Freeium:
Using ‘Free’ to Turn a Profit
By DAMON DARLIN
New York Times
August 30, 2009
GIVING away a product has always been a great marketing concept. Even an unsavvy consumer can see a benefit in snatching free products. Free has also become a mantra for business gurus who advocate giving Web start-ups a shot at fast growth by bringing the price of most of their wares to zero.
But as a revenue generator, free can come up short. Sure, it attracts customers, but the challenge is to find someone to pay for it. Although thousands of businesses offer free services online — two of the biggest are the Flickr photo service from Yahoo and YouTube from Google — few can claim to be profitable. (Analysts say Flickr and YouTube are not.) While free is an enticing proposition, it is very hard to make it work.
Indeed, in just the last few weeks, eBay has been looking to shed Skype, the free Internet phone call service. And Sampa, a personal Web site creation service started by former Microsoft executives, folded.
Advertising was always the easy answer for making free pay. But that rarely covered expenses even before a glut of advertising space and a severe recession cut the revenue stream.
The fallback position is charging a few customers for premium service, in the hope that revenue from dedicated users will cover everyone else. A number of sites, like Flickr, do this.
Fred Wilson, the New York venture capitalist, codified this model and popularized a term for it: freemium. And he continues to receive an enthusiastic reception to the idea on his blog, A VC.
But the question remains. Just how does it work? Phil Libin, the chief executive of Evernote, a start-up in Mountain View, Calif., was kind enough to give me a tour of his privately held company’s financials to reveal the mystery.
The company gives away a Web application that saves data you accumulate. You can use it to keep a wide range of information: meeting notes and voice memos, for example, or even photographs of wines consumed or recipes found in magazines. The information is stored on the company’s computers so all the data can be synchronized on every computer the customer uses — and on smartphones as well.
Snap a picture of a business card with a smartphone like a Palm Pre or an iPhone and it shows up on the phone’s Evernote app — as well as on the Dell back at the office. It is searchable, right down to words in photographs. So if you type in “Samsung,” for example, every business card from that company pops up.
“It is a universal memory drawer,” says Mr. Libin, who has run and sold two other start-ups.
Evernote, of course, is free. That’s important because the company, which does no advertising, needs to acquire customers as cheaply as possible. “Our product is our marketing,” Mr. Libin says.
In 18 months, 1.4 million people have tried the service. An additional 4,500 try it each day.
“Free is not a loss leader,” he says. “If we can get a small percentage of users to pay we start to make money.”
How many times has a venture capitalist heard that? But Mr. Libin showed that the magic is not only that it takes just a small percentage of customers to turn red ink into black, but also that the longer they remain customers, the more profitable they become.
About 75 percent of the customers walk away within the first four months. That’s not worrisome, because the revenue from Evernote’s 500,000 active users is growing faster than the growth in the customer base. How? Customers discover that they need more than the basic storage space or want some extra features, like the ability to scan PDF documents for a particular word. Evernote charges them $5 a month or $45 a year for these and other benefits.
Mr. Libin studied the behavior of the earliest adopters and found that the longer customers used the service, the more likely they were to start paying for it. About 0.5 percent convert to paying customers in the first month. But after about a year, 4 percent have converted. (He says he thinks the figure will top out at about 22 percent.)
It makes sense. The shoebox of data is more valuable to the customer as it becomes larger. In addition, compelling uses — like photographing those business cards — quickly eat up the monthly allotment of memory, inducing a person to start paying. The longer the customer stays, the more valuable he becomes.
The company gets about 3 cents of revenue for each active user in the first month of use, but after a year that same cohort of customers is providing 35 cents each.
EVERNOTE made $79,000 from paying customers in July, Mr. Libin says.
That’s not enough to cover the cost of the engineers who design new features and the additional servers to store all the added data. But the cost of staffing doesn’t rise exponentially as more customers join, and the cost of adding storage declines because computing power keeps getting cheaper. (Electricity costs go up, but that is not a budget killer.)
The variable cost for each active user was about 50 cents a month when the company started, but has been dropping along a curve to 9 cents a month. By January 2011, Mr. Libin projects, the company will break even.
Mr. Libin’s model of freemium won’t work for every company. But it certainly could work for other companies who can retain customer loyalty and make their service more valuable over time while driving down costs.
It has convinced him and his investors that giving away the store is the right plan. “We are committed to being free,” Mr. Libin says.
Copyright 2009 The New York Times Company
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