The 'Freemium' Model: Top Flaws And Potent Fixes

The song says the love we take is equal to the love we make. Try telling that to all the entrepreneurs who give away their valuable work in the hope—often futile—of upselling a fraction of the freeloaders later on. 

That freemium model (a mix of “free” and “premium”) has been gathering steam since 1994 when Esther Dyson, a prominent technology analyst, envisioned a world where intellectual property would cost nearly nothing to distribute. Back then, most providers of “creative content” had to shell out substantial sums to reproduce and deliver each additional copy of their products. Indeed, the Internet has all but eliminated those so-called marginal costs—increasing overall supply of stuff like software, media and advice, and driving consumer prices to zero. Meanwhile, pesky fixed costs like equipment, buildings and people remain.

And so the debate rages on: How to attract customers with free content without going broke in the process?

Brian DeChesare, founder of Mergers & Inquisitions and Breaking Into Wall Street (Photo credit: Brian DeChesare)

I put that question to 29-year-old Brian DeChesare, former investment banker and founder of Mergers & Inquisitions and Breaking Into Wall Street, educational Web sites aimed at students and entry-level professionals eyeing careers in banking and money management. With no outside funding, DeChesare built a “profitable, seven-figure revenue business with 20,000 customers in less than four years”—all, he says, by offering scads of free content (including newsletters, expert interviews and case studies) along with paid, interactive video courses on everything from financial modeling to job interviewing.

Here, in his words, is how he did it, and the lessons gleaned along the way.

[Warning: You don’t have to know a thing about finance to learn a lot from this post.]

It sounds appealing: Offer content or a stripped-down version of your service for free, avoid paying for expensive sales reps or traditional advertising, and instantly win tens of thousands of customers. The only problem is “freemium” doesn’t work like that. And if you approach it with a Field of Dreams mindset, you’re setting yourself up for failure.

Most online discussions of this topic are limited to theories or speculation; they’re short on what has worked in real life for ordinary businesses. So I’m going to share what has worked well—and not so well—for our team.

Avoiding the four mistakes outlined below won’t guarantee your success, but it will reduce your chances of failure and set you on the right path, whether you’re starting a new business or you want to move an existing one in this direction.

Mistake #1: Picking The Wrong Market

“Markets that don’t exist don’t care how smart you are.” -- Marc Andreessen

Almost all entrepreneurs and business leaders will tell you to focus on “the right market,” but they stop before defining precisely what that is. My definition is simple and comes in two parts:

1. The market must already have a set of customers who are paying moneyfor a solution to a problem.

2. There must be a gap in this market, such as: a) a customer segment that is underserved by existing providers; b) a product or service not delivered in an ideal way; or c) an entirely overlooked distribution channel.

In my business—which serves students, career changers, and finance professionals—the “willingness to pay” and “market gap” criteria were both satisfied.

First, many firms and some individuals were paying thousands of dollars for in-person training classes on accounting, valuation, and financial modeling. Second, there were three distinct gaps: 1) Existing providers focused on large firms and overlooked smaller businesses and individual students/professionals; 2) in-person classroom training was sub-optimal (you spend far too much time making sure everyone in the room is looking at cell number F273 in Excel); and 3) when we started, few were paying attention to the online channel.

Most freemium businesses fail because Part 1 of the “right market” definition isn’t satisfied—that is, founders pick a hobbyist or “passion” niche where it’s much more difficult to charge money no matter how great your free version is. It’s much easier to stack the odds in your favor if: 1) you help people and companies make money, or 2) you’re in a market where spending habits are already proven, even if the relationship between price and value isn’t hard and fast (as with health sites and fitness, or dating sites and relationships).

Mistake #2: Offering No Compelling Reason to Upgrade to Your Paid Product or Service

Most freemium business models fail because companies offer either too littleor too much value with their free product or service. The trick to this balancing act is ensuring that 1) anyone can get some value without having to pay, and 2) those who upgrade to the paid version receive exceptional service.

However, promising “service” and “support” likely won’t be enough to distinguish a free product from the paid version. Yes, if you’re selling enterprise software to large companies, your customers will pay for service and support—but small companies and individual consumers tend to care less about support and more about what they get for each dollar spent.

Better move: Use support as a marketing tool instead. Give users a great experience that surpasses their expectations, and let them spread the good word. For software and web applications, the approach is well-established (if not perfected): Offer a minimum set of features for free, but charge for premium features, more storage space, and so on. (Think LinkedIn,SurveyMonkey, Dropbox and myriad online games.)

But what if you’re selling content, such as articles or advice? Then the key is knowing how much to give away and how much to charge for. We strike this balance by distinguishing between the two crucial parts of any training program:

1. Teaching a specific process for how to do something (value a company, research and pitch a stock, etc.).

2. Giving examples of how to apply that process and use it to solve a specific problem.

Our strategy: We give away either the process or the examples—but if you want both, you have to pay.

For example, we recently beefed up our menu of courses by adding a comprehensive case study of Silver Lake’s potential $24 billion leveraged-buyout of Dell Computer. But we’re also giving away parts of it for free—hours of video tutorials, Excel files, and more—to our newsletter and YouTube subscribers.

Why would anyone pay for the full case study if we give away so much of it for free? Because paying customers get both the process—a step-by-step walk-through of every last detail and how to evaluate Dell as an investment—andexamples of how to apply all of the concepts. Our free members still get a lot of value, but it’s in the form of “examples” rather than “process” because we only cover a few parts of the full tutorial (e.g. how to factor in the taxes owed on repatriated cash used to fund the deal). Result: Everyone gets some value, but those who pay get a lot more.

Mistake #3: Tracking The Wrong Metrics (Or None At All)

Mastering freemium means managing the metrics. Data abounds, yet too few content creators—even those well-versed in freemium—can answer the following questions:

— What is the total cost required to create this free content, or to offer this service for free to X number of users?

— For how long will the free content keep driving in new customers? (Five years? Ten?)

— How often does the content need to be updated, and what are the all-in costs of updating it?

— What is the expected return on investment in offering this free content?

I’ve tracked the time and money required to create our paid products down to the level of individual staff minutes (using loggingit.com and Excel), and I have data on how well everything has sold over the years. I know the numbers on the free content, too. That data helps me figure out how to allocate precious resources in the future.

Before creating new content, I’ll run through the following exercise:

— This article might result in X number of search engine visitors and referrals each month based on the keywords we’re targeting.

— Using our email-newsletter-conversion rates and product-conversion rates, those visits might result in a value of $Y in Years 1-10, where $Y = Annual Visitors * Email Newsletter Sign-Up Rate * Product Conversion Rate * Average Customer Value.

— The content will require W hours to create, which costs about $Z.

— Based on the ratio $Y/$Z, this content is a [lower / higher] priority than everything else.

The exercise isn’t about precision—it’s about order of magnitude. The goal is to avoid spending $10,000 on something that might only generate $100 in revenue. So, if the ratio $Y / $Z for one content plan is, say, four times as high as the ratio for another plan, you can feel more confident about pursuing the first plan. But you have to track the numbers to do it.

Mistake #4: Not Guiding Prospects Down The Path

If your freemium strategy amounts to a simple call to action—“Here’s a free sample… now sign up for the paid version to get even more!”)—then you’re in big trouble. To convert prospects to paying customers, you have to guide them down a specific path. Here’s one way:

Step 1. Create a “general purpose” path that offers free content / tips / services to prospects who are interested in your topic, but not yet convinced they have a problem or that they need a product/service to solve this problem.

Step 2. As they proceed on that path, ask if they want to learn more about a specific topic / solve a specific problem / take advantage of a premium feature—and be perfectly clear about what’s in it for them.

Step 3. Deliver free content and/or a free service that solves part, but not all, of this problem and illustrate the benefits with case studies, testimonials, and client success stories. Throughout this sequence, offer multiple opportunities to sign up for your paid product or service.

Step 4. If the person signs up, great! At that point, offer quick start guides, tutorials on using the product/service, and all the excellent support you can.

Step 5. As part of that post-purchase period,  ask what the next problems they want to solve are and go back to Step 3 to offer more free tips, tutorials, and services that solve some, but not all, of these problems.

Step 6. If the prospect doesn’t bite on any of the paid products or services, that’s okay. Just go back to Step 1 and continue to stay in touch, offering more of your topical content and building the relationship.

We do all of the above with a strategic barrage of emails, postal mail and (for existing customers) phone calls. The system grows in size and complexity each month. As an example, the arsenal might include:

— General newsletter. This might feature weekly tips and interviews on the finance industry and tutorials on specific areas such as resume writing, networking, and interviewing.

— Interview-prep content. If someone signs up and clicks a link indicating that she wants to learn more about how to ace a job interview, we would start sending over free tips and tutorials on that topic, with occasional prompts to sign up for our paid interview guide.

— Post-purchase content. Say the person bought that guide. At this stage, we begin offering additional tips not found anywhere, and customers only receive these as a reward for continuing to open our emails. Along this path, we’ll offer opportunities to learn about more advanced topics (e.g. financial modeling or industry-specific nuances), structured tutorials, and other bundled packages.

Sound too time-consuming to set up and maintain? I hear that a lot. But really: What else are you going to spend your time and resources on? Creating random free content or promotions with no real structure or strategy?

I once considered creating free promotional sequences for all of our entry-level products. (More free tips and tutorials could only help boost conversion rates, right?) After way too many lost hours, I scrapped much of this work and focused the teaser sequences on: 1) higher-priced courses (because entry-level products are rarely the best candidates for comprehensive promotions), 2) customers who had already paid for entry-level courses and might be looking to learn more, and 3) courses where conversion rates could be substantially improved.

Remember: If you want to lure customers without giving away the store, stick to the four freemium fundamentals: Choose the right market; distinguish between free and paid content in a way users care about; track the metrics that matter; and create clear “paths” for promising prospects.

Do all that and you’ll turn your freemium fantasies into real profits.