Freemium - Free to paid conversion rates

I am at DealMaker Forum today. We just finished the speed dating sessions with start-ups and I was struck by one common theme. The most common business model is Free Service with an up sell to paid premium subscriptions, commonly known as the "freemium" model. I asked each of them what kind of conversion rates they were seeing. The average is less than 3% conversion. The companies presenting include; Echosign, Seriosity, Smartsheet, Central Desktop, Oddcast, Yugma, and others.

Freemium business models usually involve a Free service, sometimes time limited or feature limited, supported by advertising. The ads rarely cover costs. The goal is to convert these free users to paid subscriptions. Most services start with a $10 per user per month subscription and scale up to $20 or $50 per month based on a small, medium, large usage scale. They all have slightly different measurements and cut-off points, but most have some notion of small, medium, large.

The Open Source Software vendors have a similar model where they offer the software for free download and sell consulting, maintenance and support  contracts for revenue. I am working with a few companies in this space and they are seeing the same kinds of free to paid conversion rates.

The companies presenting at DealMaker Forum are seeing 1.5% to 5%, with most of them averaging around 3%. Doesn't sound like much but they are reaching tens of thousands of users...sometimes well over 100,000.

Do the math. 100,000 free users convert to 3,000 paid users. They pay between $10 to $50 per user per month. Lets use $25 as an average. That is $75K a month or $900K per year. That is an excellent revenue stream for companies that typically have 3 to 5 employees. And, it is an annuity stream that continues to grow every year. By the 3rd or 4th year these small companies can be generating $3M to $5M a year, still with less than 10 employees. Most of these small companies don't take Venture Capital so they own the whole company. pretty good cash flow business.

What are you seeing for conversion rates? How does this compare to the Open Source conversion rates?

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Comments

[Jason M. Lemkin]

Don -

For what it's worth, I think it's worth segmenting conversion. Some users in our experience convert at a very high rate; the rest don't convert at all. 3% actually may overstate conversion I think in that sense and lead one to overvalue metrics around free usage.

If you look at eFax, they have 11m free and 1m paid. But less than 10% of their paid comes from free-to-paid conversion. So really it's 11m coverts -> less than 100k ... less than 1% for a great service (a free fax #).

So we focus more on identifying which of the free want to convert, and give them value to do so, rather than the general free base, who from a biz model perspective, their best value is as viral marketers.

[Brad]

eFax has a little trick they play though. They limit the free service at a what seems like a perfectly acceptable level for the typical personal usage. Then they start posting spam faxes to your number until they push you over the limit at wish time they force you to either join or lose your number. $20/month is a ridiculous amount to pay unless you are a heavy fax user (which few are). That's why there are numerous competitors with much more reasonable prices.

[BlogReader]

[ How does this compare to the Open Source conversion rates? ]

What is an "open source conversion rate"?

[James Cooney]

BlogReader: I think "open source conversion rate" refers to the rate of those using gnu/open source software like Linux who end up paying for some aspect of service on top of the free software itself, be it easy/help in installing or down the road support. Businesses like Red Hat in the Linux arena are built on that model. I don't know the number, but I am curious. Anyone have some figures?

[Don Dodge]

James & BlogReader, Yes, James has it right. That is exactly what I meant by "open source conversion rates.

Businesses like RedHat, MySQL, and in fact all open source businesses, give the software away for free but rely on "converting" those free users to paying customers for things like maintenance, support, consulting, and training.

The question is what percentage of the free users actually pay for maintenance and support? My guess is it might be about the same...2% to 5%, but I don't know.

[framemaker fdk user]

I suppose it's a bit late to weigh in on this, but I don't think the comparison to open source conversion rates is actually particularly germane.

The "freemium" model combines "freeloaders" (who load down your servers and want everything free) and your real customers. Open source isn't a service, i.e. adding one more free MySQL user costs MySQL absolutely nothing, because MySQL isn't hosted on servers belonging to the company giving away the service.

And freeloaders in the case of MySQL, Linux and other open source software packages are in fact useful, in that they spread the word, develop the skills to build an ecosystem around the software, etc.. Long term they can be the key to the success of a piece of open source/free software, provided that that software presents itself as a platform to which you and others can add value.

Another comparison: look at wordpress.com (where each free blog adds weight, and essentially the internals of the thing are inaccessible) vs. wordpress.org (where the open-ness of the source code and the users' responsibility for hosting means zero cost, plus great plugin development that adds value). Essentially the same application (Wordpress), delivered in two very different models, leads to two different ways of creating value and ultimately monetizing. (Wordpress.com becomes a better service by virtue of the feature developments and plugins that come out of wordpress.org and the Wordpress plugin community. A variety of people find a variety of businesses they can be in, in the general vicinity of Wordpress-- commercial plugin developers, for example.)

So direct conversions don't make tremendous sense as a metric for success of open source projects either.

I suppose that you could get developers to add value to a free service like Flickr or google maps through mashups, but even there the operator of the platform incurs incremental cost for each user.

Anyway-- responses welcome.

[Sean Ellis]

Don - Looks like this post was about a year before its time. Conversations are heating up in the fremium space with the recent wired article on the fremium business model.

My favorite thing about the model is its defensibility. By building your business from the ground up to compete with a free version of your product, you have a much stronger business (you face fremium downsell pressure from day 1). Imagine the premium guy that suddenly faces competition from a new fremium startup. I play out this scenario in my most recent blog post:

http://startup-marketing.com/2008/03/10/fremium-will-squash-premium.aspx