Biases in Making a Case for Freemium

[tweetmeme source=”pricingright”]Reasoning and decision making biases are not new – they have been extensively studied and reported.  Committing the same biases are not new either – for academics and new media specialists alike. It should come as no surprise to see the same mistakes committed by very smart  thought leaders like Mr. Anderson and Mr. Om Malik when they write about how Freemium  would help startups and other businesses alike.  I have written previously about biases committed by Anderson in his book Free, now let me discuss Mr. Om Malik’s case for freemium.

To be clear, Mr. Malik’s post is titled  How Freemium Can Work for Your Startup , in which he discusses three startups, EverNote, RememberTheMilk and DropBox and on their ability to generate revenue with a freemium model. Based on these an on a NYTimes article on EverNote Mr. Malik offers 10 commandments of a successful freemium app. Let us look at the biases and flaws in the overall case for freemium and flaws in one  specific “commandment”. His rest of the commandments are actually quite good and applies to any business model a startup chooses.

  1. Survivorship Bias: – Mr. Malik looks only at those that “succeeded” (by his definition I understand, generating some revenue, not necessarily profit). What about all other startups that failed despite those? Did he closely look at all those that failed to say that these did not have the same characteristics as the three he declares to be successful? This is not new, we have seen this flaw before in the business best seller Good to Great by Jim Collins (who later followed through with Why the Mighty Fall).
  2. Availability Bias: Mr. Malik’s post came after his query to his readers for services that they find indispensable.  So we can hypothesize that his argument is based on information that is available to him and vivid in his memory.
  3. Omitted Variable Bias: This is ignoring other reasons that might have caused the success and incorrectly drawing causation conclusion from correlation.
  4. Ignoring Other Options: EverNote may be making $79,000 per month from a fraction of the free users who upgrade to paid service,  but could they have generated equal or more revenue  through other marketing options available to them including offering only paid versions? I do not have data to say either way, neither does Mr. Malik offer any to support that Freemium was the best of the available options to EverNote. After evaluating all options if freemium still offers the best chance to succeed, then by all means do it but not without exploring other options.
  5. Can the business wait? In a follow up post, Mr. Malik writes,

    I used Evernote as an example of a freemium application that’s successfully converting its free users to paid ones. Indeed, the more people use an application like Evernote, the more likely they’ll be to pay for a premium version of it.

    Mr. Malik recomends patience as a virtue, waiting for customers to fall in love and find the service indispensable not to mention switching a hassle. Customers, enamored by the free service will try it and start using it and this may take a long time before they upgrade to the paid version. Can businesses know or model this conversation rate? Without this, it is incorrect to assume that this conversion will happen and will do so before your startup runs out of cash. Customers can stay on free version longer than your startup can stay solvent (hat tip to Keynes).

  6. Free is Free marketing? One of the 10 commandments is

    Free is free marketing. Instead of advertising, the service should sell itself.

    How true is this statement? Where is the data? Does free sell better than marketing/advertising? I have some data,  a paper published in Marketing Science Aug 2009 studied the impact of marketing actions like exhibits, print ads, PR. Of these marketing actions, all but PR and Exhibits yielded better long run sales than free as the marketing action.  Another problem is when there are many similar free services available to the customers – what will be your share of mind and wallet?

To recap: New kinds of products do ot need new kinds of marketing.  If after evaluating all options  freemium still offers the best chance to succeed and maximize your profit, then by all means do it but this is not a generic solution as it is touted to be. Do not accept, without challenging, statements like “freemium works” or “it worked for 3 and hence it will for every startup”.

“For example is not proof”