This sounds like a crazy question, after all, is there anything simpler than giving things away for free? In fact, there is another question hidden behind: Why do I want to give things away for free? Why giving things away for free will determine how one should give away things for free.

Then why would a business want to give away things for free?

The answer is that the future demand for a particular good depends on whether the consumer is using this good in the current period. There are several reasons why current usage will determine future usage. The most common reason is “experience goods” that is, before trying this good, the consumer has no idea how good and how useful this good is. The rational motivates giving away samples for new products.

The second reason is network effect. For example, LinkedIn is only useful if there are many professional on this platform. However, if one charges a price to every professional, many professional will simply refuse to get on the Platform. By offering free basic services to all professionals, LinkedIn is able to increase its base dramatically. 1

The third reason is addiction. I will delay the discussion in the specific example later.

With so many reasons to give things away for free, why would anyone not give things away for free? Duh, because blindly giving things away for free actually decreases consumers’ willingness to pay, which is the opposite of our goal. Even a temporary free giving-away might anchor consumers’ expectation. This has two consequence. It lead to stronger resistance when the firm transitions to paid services; It incentivize consumers to delay purchase and wait for free offers (eg. sales and discounts). In other words, it could self-canabalizing. I for example, whenever purchasing on Amazon, would look at its price trajectory, and figure out that I can expect that Amazon will discount it to price x with 90% confidence. I will set up an automatic alert when the price on Amazon does fall to or below x.

My favorite example of giving things for free is Dropbox. Let us start with the basic. It is a freemium business, except it is different. Users are given some free space account when they sign up. The amount of free space is fixed, only nominally.  The capacity of the first disk drive, the IBM 350 disk storage unit, is only 3.75MB. The typical hard disk we use today, is probably around 1TB.2 This is a a quarter million to one change, and mirrors the inflation of file size we experienced. I still remember those days in middle school when I would use a 3.5-inch floppy disk, which has accomodates about 1.5MB. Today, even if it is still compatible with my computer, I would find a floppy disk completely useless, because the real 1.5MB has been “inflated away”. It is fair to say, in real terms, Dropbox is chipping away the size of free space every year. By inflating the free space away, it avoids the thorny problems of generating resistance or at least annoying consumers.

There is also wisdom in continuously and slowly inflating size away. When the size of free space is reduced in one stroke, one will have more incentive to find alternative storage services; however, when the consumer find himself just slightly above the limit every month or so, that incentive is greatly reduced, similar to the “boiling frog” story.  In addition, the asynchrony of hitting the limits among users poses a challenge to coordinate migrating to alternative platform.

What really brings my attention to Dropbox is actually an email from them, informing me due to a technical problem that have affected me (I was not even aware of it), they are giving me one year of Dropbox Pro for FREE, that is 1TB for free for one year:

We apologize for any inconvenience this may have caused. To thank you for bearing with us, we’re giving you Dropbox Pro for free for one year starting today, October 10, 2014. If you have any questions, please reply to this message or email us at selectivesync@dropbox.com. We’re here to help.

This is excellent, maybe for me, but definitely for them. For one thing, they made it clear this is just a compensation, so it avoids anchoring consumers’ expectation in any way—it is just my lucky day. More importantly, it could potentially convert me from a free riders to a paid customer. Here is why. First, the technical problem was Selective Sync. It is reasonable to expect that whoever uses that function derives more value from an average user and probably deal with larger data files. Good targeting. Second, addiction to a service is present here. There is a Chinese saying “It is easy to transition from a poor life to a rich one, but the reverse is much harder”. There is some psychological cost to transition from knowing no limits to living under stringent limits. This cost, is often unanticipated by consumers.

Beyond the psychological aspect, there is a more rational or orthodox source of addiction.  It might seem weird to talk about addiction to an IT service/product, but it is very relevant in this area. Let me take the least consumer-facing product–VMware’s ESX, a hypervisor technology. Swapping out ESX for alternatives are exactly hard, but many companies use the management tool designed for ESX, and they build their operations around that. These are the real switching costs.3 Dropbox is no different. When one is granted free access, the natural response is to use the heck out of it, after all, he reasons:”I probably will never get as lucky”. He figures out all the bells and whistles of using Dropbox, what a fun! Dropbox is after all an extremely useful service, and everyone can find so many uses of it. From my perspective, I might want to use it to collaborate with other people on research. Imagine one year later, my pro service is over.  I still have a couple of collaboration in progress. No, I cannot leave Dropbox. How could I propose to my collaborator that we find an alternative despite its great performance and just because I am a cheapo? The bottom line is it is very hard to switch collaboration platforms. There is a psychological aspect to it: people tends to overly discount the future cost (of moving their files away and switching to another sync service when their account expire) vis-a-vis the utility they gain from using Dropbox in the current period (a phenomenon known as time inconsistency). In other words, I would think to myself that I will simply move all my files back to hard disk when my pro service expires, but when the time comes, I will instead choose to pay for continued pro service. This problem is exacerbated by the fact that people on average tend to underestimate the cost of making the transition back (planning fallacy).

I had to say, it is a most brilliant move. I am very impressed. The only sad ending to the story is that: knowing my time-inconsistency problem, I am not taking advantage of the free offering. I am only using 0.6% of the 1TB.4


1 In this example, free basic services is a permanent feature for LinkedIn, but one can imagine a platform only provides free service during mobilization stage. For example, google search offered ad-free search in the beginning and then incorporated ads when it became dominant. In some sense, google started to charge us in terms of “attention fee”.


3 http://en.wikipedia.org/wiki/History_of_hard_disk_drives

 


3 Yoffie, David, Andrei Hagiu and Michael Slind, “VMware, Inc., 2008,” HBS No. 9-709-435 (Boston: Harvard Business School Publishing, 2010), p.15


4 If this surprises you, here is a even more surprising story. In sophomore year, I was lucky to get a dingle—a double dorm room occupied only by me. What I did? I limited myself and belongs to only half of the room (using bookcase and bed to block my use of the other half), so that I 1)will not accumulate too many belongs that I have to get ride of later 2)will not get used to having a huge room and face the difficult transition of being confined to a much smaller room the next year.

 


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eFuneral: An Innovative Approach to End-of-Life Planning

In an age where tech startups have been dominated by social networking sites in Silicon Valley, a funeral planning site, based in Cleveland, Ohio, has brought digital innovation to an economic sector old as life itself. Mike Belsito and Bryan Chaikin, both native Clevelanders, founded eFuneral in 2012 with the mission of easing the logistical burden bereaved families face after the death of a loved one. The $15 billion death care industry is driven by the myriad of expenses, from ordering flowers to booking funeral homes to selecting caskets, incurred while making end-of-life arrangements. With an average funeral costing $10,000, Belsito and Chaikin built a site that not only helps organize end-of-life logistics, but helps families plan well in advance for such a major life expense. eFuneral has the potential to deliver great value to customers, so long as it adheres to intermediary website best practices, grows at a sustainable pace and takes full financial advantage of its unique location in Cleveland.

Intermediary websites, which strive to efficiently connect customers to sellers in a specific sector via an online hub, have seen steady growth over the past decade. eFuneral is an intermediary website for the funeral industry that operates on the “freemium” revenue model. In the model, all users have the opportunity to sign up for a free basic account, but then, for a fee, can receive a premium account with enhanced services. Used by popular sites such as Dropbox, LinkedIn and Skype, the freemium model relies on the revenues generated from the premium customers (often a small minority) to more than cover the costs of the free basic users (often a large majority). eFuneral connects bereaved families with funeral homes and providers of other end-of-life services. Additionally, the site serves as a community for families in mourning, allowing space for users to share insights and advice with each other. In order to execute a successful strategy as an intermediary, eFuneral needs to adhere to best practices, such as attracting quality users, providing accurate listings and maintaining a financially viable ratio of paying premium customers to free users.

Startup companies with great ideas can often become victims of their own success. If companies don’t plan to scale their operations in accordance with their revenue growth, then either customer service can suffer from strained operations or employees can become burned out and quit at critical times. Belsito and Chaikin recently hired two more employees and plan to expand into dozens of cities across the country. An intermediary website tied to a service with demand as universal as funeral planning, eFuneral must ensure that the projected user base grows in accordance with their operational capabilities. With over $400,000 in seed funding, eFuneral would be wise to invest early in operational capacity, not just revenue generation.

Though Cleveland is not typically associated with tech startups and digital innovation, the Midwestern city offers a number of benefits over Silicon Valley. In order to compete in a field that has very low barriers to entry, and thus is likely to attract competitors, Belsito and Chaikin must seize on Cleveland’s various economic benefits. Affordable cost of living, compared to Silicon Valley, will result in lower operating expenses for eFuneral and allow the company to devote resources to building out strategically critical areas of the business plan. Additionally, Ohio doesn’t tax the first $1 million of gross revenue and has comparably low marginal rates beyond that, and small business incubator JumpStart, Inc. has provided funding and entrepreneurial support for eFuneral. Lastly, by operating in both a sector and city that many might deem “not-sexy,” eFuneral is likely to be underestimated by potential rivals, which can be a long-run competitive advantage.

eFuneral has shown that innovation in the online economy can impact any sector and originate in any city. Anyone who has ever lost a loved one and made plans in the immediate aftermath knows all too well the logistical difficulty of such an endeavor. eFuneral has the potential to provide a service that dramatically eases that burden, as long as it adheres to a solid intermediary website strategy, grows at a sustainable pace and utilizes all the entrepreneurial advantages found in the state of Ohio.

Resources:

http://www.cleveland.com/business/index.ssf/2012/02/making_it_easier_to_say_the_la.html

http://money.cnn.com/2012/11/01/pf/funeral-costs.moneymag/index.html

http://jobs-ohio.com/why-ohio/

http://siliconrustbelt.com/efuneral/

http://www.jumpstartinc.org/companies/portfolio/informationtechnology/efuneral.asp

http://efuneral.com/users/site/index

http://www.theatlantic.com/technology/archive/2012/09/bringing-innovation-to-the-funeral-home-business-no-really/262782/

 


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It is not news that the newspaper industry is being forced to migrate online as an increasing number of people consume content electronically – on computers, tablets or cellphones. The Wall Street Journal, the largest paid subscription news site onli

ne, is a case in point: it has 500,000 digital subscriptions as of March 2011, with 200,000 subscribers accessing content on mobile devices.[1] After email, reading news is the second-most popular activity on mobile devices.[2] While some (old-school) people still prefer a print newspaper, the ease of access of electronic content and the increasing penetration of smartphones and tablets makes it hard for news providers to ignore the online space.

In this shifting environment, there are many different online models that newspapers can choose to pursue. My post will describe the current landscape of the industry, and then discuss other approaches that they could take in order to continue mobilization and monetization.

Current landscape

A lot of news providers bundle their print and digital editions, but most stand-alone news websites fall into one of three categories:

1. Completely free content: These sites subsidize their costs with revenues from other sources, mostly through advertising. E.g. Huffington Post

2. Metered model: This is a hybrid approach between raising revenues from advertising and subscription fees. Some initial content is free (for instance, a certain number of articles), and the reader can then choose to subscribe to continue reading. E.g. New York Times

3. Pay wall model: A user cannot get any content online unless she pays for it. E.g. The Times (from the UK)

Most sites tend to be free, but some of the more popular ones are adopting the metered approach. With the free and metered models, the sites must attract traffic – this is usually done through search engines (visa Search Engine Optimization) and increasingly, through social media, especially Facebook and Twitter.

Where I think the industry will, or should, migrate to

1. Marquee writers as a way of attracting traffic: In some ways, news is becoming a commodity. A lot of completely free websites, such as Wikipedia, have (almost) real time updates of current events, so no user should be willing to pay for merely stating information. Readers do however, want to read engaging content and analysis, and the eventual winners in this industry will be the sites with marquee writers/columnists who people will pay to read. For instance, Thomas Friedman, or other political commentators, could pull in those readers who would otherwise get their news through completely free channels.

2. Moving to a freemium model i.e. monetize content: This would possibly replace the metered model, but instead of charging after an initial number of articles read, newspapers should charge for certain types of content. E.g. charge for a particular columnist’s columns, or detailed analyses of a presidential candidate’s debate performances.

3. Demonstrate advertising effectiveness i.e. improve the monetization of traffic: Within newspaper advertising expenditures, the online category is the only one to have a positive CAGR of 14% between 2003 and 2010; the other three categories (national, retail and classified) all showed a drop.[3] However, advertisers looking to advertise online have many other websites that they can use – newspaper websites need to either work directly with advertisers, or through ad networks to demonstrate their effectiveness at converting their traffic into paying users for the advertisers.

4. Segment the market: There is scope to segment customers based on the medium through which they access the content. Some newspapers such as The Guardian have started doing this already – access to content is free online, but a user needs to pay a monthly subscription for The Guardian’s iPhone application. While this may seem unfair at first, the newspaper should simply price based on a consumer’s willingness to pay: the iPhone user will probably pay for content, while a casual surfer may not be as willing to.

 

[1] Standard & Poor’s Publishing & Advertising Industry Survey, April 2012

[2] Sonderman, Jeff. “Pew: After email, getting news is the most popular activity on smartphones, tablets.” Poynter. October 1, 2012. Accessed on November 15, 2012. <http://www.poynter.org/latest-news/media-lab/mobile-media/189899/pew-after-email-getting-news-is-the-second-most-popular-activity-on-smartphone-tablets/>

[3] Standard & Poor’s Publishing & Advertising Industry Survey, April 2012


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Two weeks ago, I met with a Product Manager at Pocket Gems, a developer of free-to-play mobile games, and was blown away when I heard that their game, TapZoo, was the #1 top grossing app in the Apple App Store in 2011. TapZoo? Really?! Not only had it beat out Angry Birds but I hadn’t even heard of it before. Was mobile gaming becoming the next big thing?

Mobile games refer to the genre of games played on a mobile device such as a smartphone or tablet and are among the largest category of daily app consumption. They tend to have less frequent user engagement than social games played on Facebook and instead appeal to users for their shorter session lengths and instant session-based satisfaction (i.e., quick advancement to next level). Popular games include: Angry Birds, Words with Friends, and the 2012 Spring hit DrawSomething.

As smartphone and tablet penetration have significantly grown over the last few years, the performance metric for playing games has changed from quality of graphics to convenience and ease of play. People want to be able to play games on-the-go like when they’re waiting in line or have a few spare minutes in between class. Such a desire for portability and convenience has created a genre of mobile games that are attracting new, “casual” gamers – ones that never played hard-core games on PCs or consoles but are now finding themselves addicted to simple, cheap, quick, pick-up-and-play mobile games they can play whenever they want from wherever they are. But without the expensive, up-front purchase of consoles and games, mobile games have looked to new business models to rake in the dough.

Currently, there are four main ways to monetize mobile games: 1) advertising, 2) micro-transactions or “virtual good” purchases, 3) paid downloads, and 4) subscriptions. I think the money to be made in mobile gaming will largely come from (and is currently coming from) the first two strategies. This is because paid downloads are only a one-time occurrence and reliance on revenue from subscription models for mobile games is dangerous since most games follow a bell curve of consumption – users play a lot at first and then taper off quickly (e.g., DrawSomething).

Mobile advertising only really works for large-brand publishers and games that go viral, such as Angry Birds, because you need a lot of users in order to make money this way. A company called Jampp is trying to innovate in this space and get more people to view ads by allowing users to voluntarily view advertisements in return for in-game currency. Users choose to watch ads and then get something in return (1).

However, some companies like Pocket Gems have chosen not to use any external advertising and only advertise their other games to users.  With their “freemium” model, Pocket Gems does not charge users to download or play the game but instead encourages players to purchase “virtual goods”, such as power-ups and in-game currency, which help accelerate players’ progress.

A Chicago-based startup, Tap.Me, is bringing these two monetization strategies together. It has developed a platform that transforms the premium feathers of freemium games into branding opportunities for advertisers. By using Tap.Me’s solution, a brand can sponsor or augment an enhanced experience. For example, a player who wants to improve his endurance in games might choose a branded Gatorade virtual good (2).

Companies will need to continue to innovate with in-game virtual currency and goods in order for this mechanism to remain the leading driver of in-app monetization. According to the US App Store’s Rewind 2011 Top Grossing chart, 16 of the top 30 apps are freemium games and such games are heavily reliant on only a small portion of users (3). The PM at Pocket Gems I met with confirmed this theory when he alluded to that fact that most users don’t spend any money on their games but that some of TapZoo’s users spend hundreds, even a thousand dollars, a year playing the game.

Thus, in order for theirs and other’s freemium models to be successful, Pocket Gems will need to continue to create games that engage users and drive customer retention and loyalty. Only then will they be able to continue monetizing their gems.

 

(1) http://thenextweb.com/insider/2012/08/22/app-monetization-platform-jampp-goes-mobile-launches-new-tool-push-downloads/

(2) http://gigaom.com/2011/05/18/tap-me-shows-that-context-rules-in-mobile-ads/

(3) http://www.guardian.co.uk/technology/appsblog/2011/dec/09/tap-zoo-itunes-rewind-apps

 

 

 


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I like getting stuff for free. I think most people also like free stuff. To paraphrase Professor Edelman, if you want people to use your product, make it look free. The internet has made it even easier to get stuff for free, as consumers. Some companies make money by giving away free products and services to customers and then charging some customers for add-on features, advanced functionality, virtual goods and/or premium services. This business model has been dubbed “freemium” – a term combining “free” and “premium” – by Fred Wilson, a notable venture capitalist and blogger in 2006. Many of us now associate this business model with companies like LinkedIn, which charges customers for premium accounts or additional features such as messaging un-connected contacts. Another notable example is dropbox, which gives users a limited amount of free storage and then charges for additional storage. While this business model has become very popular in the most recent generation of internet companies, it has been in use in the software industry since the 80’s, when “lite” software (limited feature) was given away on floppy disk (or preinstalled on computers) for free to promote advanced paid versions. This is not to be confused with free-to-try business model where full versions are given away for a limited period of time and then require payment to continue to use.

Freemium has been a successful business model for software for a number of key reasons. First, the marginal cost of serving an additional customer is equal to or near zero. Because infrastructure costs (storage, computing, bandwidth, etc.) have decreased significantly, once a product has been developed or new features released, there is very little marginal cost. Secondly, customers are fundamentally attracted to the idea of free and will try nearly anything because they have “nothing to lose”, which does not account for the value of time. Assuming the product is actually useful and creates value for the customer, adopting a freemium model can greatly accelerate user growth. Specifically in software applications, integrating data and being compatible / integrated with other applications increases switching costs for the customer, making the app even more sticky. For these reasons, many companies have successfully adopted the freemium model as a strategy for quick growth and user adoption. Dropbox grew from 0 to 50 million users in less than 3 years.

To the extent that the economics work out profitably varies dramatically across companies, products and customers. One thing is certain, to be sustainable, the free to paid conversion rate and lifetime value of the customer must be greater than the cost to serve all customers. On its surface, the relatively straightforward economic formula should be very clear for any entrepreneur, executive or investor to understand the sustainability of a freemium business. How one thinks about a few key questions will define whether freemium really works:

  1. Who is the buyer? It’s not uncommon for the person making the decision to pay or not to be a different person than the end user. For example, enterprise software where the buyers are IT professionals, but the users are other workers in the company.  Understanding both the user and the buyer is critical.
  2. What is features will be free and what will be paid for? Seems simple, but there’s a delicate balance between creating value for the user, the costs associated with developing and delivering each product / feature and providing significant value for the buyer.
  3. How much do you charge? Not to be confused with how much you can charge. Maximizing the value you create and capture depends greatly on how much value customers derive from the product and how sensitive they are to paying for it.

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