Freemium model faces biz, IPO challenges

Companies offering services for free face difficulties such as inconsistent performance metrics and moving customers to paid model, note market analysts, who add that these will affect IPO feasibility of such businesses.

Companies operating on a freemium model will face difficulties measuring their business performance and gauging their future business outlook, as well as converting customers to a paid service. These issues will impact any decision to invest should these companies file for IPO (initial public offering), industry analysts say.

There are inconsistencies in metrics used to measure the performance of a freemium business at the startup phase, noted Aliza Sharma, industry analyst of Asia-Pacific ICT Practice at Frost & Sullivan. Most of the time, such companies fell short in gauging the future outlook of their business and consequently, were forced to shut down, she said.

Freemium companies need to know how to position themselves in the market and be "unwearied" in running the business because profits will not come in as easily, and as quickly, as other business models, Sharma added.

Another challenge these companies will face is addressing the psychological barrier of making customers pay for something they are used to getting for free, noted Michel Birnbaum, general partner of Singapore-based venture capital (VC) firm, iGlobe Partners.

Elaborating, Michael Yoshikami, CEO and founder of YCMNET Advisors, said Internet users are "notoriously frugal" and tend to migrate toward "whatever is free and useful on a transitory basis".

"The freemium model relies on the perspective that consumers will grow so attached to the product or service that you offer that they eventually pay a fee to continue using the model," Yoshikami said. "It relies on market penetration and familiarity as the way to drive business revenue in the future."

IPO investment speculative
Buying into an IPO of the freemium model requires the belief that the service offered has such strong demand that, ultimately, converting from a free to paid service will be a "compelling decision" for customers, Yoshikami explained.

He remarked that investing in a freemium company is "speculative" as only a small number of consumers typically will convert from a free to paid service model, and this will likely create pressure on the stock prices of companies operating on a freemium model.

Pandora and Spotify, for instance, are still trying to morph from a free model to a paid subscription through advertising, he said.

iGlobe's Birnbaum added that freemium businesses need to demonstrate a "robust product roadmap" which the management must execute. He noted that LinkedIn only went public after more than eight years of proving its business model.

"Freemium can be a viable business model, but the free part is only a means to attract paying customers," he said. "In the end, it is about making your product viable enough so people are willing to pay for it. Freemium is one way to get there."

According to Sharma, with the right business plans as well as applying smart innovation to adapt to evolving customer demands, freemium businesses can increase their level of success.

The Frost & Sullivan analyst cited Dropbox, Evernote and Skype as examples of freemium businesses that are still going strong and gaining customers. Pointing to last week's IPO of free antivirus maker, AVG, she noted that due to increased level of awareness over hacking and cyberattacks, such companies may be heading in the right direction when they choose to IPO.

For freemium models to work, Birnbaum suggested that the target market must be large enough so that a paid-consumer conversion rate in the single digits can still provide significant revenue growth for the company.

These organizations must also ensure that the cost of serving freemium-based users is below the marketing value of serving these customers, he said, adding that the conversion rate to premium users should be able to support the business model and the company's intended growth.