast
And in the blessed name of Elvis well I just let it blast
‘Til my TV lay in pieces there at my feet
And they busted me for disturbing the almighty peace
Judge said “What you got in your defense son?”
“Fifty-seven channels and nothin’ on”
I can see by your eyes friend you’re just about gone
Fifty-seven channels and nothin’ on
Songwriters: Bruce Springsteen
57 Channels (And Nothin’ On) lyrics © Downtown Music Publishing
Of course, now one might wish that there were only 57 channels! Content producers beware!
Striking a just-right balance–enough new choices to excite, but not too many to overwhelm—will be crucial to studios getting into the streaming game, said Dr. Schwartz. If studios end up spending millions of dollars producing too much new programming, he said, they could end up in a situation where “you give people everything under the sun and they end up watching what they watched before.”

According to Dr. Schwartz’s research, an influx of options also makes the ultimate choice more an expression of personal identity. When there are only five movies to choose from—for instance, at a multiplex—consumers do not put much stock in their decision, he said. But when there are 30 choices, it becomes a question of, “Am I the kind of person who would watch this kind of movie?”

“Even when you’re sitting at home and no one knows what you’re watching, the stakes go up, which just increases the paralysis because it’s now a big deal,” he said.

But the biggest culprit in the problem of option paralysis is not cable TV, not any more, it’s Netflix. And who does Netflix worry about?

But Netflix isn’t primarily worried about rival studios and cable giants. In a January letter to shareholders about its fourth-quarter earnings, Netflix wrote, “We compete with (and lose to) ‘Fortnite’ more than HBO,” referring to the popular videogame.
“There are thousands of competitors in this highly fragmented market vying to entertain consumers and low barriers to entry for those great experiences,” the letter noted. Chief Executive Reed Hastings has also cited sleep as one of the company’s many rivals for viewers’ attention and time.
Yep, videogames and sleep!
So attention every founder! The battle for consumers’ attention is not just with digital content – entertainment, news and information – it’s about everything, every new product requires a customer’s attention first before a purchase can be consummated.
And, of course, all your marketing – social media, legacy media, public relations, trade shows, billboards, you name it – is fighting for the tiniest slice of a consumer’s attention.
So please, forget about MVPs – Minimum Viable Products – and get with MRPs, Minimum Remarkable Products – and keep on doing things that cause your customers to remark about your product to friends, acquaintances, and colleagues. Only by strongly differentiating yourself from all the other choices presenting themselves incessantly to your customers can you perhaps rent, but never own, your customer’s attention just long enough to close a purchase.

 

 

Beware of a contract’s exclusivity clause

contract

Writing about strategic alliances brings up the issue of exclusivity clauses in distribution and sales agreements. Someday, I hope, someone will write the full story of Software Arts, Inc., the company that invented the first electronic spreadsheet, VisiCalc, and foundered on the shoals of its original distribution contract. In brief, the founders of Software Arts had no interest in sales, marketing or distribution. Upon the advice of a Harvard Business School professor, they entered into a contract with Personal Software, Inc. to distribute VisiCalc. That was in 1979 or 1980. By 1984 that exclusive distribution agreement resulted in a deadly embrace that ended up killing off both companies.

The period when VisiCalc was launched was the dawn of the personal computer era and attorneys who understood both intellectual property law and software were scarcer than women software engineers of color.  During my time working at Software Arts and after its demise I was often asked the question why didn’t they patent the spreadsheet? Then Lotus, Microsoft, and any other company would have had to pay the inventors royalties, making the founders multi-millionaires if not billionaires. They did consult an attorney who told them software could not be patented, so no filing was made.

But that’s a side note to the crux of the issue: Software Arts entered into an exclusive contract with Personal Software, later VisiCorp, to market, sell and distribute its invention. When the two companies wanted to go their separate ways a few years later litigation over that ironclad contract knocked both companies out of the game, leaving a clear field for Mitch Kapor to dominate the corporate PC software market with his
Lotus 1-2-3 spreadsheet, a brilliant blending of an advanced version of VisiCalc with Mitch’s first successful product, distributed through Personal Software, VisiTrend/VisiPlot.

When mentoring founders who are in discussions or preparing to sign a contract with another party I ask them one simple question: What is the most important part of any contract? The answer is in my post; it’s the termination clause. In my view contracts are analogous to insurance policies. You hope to never have to pull out your home insurance policy to refresh your memory for what it covers because that means you must have had some untoward incident in your home – fire, theft, vandalism, etc.  Similarly with a distribution contract, when all is going well you have no need to try to enforce its terms and conditions. But when the parties have a falling out you need to pull out that contract and read the termination clause, because if all else fails that’s your one and only recourse. Suing a large company is just slow motion suicide for a startup. Large companies have in-house attorneys – a sunk cost – who will litigate you to death as you pay legal fees to combat them. Stay out of court at all costs!

The trap that Software Arts fell into, and here I would definitely fault their legal counsel, was to make the term of the contract co-terminus with the copyright to the VisiCalc’s code.  That was a huge mistake,  as we are talking many years here! So that brings up to the nut of this post: how do startup companies deal with prospective partners who insist on an exclusive agreement? No one likes competition, let alone sales or distribution companies. They want the whole market and nothing but the market.

The VCs who trained me hated exclusivity and constantly reminded me of this as I entered into contracts with Lotus, Software Publishing Corporation, and other PC software pioneers. But if you are really desperate for the help a large partner can give you then their demand for exclusivity must be met or countered. Here’s how:

Term: the length of the period of exclusivity should be limited in time. And that time should range from about one to three years. Do not tie the term into some other exogenous factor like the length of copyright!

Territory: startups by their nature lack reach. That’s why they enter into distribution contracts with large partners. By granting your large partner exclusivity in a territory you would have trouble reaching anyway you can hope to satisfy their need to protect their investment in sales and marketing. Typically for a U.S. startup granting exclusivity to one or more international markets is a good strategy. Just keep in mind that you must also apply a restricted term, as in the future your venture may be big enough to serve international markets itself.

Type of customer: often startups will decide to negotiate exclusivity around the type of customer they target, believing that if they can maintain exclusivity for those customers they aren’t giving up anything by granting exclusivity for other customers. For example, if you have developed a new social media platform aimed at millennials you might rightly feel that you aren’t giving up anything by allowing your partner to have exclusive rights to sell to corporations. But there are two problems with this strategy. One, it can be hard to predict who will actually end up being the users of your product. By locking out a market segment like corporations you will never have the opportunity to discover if they would be good customers. The other issue is that there are other markets you may not even be thinking about, such as government or education. By ceding all other markets than consumers to your partner you may well be giving up great opportunities in unexplored or untapped markets.

Version of the product:  at Addison-Wesley Publishing Company, where I invented the student edition of professional software products, we were able to convince developers like Lotus to provide us with a different, more limited version of their crown jewels, in the case of Lotus it was 1-2-3. You can modify software in many different ways: capacity and features being two of the most common. But taking this tack puts a development, testing and support burden on your venture – a cost you might not want to bear. And your market may rebel against getting an older or less capable version of the software. So granting exclusivity to a different version of your product can work, just be careful of those two issues. An interesting twist on this idea is how Tesla sells their vehicles. All Teslas have the same basic features and performance. But Tesla can “turn on” new features and enhance performance through remotely unlocking software – if the customer is willing to pay. This clever tactic can be used in other markets to sell different versions of the same product at different price points.

Performance:  my preferred way to grant exclusivity is to make it performance based. Thus your distributor can only maintain exclusivity by selling X units in a set period, usually one year, or they risk losing their grant of exclusivity. A good twist to this is to enable your partner to “buy up” – meaning if they don’t meet the agreed upon sales targets they can pay you as if they did.  Performance is also the best way to manage term. Your partner can maintain exclusivity so long as they meet agreed upon targets, which should grow year by year. The trick to this is it is very hard to forecast sales of new products from a startup, so you need to be careful about how you handle this condition of the agreement.

The bottomline is to avoid exclusivity agreements whenever you possibly can. The main reason is that it is so difficult to predict who or where your best customers will come from and to forecast revenues for a new product. But exclusivity can be a strong motivator for sales and distribution companies – it gives them a monopoly, the best way for them to profit by selling your product.  But no matter what type of agreement you negotiate – non-exclusive, exclusive or conditionally exclusive – make sure you have an escape hatch if things don’t work out. Get a lawyer who is familiar with sales, marketing and/or distribution contracts and knows how to craft that termination clause. That’s really your only protection from entering into an agreement that you find significantly disadvantageous, but it’s vital as and those of us who lost out big-time through Software Arts’ bad contract with Personal Software learned the hard way. As the saying goes, “Those who do not learn from the past are condemned to repeat it.” And the first priority of all startup is to learn!