Wednesday, September 30, 2009

Freemium model for SaaS pricing is broken!

Recently I got this email from one of the SaaS companies that they are going to increase the subscription fees. The reason they stated was that their costs have gone up due to a surge in subscription for their free plan. That got me upset because what they are essentially asking is that we the paid customers have to subsidize the others who are using their service for free. Although I appreciate their candor (albeit it is a mistake from marketing perspective), but I find it difficult to accept. It is not right to pass the costs you incur for your "free plan" on to your paying customers.

It got me thinking that the popular "freemium" business model is not kosher from ethical perspective. I am sure this company is not the first to find itself in this situation. It is common to offer a free plan to attract new customers. Yet companies cannot continue to pay for the free service as their free customers increase. They are forced to pass the costs along to their real customers- the ones that pay. Not everyone admits this problem. Instead all companies bake the cost of free plan into their paid plans. Don't you think it is unethical? How would you feel about paying for a service that offers a free plan knowing now that you are subsidizing others?

There is another issue with the freemium model. You start with the free plan. As you start using the service more, you need to move to one of the paid plan. Did you consider that your costs of using the service is has just gone up both at the aggregate (which is understandable) level as well as unit level (which I have a problem with)? You will never see your unit costs go down. Shouldn't it be the other way around? That is your unit costs for a service should go down as you use more. You should expect volume discount, right? The vendor should encourage more usage of it services by providing volume discount. In reality, we see quite the opposite. Talk about misalignment of goals. Win-lose or lose-win proposition. When customers use free service, customers win but vendors lose. When customers use paid services, vendors win but customer lose.

Why not we all only offer free trial and make all out plans paid plans? Nobody subsidizes anybody. Customers get an opportunity to try things out before they pay for it. Vendors do not have to worry about how to pay for free plans. Customers are encouraged to use more and get discounts. That way we all win.

What is your thoughts on freemium plan? If you are a SaaS company, how are you paying for your free plan?

4 comments:

  1. Though I understand your frustration, the free services offered are marketing and nothing more, all service providers take the cost of running their business and pass it on to their paying customers. The mistake in this case is telling you why the costs are going up: "This can of coke is now 75c...we are looking for new customers in Asia and spent a lot of money sponsoring the World Cup - Enjoy!"

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  2. There's nothing called free lunch. Free plan is subsidized by 1. corporate users (Google model), or 2. charity (Wikipedia model), or 3. advertisement revenue (google, yahoo...), or 4. simply by the transition period of finding the right business model before being nailed down by VC or being acquired (twitter, youtube).

    The frustration from the premium customers is reasonable, but so is the marketing strategy. The fuel cost of economy class passenger is subsidized by the business class passenger. 80% of the profit comes from the 20% of the customers. Yes, rest 80% of the customers are being subsidized one way or another.

    Is it fair? No, it's not. Is it ethical? I guess, it is.

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  3. I got to this from the OnStartups blog about pricing your product. I am using the freemium model on our SEO Management Tool for once it comes out of beta. I believe in giving something for free continuously, and I think you manage your resources accordingly. For us, that means limiting the free version to extensive API calls or other expensive computationally expensive resources.

    While you can expect most of your users to be sitting on the free version, I think you have to really work at creating the value prop to get that user to convert - whatever that may be.

    I also like the freemium because everybody wants to "try before they buy" and don't want to fall into the put your credit card in for 30 days and then get charged when you forget to cancel crap.

    So, IMHO the example you gave would lead me to believe that the product was not good enough for you to move up to the next level, or they simply gave way too much for the free version and left no reason for you to upgrade.

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  4. Ryan,
    Thanks for your comment. Although you try to manage (minimize) the resource usage by your perpetual free customers, you still incur costs for those resources used. The question still remains- who is paying for them.

    I agree that the length of the free trial needs to be adjusted for the type of service at hand to allow the users to evaluate your service, but it should not be indefinite...:-) Perpetual free users (a.k.a free loaders) see the value in your service, otherwise they won't be using your service even for free.

    The example I gave, I am a paid customer of that service. So, I am convinced of the value of the service, but am not happy about paying for their free loaders.

    There is a very good blog on freemium model by Eric Ries. He explains how to go about setting up a freemium model.

    Good luck with your SaaS service.

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