What your bank can teach you about freemium

People are talking and writing a lot about freemium just now as if it's a completely new business model that was invented for the Web. The term, apparently coined in response to a 2006 blog post by Fred Wilson, describes a business that delivers services or content for free to gain users, and then makes its money from charging for extra services that a subset of users are willing to pay for. The key to the model is to have an attractive-enough free-of-charge offering that spreads rapidly but doesn't cost too much to run, and a compelling set of premium services that a substantial minority of users will want to pay for. Some of the commentary around freemium in the past week has been prompted by startup Contenture's plan to offer freemium as a service to commercial websites, which prompted TechCrunch's MG Siegler to list the services he'd be willing to pay a modest annual fee to use. Social media blogger Nick Barker wrote a thoughtful blog post about the model late last week and Adobe's Acrobat.com initiative is also relevant, for reasons I'll circle back to later in this post.

It seems to me the financial services industry perfected the freemium model many years ago. There was a time when people used to pay an annual fee to have a credit card. Some cards still do carry a charge, but most mass-market card providers these days are all too happy for you to sign up for one of their cards without paying for the privilege. Their 'freemium' model is amply funded by the huge margins they earn as soon as you start paying interest on your outstanding balance. Sure, a minority of customers keep their noses clean and pay off the full balance every month, avoiding interest, but even most of them make a mistake every so often and miss the payment date, which earns a penalty fee as well as a tidy interest charge.

This long-established model has several important lessons that Web businesses should heed as they develop their freemium offerings:

• Learn to target your free offering. Credit card providers don't waste their time marketing to people who never borrow. Their ideal cardholder is a shopaholic who holds down a good job — someone with a reliable income stream who's always spending rather than saving. Freemium providers should remember they're aiming to capture users who will spend money on premium services. Don't waste time trying to sign up the largest possible number of free users — acquire too many and they'll become an unnecessary burden. Once you've understood your target market, cultivate it.

• Do the math carefully. The current woes of some of the credit card issuers is a salutary reminder that freemium models rely on complex modeling. You're incurring costs to acquire customers based on predictions of how much profit you expect them to bring in over future months and years. If your customers prove less profitable than your model assumed they would be, then you may not recoup that cost.
• Lock in to minimize churn. With the advent of easy balance transfers, card providers lost their ability to hold onto their best customers. In this regard, banks that offer free banking for current accounts have a much better model. Few account holders bother to change because it's simply too much hassle to move all their regular payments to a new destination. Freemium providers should look for ways to stay 'sticky' for their best prospects, encouraging them to use the service for file storage, feeds, bookmarks and, if possible, habitual business processes.
• Price for value. Premium services are attractive because they offer value or convenience that's not available elsewhere, often far in excess of their cost to provide, so go ahead and charge what the market will bear. The banks are past masters at lowering the prices they charge their captive customers for services such as electronic wire transfers far more slowly than falls in their costs (similarly with interest rates). I'm not condoning those practices, I'm just saying, watch and learn.

Adobe's Acrobat.com initiative, which last week added Presentations, a web-based Powerpoint rival, to its line-up of Web-hosted applications, is an interesting case study to compare against the above guidelines. Acrobat.com is pursuing an avowedly freemium model, designed to take advantage of the massive market penetration achieved by its Acrobat PDF tools. Current examples of premium services include the addition of a 'create a PDF' button in the latest release of Acrobat Reader, which encourages subscribers to sign into the Acrobat.com site to access the PDF service.

The initiative has already homed in on its target customers. As Erik Larson, director of marketing and product management, explained to me last week, Adobe is focusing on two types of workers: 'problem solvers' — people in roles such as marketing, consulting and legal — and 'people managers.' Of the 100,000 US subscribers signing up to Acrobat.com every month every week, he told me, 30 percent are in the target segment, which is significantly more than their proportion of the working population, let alone the wider population at large. In addition, Adobe has established that half of them have budget to buy online services for workgroups — as many as 70-80 percent in companies with less than 500 users, and above 50 percent in companies with 500 to 5,000 users. (The figures, Larson added, are "a testament to the strength of SaaS that these people say they are comfortable buying something not provided by IT." I'd add that they're also a testament to the purchasing power of the B2I segment).

As for Adobe's cost models, it has a formidable advantage in already being in front of the target market through its Acrobat Reader, which Web users need to be able to read PDF files. A further factor is that the online Acrobat.com applications like Buzzword, Presentations and Connect are inherently collaborative, and so constantly introduce new prospects to the platform. As a result, Larson told me, "We're spending just a pittance on marketing."

So far so good, and of course the more those people get into the habit of sharing and collaborating at Acrobat.com, the stickier it's going to become. Only time will tell whether Adobe plans to follow my fourth guideline, but whatever happens, it'll be interesting to watch how Acrobat.com evolves.