Is Free the Future of Enterprise Software?

By Aaron Levie

Aaron Levie is the CEO and co-founder of Box.net, founded in 2005 with the goal of helping people and businesses easily access and share information from anywhere. Box.net is now used by millions of individuals, small businesses, and Fortune 500 enterprises worldwide.

There’s now a lot of buzz debating the business model of “Free” with the release of Chris Anderson’s new book. Most of the conversation has focused on free media and free consumer services, but ultimately the effects and expectations of free in our consumer lives will begin to emerge within our business lives. Today, there’s no shortage of examples of free or “freemium” business software, from commercial services (37Signals, PBworks, Google Apps) to open source (Mysql, SugarCRM), yet, there’s still a great divide of SaaS solutions selling their software with an “older” format (Salesforce.com) and even some with a really old model (SharePoint). Simply judging by the relative market caps of companies pursuing each model, no one in SaaS has built up a substantial enterprise business yet with the model of free or freemium alone. Mysql only got to $50M in revenue before it was acquired, and the majority of freemium enterprise service providers are still in the tens-of-millions range, with few exceptions.

Mark Cuban brings an interesting point to the debate: when you live by your free service, you die by your free service. There’s certainly merit in this argument if your business model is an advertising model based on page view volume alone or if you’re holding up solely because of venture capital. When your uniqueness and flavor dries up, so may your users, and thus your revenue and funding. This was generally Mark’s concern when we introduced the free version early in 2006 (he was an early investor in Box, with no current stake): Why would people ever pay? How do you avoid just eating up a ton of costs with no revenue to supplement? What about when someone else comes out with a version of your service that’s also free with more bells and whistles? How will you remain competitive?

To put one main argument to rest, we’ve learned that there is no business model in Free alone (duh), while there may just be a large business model in Freemium in time. There are a few reasons why the freemium model has enabled new software products to grab significant market share while also build a strong enterprise business in the face of dozens of startup competitors and giants like (both free and pay). This model allows you to surface your service to a much wider customer base (cross vertical, geography, function) and learn from and efficiently attract all types of users onto the service. And - more significantly - maintaining a free version of your service for a single user or small group is a very efficient way to get users to eventually actually pay for your product: customers can quickly try out your service without a lengthy sales pitch and users with limited requirements can get by for free, but recommend the business version to their company when the time is right.

Take a look at Google Apps for a great example of this model done right. You can use as much Gmail and Calendar as you want as a single user or small group, but if you want the real business version on your domain, it’s time to pay up (see their 15,000 seat Genentech (DNA) deal). Instead of spending large amounts of money on marketing that tells people about a product, create a community of free users and create evangelists in the process. It also helps avoid the risk of competitors coming in and undercutting your costs - fun fact: when in a sales “bake off,” Box.net loses the largest amount of deals to ourselves, not to another service.

Let me emphasize that in case you missed it: Not everyone will find the same value in your product or service. For those that don’t, why not keep them as users and turn them into evangelists?

Freemium allows the actual consumer of the technology to make decisions in an unprecedented way: if the product doesn’t solve their problem, they move on to something else. This forces you to create better, more usable products, and not simply build your business on aggressive and costly marketing and sales. Instead of focusing primarily on the purchasing party (often an IT or department manager), the model is inverted, with more power being put in the hands of the end-user of the technology. Onerous contracts and deep sales relationships don’t keep them there. This means your product has to rock, and it has to constantly be asking and answering the same fundamental question: are we providing the best valuable possible? If you’re not, Free users will leave and the rest certainly will never pay.

Freemium is also great strategy for products that have high switching costs - why not allow me to start using a free version, get hooked, and begin charging me when I hit a threshold of activity? Every day, in our own business, we have to make budget decisions on new software which can ultimately hold up the purchase by months; whereas if we were able to start using the product immediately we’d quickly hit a usage threshold, and we’d be more convinced about the solution at the point of purchase (no more buyers remorse). Instead, we end up doing a price bake off between multiple solutions, and whoever has the better sales rep and “story” essentially wins. What if Salesforce.com (CRM) gave you the first 100 contacts for free, then you start paying once you need more? Once my first 100 leads are added into SalesForce, I’m not going anywhere else. If your service offers true ROI once implemented, why not let me implement it for free and charge me once I achieve some success? These strategies will reduce the sales friction of any service, allow businesses to be more competitive, and expand the potential market dramatically.

The great news is that because software distribution and sales models are adapting with the times, the number of people that can now access and afford your product has gone up exponentially in the past decade. Given the fact that we can now develop and deliver software much more easily and cheaply (distribution over the web vs. hardware and software sales), and thus reflect these cost improvements onto customers, we can now go after much larger or harder to reach markets more efficiently (small businesses, for instance). With the right product, reaching 10 million potential business users and customers is now trivial. Imagine doing that 10 or 20 years ago. And with an addressable market in the millions of users, it becomes a lot more practical than ever before to make a meaningful business just selling to a subset of that base.

So what to take from all this? Here are some quick lessons we’ve learned from “Free” in the enterprise:

• Free is not a business model, it’s a marketing and distribution tactic. Don’t forget this, and don’t get distracted into thinking otherwise.
• Free is not an excuse to make a lesser product, in fact it forces you to make a better product or no one will ever pay.
• Free will expand your market size and scope instantly; make sure you’re prepared, and make sure you can survive and thrive if only a subset ultimately pay you.
• Freemium works when you know who will want to pay for the service and what extra bells they will pay for. This can be based on usage thresholds, ROI achieved, more features, better support, etc.
• Freemium also works because larger businesses have specialized requirements that they’ll pay for: more security, more users, better management, etc.
• Treat free as an advantage - learn from all those new potential customers of your product, pay attention and allow niches to emerge that you can sell to.
• Lose customers to yourself, not your competitors

This discussion certainly isn’t over. We’re going through a major sea change. It happened to music, it happened to consumer services, it’s happening to newspapers and publishing, and it will happen to business software. The business models are changing. It means software businesses will need to be innovative and adaptable, but ultimately you’ll survive if people want what you have to offer, regardless of the price tag. Of course there will always be room for premium software to be pay-only, just like we still expect to pay a premium for a variety of content in the “real” world (movies, research reports, education, etc); but, for mass penetration the reality is Free and Freemium will you get there quicker, faster, and with less friction along the way. If that’s what you’re looking for, then it’s just up to you to figure out the actual business model if you want it to last.

Original post

Comments

[Gregman2:]

Aaron, some great points. Isn't "freemium" a piece of what the cloud is all about, currently driven by Google and Salesforce? I appreciate that these have more to do with base platforms to develop apps on, but given the complexities of enterprise apps, how far off do you think "freemium" really is? (I mean, even Linux, as a tool box of drivers, aims at being license-free, but consider that most enterprises
have multiple operating systems and apps).

Jul 14 12:04 PM

[perramond:]

One of the better posts and comment threads I’ve read on TC in a LONG time. Now I'm partial to anything having to do with freemium but it's refreshing to see the freemium debate moving into the enterprise space vs. just B2C examples.

Until recently the it’s been kind of lonely here in the B2B space… i.e. not a whole lot of peers/reference points for successfully freemium products in the enterprise. But that’s changing quickly and there are more & more examples out there (e.g. check out GoToMyPC’s recent S1 filing to look at what your freemium business might look like “at scale”).

There are a couple of things that we set out to accomplish with our freemium strategy that are worth mentioning…

1. Cost-effective brand awareness & trust

Every day we reach tens of thousands of users in our target segment, absolutely free. We don’t pay per impression or per click — our brand is there for everyone to see without spending a cent on banner ads, Google AdWords, etc. More importantly our free product provides actual value to end users — so we’re actually building product adoption (the bane of many an enterprise app) and a real sense of trust before they ever purchase anything from us. All of this without having to be “sold” on a value prop, differentiation, etc.

2. Incremental revenue from the small end of SMB (1-3 users)

Our freemium strategy also allows us to capture incremental revenue in the small biz segment without being overwhelmed by tire-kickers. Freemium embraces tire-kicking as a free product effectively allows us to wait for people to raise their hands and purchase via self-service (e-commerce) or engage with a sales rep for larger opportunities. But only after having adopted the product and made an initial cost/value evaluation for themselves (based on use of the product, not just a data sheet, whitepaper, or case study.)

Despite being pro-freemium, the nay-sayers on this thread (along with Aaron himself) bring up some valid points for us to keep in mind. Freemium won’t work for every market segment and product category. Our CEO posted on the topic yesterday. He spells out two critical requirements for a successful freemium strategy — scale and conversion.

blog.insideview.com/20.../

And for those of you offering a freemium product in the enterprise space, I’d love to compare notes sometime and hear what & who are your go-to resources. I follow Andrew Chen, Chris Anderson, and Fred Wilson on the topic but I’m always looking for new perspectives.

Jul 14 07:51 PM

[Henry Buttal:]

I have actually been working on an analysis with my brother-in-law, an economist, called (with apologies) "Freeconomics cost".

A couple of points:
- in the short run, open source is much like out-sourcing, with developing nations benefitting from the cash flow, and developed nations benefiting from the cost effectiveness. That consulting revenue on drupal configuration looks pretty good to someone in India. Not quite so much here in the U.S. for the former Java or C++ software developer.
- in the long run, the open source and freemium model has some negative implications for local, state, and federal government tax roles. If you think they don't like interstate transactions, wait until you see large reductions in software and service revenue bases, and product that you don't "purchase" becomes the norm.

Jul 14 11:15 PM