Freemium business models for enterprise software

August 9th, 2010 by Chris Hogg Leave a reply »

Don Dodge posted an interesting discussion about Freemium business models to his blog recently, and I thought it would be worth pointing out here.

For those of you who don’t know Dodge, he’s currently a developer advocate at Google and he was formerly a startup evangelist at Microsoft. Dodge is a successful entrepreneur and is often cited as an expert source on anything to do with software.

Dodge’s recent post looks at how a startup can run a healthy business with a Freemium business model. That is, offer a product or service free and upsell users to a paid version.

When it comes to media, the closest thing to a Freemium business model is a paywall, where some content is available free and premium content is available at a cost.

Dodge breaks down the math for anyone not sure of how conversion rates work or what type of revenue potential actually exists. As he points out, most companies see a 1.5% to 5% conversion rate, with most of them averaging around 3%. So how does that translate into real dollars? Here’s Dodge’s breakdown:

Do the math. 100,000 free users convert to 3,000 paid users. If they pay $50 per user per month, that is $150K a month or $1.8M per year. That is an excellent revenue stream for small startups that typically have 3 to 5 employees. And, it is an annuity stream that continues to grow every year. By the 3rd or 4th year these small companies can be generating $5M to $10M a year, still with less than 10 employees. Most of these small companies don’t take Venture Capital so they own the whole company. It is a pretty good cash flow business.

Here is a video worth watching for any of you who want to see how VCs look at Freemium business models. Dodge moderated a panel with VC Brad Feld (Foundry Group), Dave McClure (500 Startups), Jeff Clavier (SoftTech VC), Matt Holleran (Emergence Capital) and Joe Kraus (Google Ventures).




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