Silicon Valley Watcher - Former FT journalist Tom Foremski reporting from the intersection of technology and media

Emergence Capital: Profitable Lessons From Freemium Business Models

Posted by Tom Foremski - March 25, 2010

It pays to specialize. VC firm Emergence Capital Partners is doing very well by focusing on investments in the enterprise IT market, and on startups that make use of the 'freemium' business model.

Freemium is not a new idea, companies have been giving away products and services for free for a long time but it is a new word -- popularized by Fred Wilson, a VC at New York City based Union Square Ventures. Chris Anderson, the editor-in-chief of Wired magazine, has also written about "free" business models.

A freemium model means that you offer a free version of your online service and try to convert some of those users to premium subscribers through offering additional features and value.

This business model can work very well for some companies -- especially the portfolio companies managed by Emergence Capital.

I spent most of Wednesday evening with Brian Jacobs and Gordon Ritter, general partners of Emergent Capital, and the CEOs of their most successful 'freemium' startups:

David Sacks, CEO, Yammer

Ivan Koon, CEO, YouSendIt

Brent Chudoba, VP Business Strategy, Survey Monkey

Umberto Milletti, InsideView

Jason Lemkin, CEO, Echosign

It was an excellent discussion and I came away with a notebook full of great content and it also sparked some new angles and ideas. It was also interesting to see how polarized the discussion became at times, and how the CEOs would band together on a series of points.

Emergence has the benefit of working with many companies in the enterprise space, so they can highlight best practices. Although the CEOs have a much narrower view, they know what it's like inside the trenches, and what is workable.

Here are some of my notes from the discussion:

- You can have a conversion rate of 2 to 4 per cent and still be successful with the freemium business model, says Ivan Koon.

- What should you do with your "deadbeat" users, the ones that won't convert to premium? Ivan Koon was in favor of cutting them off, once you have a 60 percent market share, and to stop accepting free users. Others said it was worth keeping them. I pointed out that with a 4 percent conversion rate you have a potential 96 per cent upside to play with.

Umberto Milletti said you should keep trying to entice your free users and that you mustn't use free trial periods because that's a power play, it means the company can take away a service and that users won't put up with that.

- Freemium means much lower, or virtually no marketing costs, said Brent Chudoba, and viral marketing helps bring new users. Survey Monkey users send surveys to thousands of people, which exposes the brand very widely.

- Where do you set your premium crossover? That depends on your service, your sector. Holding data hostage is not a good idea or doing a bait and switch -- switching off free users if they don't pay.

- Gordon Ritter focused on user data. He said that the companies were collecting lots of user data all the time and they needed to mine that data.

- Gordon Ritter also spoke about the need to do A, B, C, D, E testing. There was no sense in waiting around to see what features or what pricing would work when you could set up multiple tests to measure various aspects of your business.

The CEOs gave a bit of pushback on this point. Ivan Koon talked about using their intuition to know what will work and what won't. Umberto Milletti made a good point saying that his intuition has been wrong in the past, sometimes "shockingly wrong," and that testing was the best way to prove your intuition.

The CEOs said they didn't have the resources to carry out multiple tests and Jason Lemkin said it would mean certain planned features would be delayed.

I understand the pressures of startup CEOs, there are tons of things they could/should be doing, but it would require a week in every day to keep up.

- The human touch is important. When premium pricing reaches a certain level, it is important to have a sales representative talk with customers. This also gives an opportunity to up-sell or cross sell. The East coast digital camera stores are a good example, you have to call them to get their low prices but they generally manage to sell you extra memory, a camera kit, and some lenses too.

- Why don't free trials work? Umberto Milletti says it's because you can't create advocates for your service in 30 days, it takes longer.

- Gordon Ritter said that the companies have to think in terms of a machine, how to create a business process that acts like a machine. A machine means a service can be scaled -- if it is too dependent on humans, it can't be scaled.

- Is an ad supported model the same as a freemium model? I said no, partly because you don't want to have to start relying on online ads because the rates are low and moving lower. Online ads can bring a little extra revenues but, why give up that real-estate? Why not use that real estate on your web page to entice users to premium plans, or other services?

- David Sacks asked how do we fight commoditization of our business? That's an excellent question because the dirty little secret of freemium business models is that a competitor could offer a similar service for very little cost -- you have to find a way of differentiating your business, whether it is through community, great user experience, or something else.

- Should you get rid of your free users over time and just start charging?And can you charge a high price for your service if you have a large market share? Are you leaving money on the table by not pricing higher? The danger is that a competitor could come along and offer a freemium model priced under you. If you offer a free service, it creates an obstacle for a competitor, there is no price umbrella to shelter under. Thus, freemium can be part of a defensible business strategy.

- Brent Chudoba pointed out that if your service isn't something that is producing value, you don't have a business -- no business model, freemium or otherwise, will help you.

- Gordon Ritter continued to hammer home the point about testing, and mining user data. He pointed out that Marc Benioff (Emergence was an investor in Salesforce) is sitting on a huge mountain of user data. He can see what new features or applications it is worth launching, and what their monetization potential is.

- One of the CEOs pointed out that there hadn't yet been a large acquisition of a freemium company.

- Brian Jacobs wrapped things up, saying that there were still many questions around the freemium business model, and that it is still evolving.

It was an excellent discussion and for me, it sparked a lot of ideas that I'll be returning to in future posts.

Also, it struck me that there is a good roll-up opportunity here. I proposed that Emergence should combine its freemium portfolio companies, maybe add one or two more, and launch an IPO with the NASDAQ ticker FREE.

Salesforce is likely to do a roll-up, with the half-a-billion dollars it raised earlier this year.

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Here is a PearlTree showing related web content to this story.

 Freemium + Emergence Capital Partners 

Please see: Emergence Raises New Fund and Maintains Focus - SVW


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