Comparing Free Trial and Freemium Models

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1 Whitepaper ariasystems.com / experts Comparing Free Trial and Freemium Models Billing and Subscription Management Expert Series

2 Executive Summary Free trial periods and Freemium models have grown in popularity as ways to drive increased adoption of recurring services. The thinking behind both is that giving potential customers exposure to the service, even in a less-functional variant will entice some subset of free users to convert to paying customers. While there are many popular examples of successful products that have used free trials or freemium offerings to develop large and loyal paying customer bases, not all services are a good fit for such models. Furthermore, there are a number of considerations in approaching these models that are important to help organizations achieve their goals in terms of adoption, conversion, and long-term monetization. This white paper describes and analyzes both free trial and freemium approaches. It highlights the inherent trade-offs and sometimes-difficult choices that must be made to maximize success. It concludes with some recommended best practices for deploying free trial and freemium offerings. Letting Your Service Sell Itself Free Trials and Freemium (FT&F) models Many companies already use FT&F models as a marketing vehicle for their products and services to drive engagement with more prospects and to use free evaluations to convert interested free users into paying customers. While there are some exceptions, the most widely deployed FT&F offerings generally share a few common traits: Digitally-delivered with limited or zero costs associated with allowing users to try the service Recurring revenue model Recurring and subscription revenue models have become increasingly popular vs. traditional one-time purchases. Whether for content (i.e. Hulu, NetFlix, New York Times), B2C applications (online games, cloud-based consumer backup services) or B2B applications ( Enterprise editions of open source applications, web visitor analytics), many FT&F offerings promote services delivered via a subscription or usage model. Touchless sales cycle FT&F models rely on the assumption that experiencing the service in a self-service fashion, without significant Sales interaction or live customer support, will be sufficient to drive conversions. Free Trials For the purposes of this discussion, we will define a free trial as access to a service at no cost though limited either by time or usage. Sometimes free trials provide access to a reduced-functionality version of the service, but in most cases offer access to a full-featured version. Time-bound free trials may last for an arbitrary period such as 30 days or 3 months. Usually the service is automatically disabled after the specified trial period has elapsed. Usage-bound free trials typically involve some initial credit either as dollars or units of service. Usually the service is automatically disabled when the units or dollar credits have been exhausted, similarly to the time-bound scenario. A good example of usage-bound free trial approach is LinkedIn, the popular professional social networking site that tempts potential advertisers with offers for $50 in free ad placement credits to try advertising on LinkedIn. Opt-in or Opt-out? One key consideration for free trial offers is whether to make it an opt-in or opt-out program. The opt-in model generally means that the user of the trial will be informed at some point that their trial is about to expire or has expired, with an offer to sign up for the paid version of the service. Clients can then opt in by providing payment information for subscription fees WHITEPAPER 2

3 ariasystems.com / experts (i.e. first month or first-year subscription fees) if they such as commercial open source products, compa- want to continue using the service. nies can use products from MySQL (database), Red The opt-out model allows companies to automatically convert free trial users to paid users when the trial has expired. Typically in an opt-out model, payment information is captured at the start of the free trial period so that no additional user action is necessary Hat (Linux operating system) and Pentaho (business intelligence) who all offer both free versions as well as Enterprise versions. The Enterprise versions include additional features, technical support, and other services. to convert the free trial user to a paying customer. The key challenge when using a freemium model is to Instead, the burden is on the user to interrupt this find the right balance between adoption and conver- process and make it known that they do not want sion to paid usage. To illustrate this point, let s con- to sign up for paid access to the service. Personal sider a couple of extreme examples. credit monitoring services are a good example of this model, with most offering 3 months of free monitoring service that automatically converts free trial users to paid customers after 3 months. It is critical in the opt-out model to make sure that users are complete- This freemium service would probably lead ly aware when they sign up that if they take no ac- to extremely high tion, including never even using the free trial service, adoption given the that they will be charged and subject to some kind of commitment (i.e. a one-year subscription). Oth- value provided in erwise, users will feel misled, complain about your the free offering company online, demand their fees back or fight the charges through their credit card provider. Too many of these disgruntled customers can actually cause you to lose money on your free trial program and damage your business reputation. Freemium Offerings This white paper will define a freemium offering as a perpetual-use/non-time-bound service. In most cases, the free offerings in a freemium model are a functional but degraded version of the for-pay premium offering. But importantly, it is not time-bound so theoretically the user can use it for as long as the service exists without paying any fees. For B2C online services, such as personal accounts, individuals can subscribe to a free Hotmail, Yahoo, or Gmail account and use it perpetually for free. However, you will be offered a paid upgrade to the premium service that First, imagine a freemium service that allowed users to watch 15 seconds of any movie for free. This freemium service would be perceived as nearly nonfunctional and would likely achieve very low adoption. However, the vendor may see a very high conversion rate of the few freemium adopters since they want to view the entire movie. Now imagine an alternative where a service offered unlimited free movies in its free offering, but the Premium offering also gave you the option to watch the movies with subtitles in Japanese. This freemium service would probably lead to extremely high adoption given the value provided in the free offering, but very limited conversion in non-japanese-speaking countries because of the low value of the Premium service to most users. might offer some combination of expanded file storage, better spam or virus checking, mobile device Again, the key to freemium models is striking the support, no advertisements, and more. In B2C, some right balance that drives healthy freemium adoption, freemium offerings are actually supported by third- but also healthy paid conversion. And that begs the party advertising, with free mobile device apps being question, what are healthy adoption and conver- the best example of this model. For B2B applications, sion rates? This is a hard question to answer since 3 Free Trials vs. Freemium

4 Talent Exchange is a strategic initiative for us, and we needed a proven partner for billing and monetization that could get us to market quickly. Aria Systems provided the functionality, secure SaaS platform, and delivery expertise to implement rapidly with a complete billing solution. Taleo it is highly dependent upon individual markets and businesses. In some cases, if your competition is offering a freemium product, you may be able to get a feel for their adoption and possibly even conversion. Now you can use these metrics as benchmarks for your business, but more often than not, beyond internal targets built on day one assumptions, it s difficult to know how many adoptions or conversions should be expected with a new freemium service. Freemium Fails without Adoption While there is no way to guarantee the success of a given service offered in a freemium model, there is one phenomenon that can guarantee failure: weak adoption. Weak adoption of a free offering is generally a function of one of the following: Insufficient perceived value or functionality your free offering needs to do something useful or no one will use it or recommend it to their friends and colleagues. Demoware is a term sometimes used to describe a free offering that s actually just a demo rather than a minimally functional product. For example, a full-featured image editor whose free version doesn t let you save your work is nearly useless beyond letting you get a demo of the product s image-creation capability. Feebleware is another term that describes a free product that is so limited in functionality compared to its forpay cousin that no trial user is going to use it repeatedly over any period of time beyond the initial, disappointing experience. Better or equivalent free alternatives Just because you offer something functional for free doesn t mean that you ll get meaningful adoption. Do your competitors offer free versions with equivalent or better functionality? Is a competitor s service easier to use? If your free version requires the user to disclose significant personal or contact information while your competitor only asks for a name and , they re going to get higher adoption than you. A solution without a problem Are you sure that your free offering actually does something that people appreciate? Does it solve a problem for them, or in the case of consumer services, does it entertain and delight them? Creating a successful freemium offering starts with making sure your free offering does something useful for your target customer segment. It needs to be as good as, or better, than other free alternatives. Finally, it should be easy for prospects to access and refer to their colleagues. Assuming that you ve identified a compelling free offering, now the rest of the puzzle that needs to be solved revolves around conversion: how do you entice a reasonable percent of your free users to pay for the service? The Value Gap The notion of a value gap is useful when considering what will drive successful conversion of free users to paid users. The chart below provides a conceptual model showing a few different aspects of freemium models, and how the functionality offered in both free and paid offerings influences adoption and conversion. With insufficient value or functionality, adoption does not occur. Once there s enough value to drive adoption, conversion to paid offerings will depend significantly on the value gap the incremental value or functionality that the paid offering provides beyond the free version. If the value gap is low, for example if premium features are just considered minor conveniences or nice-to-haves, conversion will remain low even with strong adoption. Conversion will grow as users perceive a larger value gap and thus more incremental value from the upgrade. Of course, the price of the premium offering matters as well do customers perceive greater value in the paid offering but not enough to justify what they see as a high cost? Tough questions FT&F models aren t appropriate for every product or service, and while they might be trendy or seem innovative or aggressive from a marketing perspective, they still may not make sense for your business. Here are some key questions to ask and make sure that your management team can answer before WHITEPAPER 4

5 launching a free trial or freemium offering: Can your service actually sell itself? This point focuses on how a new prospect perceives the value of your free service and the difficulty to use it, before signing up. How likely is it that your prospects will quickly perceive the value of the freemium offering or does it require extensive pre-sales explanation? What will it take for your user to get started with your free service? Closely related to the first issue, consider what it takes for your user to get going with your free service. Just because you have a great product doesn t mean that you deliver a great user experience in a self-service evaluation. How many of your paying customers get going with your service without any help? There are many examples of very good, very high-value products that simply can t sell themselves in FT&F models because of excessive complexity or sophistication, or excessive dependency on Sales or Service interactions to help the user be successful or to really convince your free user of the value in paying. For example, some great enterprise software still requires enough support or user know-how for someone to be successful that a free trial might be the worst thing the vendor could do to convince prospects of your product s value. But if your service shares attributes with an online photo-sharing service, then it s probably just a few clicks to deliver value to the user and it likely doesn t need any support for most users to get up and running. But if significant effort is required to configure the service, integrate existing data from other systems, or to learn to use standard functionality, your FT&F users may start searching for other alternatives rather than invest the effort to evaluate your free offering. So an easy service with a short time to value is a good candidate for freemium models. Does your free trial actually promote your real value? The best examples here are when services provide some invisible or less-visible benefits peace of mind, better support, regular backups of information, certified versions of software, etc. For example, if you offer a free trial of your software application, but most of the benefits and value of your paid version is in support, training, or other add-on services, then your free trial user isn t really getting a chance to evaluate the primary benefits of your paid solution during the trial. For this reason, some organizations offer partial or even full technical support and training during free trials, both to increase the success rate among trial users and to let them experience the benefits of the paid offering. The notion of a value gap is useful when considering what will drive successful conversion of free users to paid users. Does your free offering cost you anything to deliver? While it s not usually top-of-mind for Marketing or Sales professionals introducing new FT&F services, you should not overlook the costs associated with allowing users free access to your services. For example, itunes offers free song previews that you can play the initial seconds of a song you re considering. Whether 10 or 10,000 people listen to that song sample, the cost to Apple is fairly minimal. On the other hand, if your service is more like Kodak Gallery (formerly Ofoto), you may want to spend some more time modeling your cost structure. Kodak Gallery initially allowed users to store unlimited pictures online. They assumed that users ordering paper prints of their online pictures would offset these sharing and storage costs. But last year, they changed their service model and limited storage capacity for free users. Why? Because too many people were 5 Free Trials vs. Freemium

6 HootSuite is a fast-moving innovator, and we wanted a SaaS billing platform that could support the pace of our business. Aria s platform offered the flexibility, ease of integration, and robust monetization capabilities that we needed for the next step in our evolution. HootSuite HootSuite.com sharing photos for free and not ordering paper prints. Their free offering was costing them real money in terms of storage hardware and networking charges. From a financial modeling perspective, having a productive FT&F program means making sure that the incremental profit delivered by the FT&F offering is greater than the incremental cost associated with free users. Here s a simplified financial model that illustrates how different variables will influence the success or failure of your FT&F offering. Recommendations & Best Practices Don t over-promote your free version Your most ideal situation would be that every prospective paying customer signs up for your paid version without ever trying out your free version. So in your desire to lure people in to get them using your free version, don t confuse or divert the prospects willing to pay without going through a free version experience first. Balance this goal with a reasonable promotional approach to attract free version prospects. You don t want to hide your free trial or you won t get any lift from it, but if it dominates your website for example, you may actually steer some prospects into your free trial when they would otherwise have purchased a subscription without a free trial. Monitor usage for free users No business ever perfects their FT&F offer on the first try. To finetune yours, you need as much intelligence as possible regarding how free trial users interact with your free service. If you start to see trends in usage patterns, you might find an opportunity to better segment your paid offerings for infrequent vs. heavy users. Even better, if you can monitor what features a user interacts with, you may be able to tune his trial experience and consider what other features would motivate him to convert to the paid version. Use your intelligence for targeted and timely marketing Rather than giving your prospect a free service and crossing your fingers, if you re learning from their usage of your free service, you can use that knowledge for timely, targeted marketing. For example, instead of a generic 5 reasons to upgrade now! campaign, you can send them a campaign that s more focused on the way they use your service. The same can be true in terms of intelligently timing your upgrade offers. For example, if your free service provides up to 10GB of free online storage, you can send them a notification and upgrade offer when they get to 8GB. Do surveys of your converted users It s critically important to know why free users convert to paid subscriptions. If your paid service provides multiple benefits over your free version, knowing how your paying users prioritized those benefits will help you sharpen your marketing message to your free users. This insight may give you clues as to what kinds of additional features would increase the value gap in future versions of your paid service. Do not just trust your own marketing assumptions and assume that the customers upgraded for exactly the benefits that your marketing team is promoting. Relentlessly measure usage and regularly survey your users. You may get benefits even from users who don t convert Even users who never convert to your paid service can give you value in many different ways; through feedback provided online, and through word-of-mouth referrals to their colleagues and other free advertising. Automate, automate, automate Services offered via FT&F models are often low-cost, sometimes in the range of tens of dollars on a monthly basis. While you can afford some inefficiency and manual touch points in a traditional up-front sales model where you re collecting a lot of cash at the outset, FT&F business models mandate end-to-end automation. Use technology that automates your FT&F model all the way through the process of: Signs up new free users Automatically (and ideally, instantly) turns on the right services at registration time WHITEPAPER 6

7 Tracks free usage and gives you the ability to analyze and understand it Upgrades users either via automatic opt-in or by automatically reminding them that their trial period is about to expire and asking them to opt in Bills and collects payments Renews paid users so that you continue to generate recurring revenues Conclusion FT&F models have launched many of the most successful recurring revenue businesses and services. But not all companies or services are a good fit for FT&F offers, so you need to take the time to understand the expected costs as well as the benefits of an FT&F model before launching a service. There are different considerations and variables that contribute to your success so plan carefully. Lastly, FT&F best practices are constantly evolving so it s important to stay abreast of the latest developments and plan for agility no matter how you initial launch your subscription service. APPL X PUP X R C > AFPL X CUP X (1- R C ) Incremental profit from conversions Incremental cost from free users Example: Cloud-based backup service for consumers laptops Plugging in some simple numbers, let s suppose we re considering a freemium offering for a cloud-based backup service for consumers laptops. Suppose that we model 5% conversion from free users to paid users. Assume that paid users will use the service for 15 months on average, and that their fees generate $12 per month beyond the average cost of supporting them. Now let s assume that the other 95% of users who never convert to a paid subscription use the free service for 2 months on average. It costs our company $4 per month while they use the free service. Our incremental profit contribution is (15 periods) X ($12 profit per period) X (5% conversion to paid), which is $9. Our incremental cost from free users is (2 periods) X ($4 cost per period) X (95% free users), which is $7.60. So our freemium model works. You ll notice how sensitive this model can be if you consider what happens when we drive the conversion rate from 5% to 10%. In this case our incremental profit rises to $18 while our incremental cost shrinks to $7.20. Likewise consider what happens if our average free-use period grows to 3 months and our conversion rate drops by only 1% to 4%. Suddenly, our incremental profit is $7.20 and our incremental cost is $ That s a freemium model that s doomed to fail. Of course, if you haven t already offered an FT&F service and you don t have any visibility into what your competition is achieving with their FT&F offers, it s very hard to predict the financials of a new freemium business model. The best approach is to make some initial measurements and then measure relentlessly throughout your FT&F launch. This approach touches on a best practice we ll discuss next. APPL = Average Paid Period Length, typically in years or months PPP = Profit / User Period (subscription fees exclusive of costs) for paying users R C = Rate of Conversion. Note that this is not the same as your percentage of paying users, which would include users who signed up as paying users from the outset. To measure the value of the FT&F offering, this has to focus on the number of paying users you re getting through the FT&F offer. AFPL = Average Free Period Length, typically in years or months. Note that in Freemium models, this can be very long. Some people have been free users of hotmail for 12 years. This is one reason why - unlike freemium - free trials put a cap on the length of free use period. CUP = Cost / User Period for free users (1-R C ) = Rate of free usage reflecting free users that never convert to paid 7 Free Trials vs. Freemium

8 Issuu serves a large, global audience and we needed a platform that could scale with our growth and support our various revenue models. The Aria Platform was the clear choice for rapid deployment and short term results as well as the flexibility and reliability to deliver long-term success. Issuu About Aria Systems Contact Aria Systems Today! sales@ariasystems.com info@ariasystems.com Aria Systems is the subscription billing and management market leader serving Global 2000 companies. The Aria Subscription Billing Platform is the industry s only enterprise-class solution that automates the entire subscriber life cycle for all recurring revenue models. Disney, Ingersoll Rand, DreamWorks, EMC, Internap, Roku, VMware, Taleo, and Hootsuite all rely on Aria for fast time-tomarket, low operational costs, and monetization flexibility. Aria Corporate Headquarters Silicon Valley Aria Research & Development Suburban Philadelphia Aria Systems, Inc. 101 S. Ellsworth Avenue, Suite 100 San Mateo, CA Phone: Fax: Sales Toll Free: Aria Systems, Inc. 600 Reed Road. Suite 302 Broomall, PA Phone: Fax: Sales Toll Free: ARIA (2742) WHITEPAPER 8