Freemium has not disrupted Segmentation

Is that enough buzzwords packed into single title? I bet I do not have to explain what is freemium or what is disruption, two of most overused words these days. Segmentation however is not new, in fact a very old concept, and yet it is not as popular and needs explanation.

Segmentation: I am not talking demographics based indirect segmentationhere but the right way of segmenting based on customer needs (or needs based segmentation). You are grouping together customers based on the similar jobs they are trying to get done. (see here and here for more details)

When you identify customer segment and the common job to be done, understand the alternatives, surface their willingness to pay for the job, and map the budget from which those customers will pay for that job, you have marketing and product strategy.

Four years ago, when Om Malik of GigaOm wrote, “How freemium can work for your business”, I called out the cognitives biases in looking only at successful businesses.

Two years ago I wrote Freemium has run its course in GigaOm (I am surprised he let me write after my Biases articles).

Fast forward to present day and let us look at one of the poster boys for the freemium model, Dropbox. We have seen numbers on how Dropbox can be profitable with just  3% of the user base converting to paying customers. Small percentage of a very large number is still a large number is the thinking.

Om Malik recently did a fantastic research report on their business and growth. In his report he found,

(Dropbox), according to sources close to the company, is rumored to be valued at more than $4 billion and is on its way to a billion dollars in revenue. It has about 200 million accounts and about 4 million of those are businesses.

The numbers speak loud and clear where their success is coming from -segmentation. While both consumers and businesses may have the same job to be done (easily sharing information in a safe and secure way) one segment values it more and has almost no alternatives compared to the other segment. And it also has a budge to pay for it.

dropbox-pricing

If we assumed businesses chose only the Pro edition at $99 a  year with just two users (over the business edition at minimum of $795/year) that comes to 5 million business customers. If we take 4 million number from Om Malik’s report that would imply businesses with average number of users of 2.5 (generating $250 a year).

In other words, we can explain almost all of Dropbox’s $1 billion a year revenue from its business customers – those with a job to be done that is hard to be filled by alternatives and have a budget to pay for the job.  You and I, consumers, do not have a budget we set aside for such services.

If they were to increase the average number of users per business to 4,  even with no change in 4 million number, their run rate will jump to, $1.6 billion. If they were to target businesses with more than 5 users (and there are many if you look at US Census site), their revenue rate will rise very quickly to $5 and $8 billion.

That is Dropbox’s $1 billion run rate and its valuation are supported not by its freemium but by its segmentation strategy. Freemium may have captured everyone’s attention but it is segmentation strategy that is driving Dropbox’s success.

 

Paywall, Charging for Content and Commodity

In a long essay defending the importance of paywalls, Harper’s Magazine’s John MacArthur wrote this,

I can’t quite believe my ears at the nonsense still being peddled by the advocates of free content.

I can see his anger what he must be feeling to hear new media Gurus (aka charlatans) advise him and every other content creator why giving away content to attract more readers is the new reality.  MacArthur is in his rights to be incensed by such business advice from those who do not know what marketing or value creation is.  However my support to his argument ends there.

If Gurus make a nonsensical case based on marginal cost of digital content, MacArthur commits the same mistake based on his cost (fixed cost) to produce and distribute quality content.

Why doesn’t Harper’s give away a particularly good investigative piece (such as Ted Conover’s powerful undercover report in May on an industrial slaughterhouse) so that more people will read it?

Because good publishing, good editing, and good writing cost money, and publishers, editors, and writers have to earn a living.

This cost based argument justifying charging for content is same as marginal cost argument asking for it to be free.  We cannot ask customers to pay for content or anything else because we have costs. See this for how ridiculous such an argument sounds.

You charge for a product as your fair share of the value you created for your customer.  The fact that it costs you to edit, write and pay writers is your concern, not customers’. If the content you create is no different from many other options or adds no perceived or real value to the customers then they will have no reason to pay for it.

MacAcrthur takes his argument even a step further and making it an argument about fairness,

This photographer, who requested anonymity, risked arrest and prison to take excellent pictures — as do other photographers such as Samuel James — for the benefit of Harper’s and you. The censors in Tehran are surely upset. Shouldn’t Anonymous be paid for this courage and skill? Shouldn’t Harper’s be compensated for sending Anonymous into the field?

Do not try answering his questions because they are irrelevant. People take risks because they see payoff at the end and are willing to trade-off risk and reward. If the photographer believes his content will be just another commodity and will only be valued thusly by his customers (publishers and readers) he would not be willing to take the risk.

It is not that the Anonymous must be paid for courage and skill but Anonymous is showing courage and skill because he sees opportunity to get  fair share of differentiated value he creates through this courage and skill.

And definitely Harper’s cannot expect to be compensated for sending Anonymous. It your risk and your risk alone.

In the customer value equation it is just pure and simple:

  1. You create value to customers through your product
  2. Customers share part of that value as price
  3. You find a way to turn a profit from this price by producing the product at lowest cost

You do not incur costs, take risks then demand to be paid.

Value Equation

Do you still believe freemium has not run its course?

Let me start by reiterating my past objections about giving Apps away for free in the hope of getting attention now and monetization later. Call it by whatever portmanteau you wish – freemium etc. or use the justification that free is free marketing. It does not matter if customers are not hiring your App for a job they are willing to pay for and you do not take the time and effort to understand customer jobs and position your App for the right job.

The App economy tempts us all with billion customers – small percentage of a large number is still a large number. But trying to target billion customers is what SurveyGizmo CEO described as shotgun approach to marketing.

And guess what? You are not the only one with the same shotgun – the App ecosystem has made the same shotgun available to everyone. There are many just like you and their App just like yours with the same hope of converting the same 1-2% of users into paying customers.

With hundreds of thousands of games, productivity tools and other apps already on the market, and thousands more launched every week, many startups are finding that their ideas aren’t so unique after all. (source)

With all these thousands of look alike Apps, the small percentage of large number becomes small fraction of the small percentage of a large number. Which I assure you is a really small number.

The odds of striking gold in the apps business are quite long. While there are more than 800,000 mobile apps available in Apple Inc.’s App Store, only 80 of them generated more than $1 million in revenue during the fourth quarter, according to research firm Distimo

That is the chances of an App making $4 million a year is 1 in 10,000. And there is no point in trying to do expected value math here because the winner takes it all.

And it turns out Free is not even close to free marketing or to be precise marketing is not free even for free Apps. If you want any thing close to decent installs (let alone frequent usage) it takes considerable marketing resources.

In this environment, well-heeled companies with big marketing budgets hold sway.

It gets worse than Free – you end up paying users to install and tell others about the App as the App maker Mouthee found out

Mouthee ran promotions—giving out free iTunes gift cards or other gifts to users who signed up their friends—which would bring a spike in downloads, but the boost would taper off after a week or so,

Let us recap the App situation

  1. There are hundreds if not thousands with App just like yours
  2. They are free as well
  3. Free isn’t free marketing and marketing isn’t free
  4. Building passionate user base is a myth and the chances a newbie App maker without marketing resources will make it into Top 250 is less than 2%
  5. Chances your freemium App will make $4 Million a year is 1 in 10,000

Finally even when you gain millions of installs, your users can stay on free version longer than your startup can stay solvent,

There are so many startups that die with a whimper

Do you still believe freemium has not run its course?

Cast aside these fads and start with the business first principles to go from plan to profit.

Start with the customers, not your App. The App could be new but the customer needs are not. Whether it is a “bits” product with zero marginal cost or “atoms” product with non-zero marginal cost, customer needs come first. In fact, it is not a product until you have identified a set of customers whose needs you meet and who want to pay you for that value.

Make your choice. Successful strategy involves making choices. You cannot treat billion users as customers. Getting 90 percent of customers to take free Hershey’s chocolates with the hope that they will pay more for extras or will upgrade later is not a strategy.

Get your fair share of the value created. Charging for the product is still the simplest of all business models. Product and platform innovation do not mean business model innovation like freemium (which should never be called a business model). If your product adds compelling value to customers, charging for it is simply getting your fair share of the value created. You do not have to be ashamed of making a profit.

How do you go from plan to profit?

How do you compete against free?

You likely have heard the refrain many times. Be it from app developers, startup founders, guru bloggers, or even sales folks and product managers from large enterprises.

How can we compete against free? Customers have so many free options. If we don’t give it away for free they are happy to go with so many others who are willing to do so.

And the free argument is bolstered by pointless justification about market size. If no one is paying, there is no market size (as it is measured in $).

So what is the answer to competing against free? Let me point you to a story about how some skateparks are making money.

There is practically no dearth of public and free skateparks – every city, however small seem to have one. I was surprised to see one in the town of Lahaina in Maui. There are enough public skateparks to the extent that I feel resources are being diverted to one kind of outdoor entertainment. According to SkatePark.org, in 2011 alone cities across Unites States added 845,205 sq. ft of skatepark. (That is decent sized homes for 845 people.)

Is there a market for private skatepark that charges (gasp) for skating? It turns out yes and many different parks are doing so. And they do that by starting with — wait for it — customer segmentation.

They are targeting customers who are turned off by public skateparks – those who feel the public skateparks are too crowded and infested with “snot-nosed punks”.

“It’s guys getting away from their wives and kids.”

And by offering this segment a differentiated product the private skateparks are able to charge for it.

They charge dues and maintenance fees that allow members—most of whom are over 30—to ride in a controlled environment free of the nonpaying skaters, scooters and Rollerbladers who clog up public skateparks.
Members pay a $500 initiation fee in addition to $80 a month in dues

It is true that presence of free options takes away large portion of user base but it does not mean you will only succeed by also giving away your product for free or lowering your prices as close to free as possible. Competing against free starts with customer segmentation and not by seeing the entire market as your target segment.

Every skater in the park is not your customer. Stop doing market size estimates based on billions of users. Nor should a marketer resort to simply getting skaters to skate in ones skatepark for free with the hope of monetizing them later.

Rings a bell?

Find those segments whose needs are not served well by the free options, find what they value and willing to pay for and offer them a product with compelling value proposition.

Saying we can’t compete against free shows you have not done your segmentation right.

Starting with free to get everyone’s attention with the hope for monetizing later is just that, hope, not marketing strategy.

On Temple Run 2 Avatar Upgrade – A Smart Girl’s Perspective

The default runner is a man. It is free (and the game is free as well)

photo

But take a look at upgrades that require to collect or buy coins (either way you expend effort or money as per freemium model). So if you want to choose a female runner you have to first collect 5000 coins (by running the man) or pay for it.

I see this as bad price discrimination – purely s a pricing practitioner as well as a dad. But …

image

My eight year old daughter, who has become a fan of the game, believes it isn’t so. She argues it merely says you have to pay more to be a girl because girls are superior.

What is your take?

The Simplest of all Business Models

Wi-Fi Signal logo

If you want to use Wifi at Pete’s Coffee & Tea you will have to buy something first.  At the counter they give you a code to use, that allows you about an hour of surfing time.

In many local coffee stores you technically have to buy something but once you do, you can stay parked in their tables for hours without buying anything. In Pete’s bigger competitor, Starbucks coffee, it is the similar unlimited free access plus access to premium extras like The Wall Street Journal.

Coffee shops complain about those who occupy tables for hours at a stretch, buy little or nothing and mooch on their bandwidth as well as electricity. Customers who do spend money at coffee shop and need good connectivity for an hour or two complain about the poor speed and difficulty in finding tables near outlets. General customers (who hire the coffee shop for, coffee) complain about the crowd and lack of seats to simply sit and enjoy their brew or have a conversation.

Free Wifi became a popular perk for coffee shops, restaurants and hotels to attract customers and keep them in their shops. If the customers chose your business over others because of free Wifi, you win. If the customers stay because of free wifi and continue to spend during their stay, you win. You have successfully used free wifi as lead generation tactic and customer retention  tool. (Freemium?). For instance, Panera bread saw its sales increase by 15% when they introduced free wifi.

On the other hand, what is free to customers, is not so to businesses. There are costs of operation (making sure there is enough capacity) and opportunity costs (both for the money spent on their big pipe broadband and the moochers). When everyone else offers free wifi it becomes difficult for a business to either stop offering it or start charging for it. Add to this customer dissatisfaction from providing poor internet service.

Look at where we are in the discussion. We are not talking about the compelling value proposition a coffee shop (or a restaurant) offers but talking about a perk. Let us not forget the primary job these businesses wanted customers to hire them for. If customers’ choice is made based on secondary and tertiary factors, the primary value proposition has become irrelevant. If a business fears their customers will walk next door for free wifi they are admitting that their product is an easily replaceable commodity.

That is a bigger problem they ignore while fretting about wifi costs. In focusing on free wifi as lead-gen activity they ignored the core customer segment they started with and the customer jobs they hoped to serve. While some may call free wifi (and Freemium?) as business model innovation, this is essentially losing sight of customer needs and your core competence.

If the customers didn’t hire your coffee shop for coffee, should you tie your business model to selling coffee? That is an incongruence between value creation and value capture.

On the other hand your strategy – to serve the most amazing coffee – need not be fixed. You can see the customer shift and decide your strategy is to serve those customers who have a connectivity need and are not satisfied with existing alternatives. You recognize customer issues with poor speeds in free wifi places and provide reliable speeds as differentiated feature. In such a case you cease being a coffee shop and become a workspace provider. And guess what, you now can charge for that value delivered.

The business model is back in sync with value capture matched to value creation.

That is exactly what is happening in Russia’s Clock Cafe.

“You don’t have to pay for coffee or tea or cookies. You should pay for time, and time costs — I hope — [are] not that expensive.”

And their target segment? Students and business folks who hire them for connectivity and hence pay for the value they get.  Nicely done. However, I think they fixed one mistake but introduced another – making coffee free. There really is no reason for them to offer free coffee, especially the premium kind they claim they deliver,

We have cappuccino, latte, espresso, Americano, and our coffee is not the cheap one

They are committing the flip side of free wifi at coffee shop mistake. Sooner or later they will run into the free wifi problem in reverse. Why bother with coffee or why not charge for it? Especially if the customers didn’t hire you for coffee?

When it comes to business strategy, starting with customer needs and choosing the ones that you can serve better than others remains the best approach. And when it comes to business models, charging for value you deliver remains the simplest of all approaches.

What is your strategy? What is your business model?