Why freemium is bad for business

Businesses should spurn free online services. Here are four good reasons why it's not in the customer's interest to be lured into using them. Look instead for providers that have a sound revenue base.
Written by Phil Wainewright, Contributor

I've never been comfortable with free products for business use, even though it's difficult to avoid using them if you're a small or one-person business (web analytics, for example, has been all but wiped out as a low-end paid service by Google's free offering). As a long-term observer of the scene, my worry is that the track record over the past decade isn't encouraging; many more free services have failed or faded away than have continued successfully. That's why my New Year advice to SaaS and cloud vendors was to concentrate on "sound business revenues, earned in exchange for delivering real business value." So yesterday I was pleased to read Lincoln Murphy's newly published white paper, The Reality of Freemium in SaaS, which lays bare many of the drawbacks of the model for providers.

The trouble is, many SaaS vendors will still be tempted into loss-making freemium plays of the kind Murphy warns about because there seems to be so much demand they can tap. That's why I want to devote this blog post to examining why businesses should spurn free online services. Dear Mr/Ms Customer, it is not in your interest to be lured into using free for your business, and here are four good reasons why not:

It means vendors don't invest in proper access controls. Most low-end free services target individuals ('consumers') and so they're built around giving access to a single user. If you're a business, you'll probably want more than one user to have access to the same account, but that sort of access control infrastructure is expensive to set up and manage, so free services won't support it. That's fine if you can start off free and then migrate to a paid version when you need more access control, but many freemium vendors don't offer that option.

Here's what I discovered this week when I wanted to bring another user into the MailChimp account that's handling EuroCloud UK's email campaign management (we needed to co-ordinate ahead of next week's member meeting):

"Your MailChimp account only has one login per user with access to all areas of the account. We do not offer multiple users with different levels of access. If you need multiple users, feel free to share the login information as more than one person can be in an account at one time."

That's very limiting. And no mention of record locking, check-in/check-out and all the other controls that go along with multiple users. I would say, you get what you pay for, except Mailchimp simply doesn't offer any of these functions, at any price.

It means vendors don't invest in instrumentation. If there's no fee, there's little incentive to monitor usage patterns and service levels. Again, the infrastructure for this kind of capability is expensive, and if a vendor is focused on the kind of mass market that a free product has to appeal to, it's unlikely to want to spend money on features such as SLA monitoring, uptime dashboards, real-time user support or detailed usage pattern analysis. This limits its ability to offer differentiated services that performance-sensitive business customers will pay good money for, forcing it to focus even more on volume rather than quality.

There's no such thing as a free lunch. If the vendor is cutting corners on the above, what else is it skipping? Never mind functionality in the product, has it invested in enough advice and forethought to make sure it has a robust business plan? Probably not. "Many times 'free' is a cop-out," writes Murphy — a phenomenon I once called the 'lunatic fringe of freemium'. Murphy adds: "Business-focused people understand that free is not sustainable and they will wonder how long the vendor will be around if they do not charge for their product." Indeed.

It restricts choice because only the big guys can survive. I have to dissent from another of Murphy's assertions about freemium, however. "Rarely do existing companies wanting to bring a SaaS product to market default to freemium," he writes. I can understand why, in a paper designed to discourage naive vendors from plunging into freemium, he might want to say that. But the assertion is disproved by, for example, Google, which chose freemium as the model for Google Apps, or Adobe, which is using freemium to drive forwards its SaaS strategy. I think we're going to see established companies increasingly adopting the freemium model, but in many cases their motivation will be thoroughly pernicious: freemium by a big player effectively shuts a market to smaller competitors, because the mountainous investment required to build up sufficient market share to reach viability becomes too costly a barrier to entry.

Now you have been warned of the perils of signing up for a freemium service, I'll conclude by highlighting the exceptions where a freemium strategy offers buyers a safer, more trustworthy choice. Murphy explains how freemium can work if a vendor with a proven, revenue-generating service offering then spins off a separate free service that is compelling enough to fund itself:

"In this version of Freemium, and after the appropriate market due diligence, companies will build a very simple, single-purpose Alternative Product (AP) that solves an immediate, specific and highly targeted need, but which promotes significant network effect and ecosystem opportunities well beyond that application ... Users of this application will not need to convert to the flagship 'premium' product to generate revenue; the product is designed from the ground up to generate revenue by leveraging unpaid users ... the single-purpose AP is also more likely to be spread virally than a larger, full-featured application suite."

Such a service is still likely to kill off other, paid alternatives, but I guess we shouldn't grieve: that's capitalism in action. Examples that spring to mind include Adobe's Acrobat.com offerings, which I've mentioned above, or SaaS recruitment software vendor MrTed's launch of the free SmartRecruiters.com service in the US market (more on that in this more recent podcast).

Venture capitalist Bill Gurney, prompted by Google's announcement of free turn-by-turn navigation in its Android mobile operating system, called this the 'less-than-free business model'. It threatens to be highly disruptive, but the more disruptive it is, the bigger the spending it requires. Start-ups capable of achieving disruption on this scale are going to have to tap venture funding that runs to 9 figures (that's before you get to the decimal point). Everyone else would be well advised to stick to building sound revenue first. And business customers should be wary of trusting any vendor that doesn't have a self-evident revenue base.

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