Can Paid Customer Acquisition Work With Freemium?


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I received the following question from a reader:

I was wondering if you had any thoughts on cost of customer acquisition for freemium businesses. When you calculate it out, it seems that paid marketing efforts like AdWords are almost universally doomed to fail. Our lifetime value of a customer is only around $1 when you factor in a high initial churn and all the free users. I imagine companies like Evernote are in a very similar position since they have a similar pricing model.

We are obviously hitting social media, PR, etc. quite hard, but I don’t think paid acquisition could possibly work here. Have you seen paid acquisition work for freemium businesses?

My Thoughts
I’ll admit up front: I’m not a fan of using freemium in a bootstrapped business. While I didn’t write the post Why Free Plans Don’t Work, I wish I had.

If you have funding then freemium is possible to pull off, but growing a company organically using its own revenue doesn’t work when you have an extremely low customer lifetime value (LTV).

I think of freemium like trying to build a campfire in the middle of a dry forest. If you are sufficiently skilled you can build a nice, warm fire, but you’re more likely to burn the whole place down. I don’t know of any bootstrapped business that have used freemium successfully (though I’d love to hear about them in the comments), and I know of many funded businesses that have not used it successfully.

Typically, low LTV businesses only work when there’s some kind of viral loop in place that ensures every customer you sign up brings in X more customers. This lowers your cost of acquisition to such a level that you can turn a profit eventually.

The problem is that pulling off a viral loop is extremely difficult; you either have to be an expert in doing so (a la Peldi, Sean Ellis, or Matt Inman) or get really lucky…or both. And I hate basing a business on luck and outlier-class talent.

Adjust the Funnel
So yes, your intuition that paid acquisition strategies are not going to work with a low LTV are correct. However, if you look not at every user who signs up, but only those who sign up for your paid plan, you will have a higher LTV (though a lower conversion rate).

Instead of thinking of it as “I can only spend $1 to acquire a free user” you can think of it as “I can spend $50 to acquire a paid user,” and look at optimizing that funnel.

Also, keep in mind that some of your freemium users may convert over time…Dropbox indicates they get a decent percentage of their users converting to paid within 12 months (I think it’s 3%?). The problem is that you need piles of cash to sustain yourself while you wait them out. And you need to have funds to support the other 97% who never convert. Both of these typically require some kind of funding.

If you are in a business where everyone else is freemium I would encourage you to think about charging for your product. Go upmarket or figure out a way to differentiate. What can you build that will provide your customers with $19, $39 or $79 per month of value?

Unless you have a large bank balance, I’m not sure how you can begin to compete with free unless your product is very, very different from your competition.

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8 comments ↓

#1 JD Conley on 11.15.11 at 5:45 pm

We are successful with paying for free users in social games, BUT, many games wouldn’t be profitable if they had no built-in viral mechanics. If you can’t also get users for free, paying for the free ones will probably bankrupt you. 🙂 We also target huge markets, have funding, offer minimal/community support to free users, track ludicrous amounts of analytics, and do predictive modeling. For instance we have multiple full time statisticians on staff…

Another reason DropBox is able to buy free users, and they do have PPC ads out there, is because of their viral referral incentive program. If it works for you, the referral program could turn one free user you had to buy into 2+ others, essentially dividing your CPA… That might be something worth trying, but make sure you have the analytics in place to know what’s going on and if it’s a valuable program. 🙂

Rob Walling Reply:

This is good insight. Thanks for the inside info, JD.

#2 Giles Farrow on 11.16.11 at 6:06 am

I will play devil’s advocate here…

Let’s say you have lots of competitors with similar products all charging £50 or so. Someone comes along offers very similar product for free, what are you going to do?

I would rather be the one disrupting the market with a freemium offering, assuming:
– incremental costs are near zero
– reasonable viral coefficient is achievable
– can structure freemium to “hook” users the more they use it

Even if I don’t have my premium offering built, the free version gets me
– awareness
– traffic
– learning
– advocates
and probably reduces competition

Would you choose to enter a market with a successful freemium competitor?

Rob Reply:

You’re right; that’s a great way to disrupt a market. But not a great way to make money. You need a long runway of cash to be able to develop, market and support an app that others are charging $50 a month for.

matt Reply:

But not a great way to make money. You need a long runway of cash to be able to develop, market and support an app that others are charging $50 a month for.

exactly….

#3 Crave Invoice on 11.16.11 at 6:07 am

I believe in freemium as it works for me. I provide free version of our invoicing software to customers. Of course, it has some limitations and after some time user prefers to upgrade to Pro edition.

There are cons to this model but it is easy to reach to large audience with it.

#4 Peter Alberti on 11.17.11 at 10:52 am

I am happy to see that “Freemium or perish!” is starting to fade away. I was concerned when we decided not to do a Freemium model that we’d automatically preclude ourselves from getting traction, but that’s certainly not the case. Create value – get paid. It works.

We do offer a 1-month free trial for one level of our service to avoid having credit cards be the obstacle to try us. But after 1 month – pay or don’t use us.

#5 Bryan Sise on 11.24.11 at 12:50 am

“I don’t know of any bootstrapped business that have used freemium successfully (though I’d love to hear about them in the comments)”

GitHub. Which you list among your list of of Ten Highly Successful Bootstrapped Startups!

But all your points among freemium being a tough road to hoe are well taken. The fundamental truth is that freemium only has a chance at working when you’ve reached scale (and even then it’s not guaranteed; it comes down to cost of acquisition and lifetime value), and that scale requires a runway that most bootstrapped startups don’t have.

Nevertheless, I chose to start a business that pretty much _has_ to be a freemium play (at least I can’t think of how I would be able to make it work without a free option), and I’m gonna stick with it 🙂

Thanks for all your great writings.