If you are selling Enterprise Apps you don’t start with freemium

I thought the word freemium went the way of singing fish and MySpace and hoped I never have to write yet another article with this portmanteau in the title. Unfortunately wrong ideas  and false beliefs don’t die easily. They are not replaced by some profound truth because the believers suddenly achieve self-realization. As Kathryn Schulz wrote in her book, Being Wrong, bad ideas die hard because they can only be replaced by another equally bad idea. Until another such bad idea comes around we are stuck with freemium.

This time we are presented with some profound advice on go to market strategy for Enterprise Apps by Scott Irwin from Rembrandt Venture Partners. In his article for GigaOm , Mr. Irwin recommends freemium as the first option for go to market strategy for Enterprise apps before inside sales and before enterprise sales.

Those who are already sold on the idea of freemium will see this as further evidence supporting their case.  Those who are new to the idea will likely see the popularity of the post as evidence for its veracity. Those like me are not going to be convinced as usual. The problem this time is the flagrant errors in the case Mr. Irwin makes by recommending freemium for enterprise apps.

If you stopped reading here, think about it – Enterprises have a budget and have wherewithal to pay. Why shouldn’t you charge for your value-add?

Now to the flaws in Mr. Irwin’s argument.

  1. Ignoring Customer Needs: There is absolutely no mention of the customer segmentation and their needs. Why are customers hiring the Enterprise 2.0 Apps for? If you do not understand your target segment and their needs you cannot deliver them an effective product. And if there is an urgent your product fulfills why should you not charge for it? These are enterprise customers and they have a budget to pay for these apps that add value.
  2. Ignoring Customer-Channel Alignment: Mr.Irwin starts out by making a case with Salesforce.com, a company I admire for its disruption of the enterprise software landscape and its marketing. But it should be noted that they very carefully chose their initial go to market strategy that aligned with how enterprises buy software – building an highly effective enterprise sales team backed by phenomenal marketing. It was not freemium that helped Salesforce.com grow to $3 billion a year company. Sure their product was easy to setup and use but they were not just fighting against customer apathy, they were competing against strong players with significant sales prowess. Do not for a second think freemium would help compete against entrenched players or serve as free marketing.
  3. Choosing Irrelevant Examples: If the topic is about go to marketing for Enterprise Apps the examples used should at the very least use such companies. Not Evernote, a consumer based webapp. When it comes to freemium examples, for the past two years, there have been no other examples than Dropbox and Evernote. Such a model of try the free version and upgrade to premium may work in consumer segment (barely, only 3% upgrade to paid version) but the competition is not going to let that happen for enterprise segment.  In addition any such popular example also suffers from biases.
  4. Choosing Selective Evidence:  Mr. Irwin makes a case using SurveyMonkey, specifically goading us to make app fun so users will use it. First, why should making the app fun be mutually exclusive to charging for it? What about many other applications that are fun to use and but not free. If we want to stick with the same application family as SurveyMonkey, we have SurveyGizmo which you know decided against freemium model to target enterprise customers. There are many other examples of applications that are fun to use and not free. By using selective evidence Mr. Irwin not only succumbs to biases but leads his readers down the wrong path.
  5. Anything but Charging For Value: Rest of his article is presented as a recipe for freemium. If you did not have your segmentation right, you do not have your product strategy or go to marketing strategy right. Any other revenue model, however innovative it is, is not effective. Yes Atlassian and others adopted pay to charity, pay what you want, pay with WOM etc models. Likely these models were relevant for them because they started with right customer segmentation. But all those do not apply to your business.

Why are management gurus, entrepreneurs, startup gurus and now venture capitalists  dead set against getting fair share of the value they create for their customers?

Can you answer the “Why” questions with your segmentation strategy?

Read these three quotes about customer segments and write down what you think about their definitions

It’s a higher-educated, higher-income user that resides in the Northeast. More often than not, the Greek yogurt consumer is a female. – Analyst on Chobani target segment

Verano (Buick’s new compact car) is primarily aimed at younger professionals, in their 30s, and empty-nesters accustomed to driving luxury cars but needing less space now. – Buick’s Product Markting Director

McDonald’s said that in Europe, “severe winter weather in certain markets negatively impacted the segment’s overall February results.” In the U.S., the company cited strength in the sales of Chicken McBites, Filet-O-Fish, signature beverages and breakfast items.

Say the word “Segment”, the responses would fall into a predictable range

  1. Industry verticals
  2. Size of enterprises served (Small, Medium, Large)
  3. Geographies
  4. Age brackets
  5. Education levels
  6. Gender
  7. Everyone

The first three are the most common (and arguably the only type of) segmentation practiced by B2B companies. In all these cases segmentation is done after the fact, to analyze the revenue mix (where is the revenue coming from) and not as a driver for product and pricing strategy. B2B segmentation is more about sales team design and marketing resource allocation than about customer driven product development.

The last five are the answers of those in B2C companies. Unlike B2B, here segmentation is not an afterthought. It is used to guide product strategy and product mix, as you can see from McDonald’s example and Verano example above. Undeniably this is a better approach than what is practiced by B2B companies. But let us stop and think about it for a moment

  1. Why do highly educated, higher income people in North-East prefer Chobani?
  2. Why is Verano attractive to both young professionals in their 30s and empty nesters?
  3. Why do McDonald’s US customers prefer its breakfast items?

The Whys cannot be answered here.

All the seven types of segmentation we saw above are based on externally observable factors vs. the intrinsic need of the customers buying the product. That is the problem with both B2B and B2C segmentation schemes. Businesses confuse externally observable differences and easily measurable distinctions with segmentation and fail to ask the most important question

Why will the customer hire the product?

Stated differently by Clayton Christensen

What job is the customer hiring the product for?

Everything else – the product mix, product characteristics, customer mix and their demographics, Geography – are at best secondary and at worst red-herrings.

Answering the Why question is the only right starting point for your segmentation strategy.

If you cannot answer Why you do not have segmentation.

I started this article with quotes, here’s another from a successful business man known for his basketball victories,

Because Republicans buy sneakers too – Michael Jordan when asked why he didn’t  endorse the Democratic Senate candidate against Republican Jesse Helmes

When the customers don’t know what they want

If we are selling jelly beans, there is not much the customer do not know, be it they are buying the regular ones or the regular ones branded as “Bertie Bott’s All Flavour Beans”. Customers know

  • about the product
  • what they are buying
  • why they are buying
  • what they should pay

But what if customers do not know what they are buying and the value from it?

Economist Brad DeLong from UC Berkeley writes in his 1999 paper titled, Speculative Microeconomics for Tomorrow’s economy,

In many information-based sectors of the next economy, the purchase of a good will no longer be transparent. The invisible hand theory assumes that purchasers know what they want and what they are buying so that they can effectively take advantage of competition and comparison-shop. If purchasers need first to figure out what they want and what they are buying, there is no good reason to assume that their willingness to pay corresponds to its true value to them.

What DeLong wrote in 1999 is even more applicable to the information driven products and services of the new decade.

One way  marketers solve this problem today is by way of unusually long free trials in the form of free products. The argument is, “customers do not yet know they need this product but when they start using it they fall in love and start paying for it”.

That would work, if businesses have the time and resources to wait and competition will do the same as well. There are just too many uncertainties and this method of waiting for customers to figure out the value from an offering is too passive.

The alternative is to take a more active role. Instead of letting customers tell us, “what job they are hiring the product for”, we define, “what job we want them to hire our product for”.

This starts with segmentation, targeting and positioning.

Are you passive or active?

An Approximate Guide To Pricing Your Webapp

When it comes to pricing a webapp, we seem to spend lot more time and resources on fine-tuning activities over getting it roughly right.  Pricing your product is much more than deciding between rounded vs. square corners for your pricing page, whether to end price with 9 and whether you should list monthly/yearly price. In fact if you are considering pricing only as part of your pricing page design it is already too late. As a start-up you are hard pressed for time and resources, you are constantly prioritizing, focusing on your pricing strategy is inseparably tied to your overall product strategy and hence  falls in the super-important task bucket.

There is no easy solution for pricing and no one size that fits all. I do not have all the right answers for defining a universal pricing strategy, but I present a roadmap for defining an effective pricing strategy for your webapp.

Where do we start for pricing?
You are building an amazing product. It is truly innovative. But where do you start to define its pricing? Start by answering the question that Clayton Christensen posed, “What job do I want my customers to hire my product for?”. Note the level of control you have with this question as opposed to asking, “What job will customers hire my product for?”.  The latter question is passive and lets someone else decide what to do with your product and the former is more active, letting you decide which job you want to go for.

What if there is nothing like my product that customers are using today?
If  customers are going to hire your product some other product has to lose its job. It need not be another competitor’s product, it can even be a substitute. For example, Intuit defined their competition as pen and paper. If you cannot think of one, then there may really be no market for your product. You may try hard to write your own job description but research done in this area recommends that you are better off applying for jobs that customers are already hiring for rather than creating a whole new job.

I found the job I like, now what?
Narrowing down the answer to above question helps you answer, “What are they paying for the job now?” This is your customer’s reference price and also the starting point for your price. When a customer is paying less than $10,000 currently, you cannot go with a product with a price of $1MM. But based on your unique value add you have the flexibility to charge higher than their current reference price. If your customers are not paying anything for the job now, their Reference Price is $0. You can either re-position your product and apply for a job they are currently paying for or make the conversation about the incremental value your product adds and price it to get a fair share of that value-add.  That said, please read the previous two points again.

Why stop with just one price?
Not all of your customers are alike and definitely not all would want to hire your product at one common price. In the presence of uncertainties about customer preferences and their willingness to pay, offering multiple versions of your product at different price-points  is better than offering just a single version at one price. Big companies spend $100,000+  to do  rigorous segmentation analysis to define their versions and price points. While you could hire me1 for half as much to do such work, Hal Varian (Economics Professor at my alma mater and Chief Economist at Google) gives us the poorman’s versioning rule:  “Practice Goldilocks pricing – offer three versions of your product and your customers will most likely choose the middle version2”. Even if you are not building all the versions from day one, the versioning hooks and modularity must be built in so it is easy for you to pivot.

What about marketing strategy?
By answering the  last four questions you are practicing three key components of marketing strategy, Segmentation, Targeting and Positioning. You defined the segments by finding those with a need you believe your product can serve, you targeted them with different versions and you positioned your product in the minds of the target segment. That is marketing strategy.

What about my pricing page?
Setting your price is different from the presenting the prices in your pricing page. Unlike a sales call, you or your rep is not there when the customer makes the purchase. Make it very easy and painless for the customers to give their money. Getting the pricing page is important but if your overall pricing and versioning strategy is wrong, no amount of A/B testing or design changes will help you overcome the initial mistake. There are two pricing page tactics I recommend,

  1. Nudge your customers: Nudging is applying many of consumer behavior tactics so your customers pick the version that is most advantageous to you. The most common visual nudge is highlighting one of the versions as the most popular version (Conformity bias).
  2. Categorize your product benefits: When you present customers with options they incur significant cognitive cost in understanding the value differences and selecting the one that fits their needs. When listing product benefits do not list every possible feature and whether or not is supported across the versions. Use categorizations and list just the benefit categories that are most relevant to the job your customers are hiring for. Offer drill-down if customers want to look under each category.

As I sign off most of my posts, “If one price is good, two are better”, and if you add Varian’s findings, “If one price is good, in most cases three are better”.

  • Note 1: Did you notice which job I positioned my services for and how I set your reference price?
  • Note 2:  This claim comes with qualifiers and it depends on the version design. If the lowest priced version gives away too much at low price, then the middle option will not be the attractive one.

The Rational and Not So Irrational Reasons Why Customers Buy

Why a customer buys a product has exactly two sets of reasons:

  1. Rational
  2. Emotional (I would have labeled it irrational, but a reason however irrational it may sound to one is perfectly rational from the buyer’s perspective)

This is just a classification so it is trivially true even though this reads like a generalization. Any reason can be tagged as either rational or emotions and I will expand on these in a moment. This is true for consumer products or B2B buying processes. What varies is  share of each component in the overall buying decision.

The Rational reasons are rooted in “needs”, based on objective evaluation of product attributes, its price, and comparing it to all other alternatives. We can write the Rational reasons to be driven by two components,

  1. Price
  2. Functional attributes (utilitarian benefits)

Emotional reasons are rooted in “wants”, they are the hedonistic reasons. These are all reasons other than those directly driven by the product’s functionality even if the reason is rooted in a product attribute. For instance, a customer buying a 1.5 Tonne truck may also have emotional reasons for rooted in the size of the truck. The emotional reasons are driven by

  1. Stories we tell ourselves (Brand, feeling, Price level etc)
  2. Stories we think others will tell about us (Brand, conspicuous consumption, “nobody gets fired for hiring IBM”)
  3. The Unknown ( this is the unquantifiable part, examples include habit, apathy and nepotism)

What does this classification mean to you as a marketer, product manager or entrepreneur?

It is important for you know all the reasons a customer is buying your product. The reasons vary across:

  1. Product Categories
  2. Purchase Occasions
  3. Customer Segments

You cannot simply copy a template that worked for someone and apply it for your situation, especially when you read a compelling narratives about certain brands. Zappos may have did it, that does not mean you could or should.

Do not confuse product attributes with the reasons why a customer is buying. A customer buying $250 Nimbus 2000 at Harry Potter attraction at Universal Florida is not buying it to fly or sweep.

You cannot focus on any one aspect thinking that alone drives your customer decision. For customers it is always a trade-off and the trade-off as said before isn’t static even for the same customer. You may buy a $12 bottle of wine for your own consumption but when you buy wine as a gift you are thinking about “what stories the host will say about you”.

You cannot also take the shortcut of giving more of everything in the name of delighting everyone.  If you did then you either price it so high that it is unattractive to most or price it too low that you are not making profit from your value-add.

You need to find out what is relevant to the segments you are targeting and deliver them a version at a price they are willing to pay for.

That is marketing strategy!

The 1% Price Increase Fallacy

Updated on 10/27/2010:  Today’s Journal features an article on Small Business pricing and has the same famous 1% price increase quote from  McKinsey “study”.

A price rise of 1% at an average company in the S&P 1500 index, which includes large-, mid- and small-cap companies, would generate an 8% increase in operating profit if sales volume stays steady, the study found

As you read below, the study is not a market experiment. It simply looked at current margins of S&P 500 firms and plugged in the numbers to see how much the income will change. It is sad that a simple what-if analysis gets quoted as indisputable research.

Now on to the article —
The idea is very simple and appealing and managers are smitten by the beauty of this rule.  It is the 1% price increase rule. Its origin is unknown but it became popular when it was described in the book The Price Advantage. Now there is another book out called The 1% Windfall. The premise is,

“1% increase in price will increase your profit by 10-12%”

It is true because it is an artifact of the simple math on revenue and profit calculations. You apply any multiplier to the factors, the calculated metric moves as well. The only take way from the concept should be, notes in parenthesis and edits added by me:

(Under certain conditions for some businesses), increasing focusing on pricing will yield higher profit better results than decreasing focusing on costs, which is due to the fact that price increases flow directly to profit.

But the problem is the 1% is now considered the magical number and in the process of simplification the nuances and caveats are lost. This makes it look as if the way to increase profit is just turning knobs on a proverbial pricing dial.  Increase prices to increase profits.

Here are the key problems with 1% argument:

  1. Elasticity: It ignores where in the demand curve is the current pricing (or states it as footnote and not as primary argument). Only products that are currently priced at inelastic part of the demand curve, will see change in demand from a modest price increase.
  2. Reductio Ad Absurdum: So if 1% is good, is 2% better? 10%?  Suppose we did the 1% price increase and achieved profits, can we keep at it? This brings us back to first point on where in demand curve is the product. This means the 1% rule is a gross generalization.
  3. Why just 1%? This is flip side of above two points. If your current prices are in the inelastic part of demand curve, shouldn’t you find the true price increase needed before profit starts dropping off?
  4. Roughly Right Vs Precisely Wrong: If the product is priced wrong, there are other ways that are needed to get it right. For example, is the product targeting the right segment and offers right value at the price the segment is willing to pay?  In fact, instead of increasing prices a reduction may be needed to maximize profits. The 1% rule will fine tune a wrong price and achieve precision but will still be wrong.
  5. Versioning: Focusing on 1%, you shut yourself from the opportunity to develop and deliver high value products to segments that are willing to pay much higher prices or lower value version at lower prices to others.

The 1% price increase is just a catchy tagline – simple, popular and irrelevant. Effective pricing starts with segmentation and targeting and not dialing knobs. 1% price increase may be relevant to businesses that already have the right segmentation and versioning but not when the marketing and pricing strategy are wrong.

Final note, the book  1% Windfall that talks about how successful companies use price to profit and grow is discounted 45% on Amazon (wonder why not 44%).