How to Make Piles of Money from Charging Nothing

Last Updated Jul 19, 2011 3:32 PM EDT

The streaming music service Spotify arrived in the US market to much hoopla and expectations of huge success. A music observer might wonder why, considering the fact that Rdio, MOG, and Rhapsody have been offering pretty much the same product in America for a while now. Yet, I tend to agree with the hype-sters: I think Spotify will be very successful. What's the difference?

Spotify Offers a Hook
The basic service is free. Sure, you may want to upgrade to a paid subscription in order to skip Spotify's radio ads, or listen more than 10 hours a month, or use it on your mobile phone. But Spotify will soon be offering millions of Americans the chance to choose any song they want and listen to it immediately over their desktop-- at absolutely no charge.

Charging most of your customers nothing for a valuable product might sound like a crazy business proposition. But its value is by now well documented.

A recent study by Flurry Analytics found that mobile phone games that are free to download, are actually making more money than those that charge. Rather than asking $0.99 to download a game you have never tried, these companies let you download the app for free, then entice their most avid players into paying quite a bit more than $0.99 for in-game virtual goodies like farm crops or power boosters. In June 2011, among the top 100 games in the iTunes store, free games generated almost twice as much revenue as games that charged to download.

The "Freemium" Business Model
Offering your product for free, and charging your more committed customers for premium services, is actually a common strategy. This business model is often called "freemium," a term coined by Jarid Lukin and popularized by venture capitalist Fred Wilson.

A freemium business is not a free ad-supported service like Gmail. Nor it is that hoary come-on, the "free trial period." The problem with trial periods is that far fewer customers sign up, especially if they have to give a credit card in advance so you can charge them after 30 days. In fact, after 30 days, a customer may still not have gotten around to finding out if they really love your service, so you just lose them as a customer.

The freemium business model works like this: Everyone gets your product or service for free, forever. But those customers who really like it, and find most value in it, will have a strong temptation to upgrade to a "premium" (paid) service which has lots of additional goodies. It is, at heart, a strategy of pricing by customer segmentation. It also requires a lot of insight into your customers and how they use your product.

Here are four examples:

1) Skype. The popular internet calling service is free for those millions of customers who use it just to call or videochat between two computers anywhere in the world. Skype only charges if you want to use it to call a landline phone. And yet, so many of its avid customers ponied up for that extra service, that the company was able to sell itself to Microsoft for $8.5 billion.

2) The New York Times. After building up a huge online readership (the source of lots of online ad revenue), the newspaper has has recently switched to a freemium model. Casual readers can still get up to 20 articles a month for free, and articles spread by social media like Facebook don't even count towards this limit (so the Times keeps its audience large for advertisers). But loyal readers now have to sign up for paid accounts if they want to read more than 20 articles, or enjoy the Times mobile apps.

3) Evernote. The popular note-taking web service recently topped 10 million users, thanks it to its free service, which allows users to clip articles, images, photos, and voice memos into virtual "notebooks" that they can access from anywhere via the Web. Nearly half a million of those users are paying for Evernote's premium service, which allows them to store much more data, include more file types (like PDFs), and easily share and collaborate with others.

4) Apple's iCloud music service. Recently announced, and launching this fall, this service will allow Apple users to store online every song that they have purchased from the iTunes store, and to synch them across phone, mp3 player, or computer, without any need for pesky wires. If you love the wireless experience, you can also store and synch all your non-iTunes songs--for a fee of $25 a year.

Real Customer Insight Required
The freemium model requires that businesses rethink their customer equation. Acquisition (attracting customers) comes first, and monetization (turning them into revenue) is second.

A freemium model adds value to your customer, by demonstrating the benefits of your service before they are expected to pay for it (a powerful incentive in this lean economy). It also adds value to your business in two ways:

  • Acquiring customers incredibly rapidly, with much less marketing spend
  • Monetizing your customers based on their price sensitivity, and the value they derive from your business. (Even your free customers may generate revenue via advertising)
Most importantly, a freemium model requires deep customer insight. It hinges on uncovering the key shift in behavior between your casual users, and those customers who truly value your service. What happens when customer love you? Do they use your service more hours each month? Use more data storage? Go on to advanced game levels? Use your product for work and not just personal use?

If you can find that customer insight, and if you can offer at least a basic version of your service at minimal cost to your firm, then you may be able to follow the freemium model, and make much more money by letting your customers in for free.

image courtesy of flickr user, Sorosh

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    David Rogers is a consultant, speaker, and author of The Network Is Your Customer: Five Strategies to Thrive in a Digital Age. He teaches Digital Marketing Strategy at Columbia Business School, where he is Executive Director of the Center on Global Brand Leadership. Rogers has advised and developed marketing and digital strategies for numerous companies such as SAP, Eli Lilly, and Visa.