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I received the following question from a reader:
I was wondering if you had any thoughts on cost of customer acquisition for freemium businesses. When you calculate it out, it seems that paid marketing efforts like AdWords are almost universally doomed to fail. Our lifetime value of a customer is only around $1 when you factor in a high initial churn and all the free users. I imagine companies like Evernote are in a very similar position since they have a similar pricing model.
We are obviously hitting social media, PR, etc. quite hard, but I don’t think paid acquisition could possibly work here. Have you seen paid acquisition work for freemium businesses?
I’ll admit up front: I’m not a fan of using freemium in a bootstrapped business. While I didn’t write the post Why Free Plans Don’t Work, I wish I had.
If you have funding then freemium is possible to pull off, but growing a company organically using its own revenue doesn’t work when you have an extremely low customer lifetime value (LTV).
I think of freemium like trying to build a campfire in the middle of a dry forest. If you are sufficiently skilled you can build a nice, warm fire, but you’re more likely to burn the whole place down. I don’t know of any bootstrapped business that have used freemium successfully (though I’d love to hear about them in the comments), and I know of many funded businesses that have not used it successfully.
Typically, low LTV businesses only work when there’s some kind of viral loop in place that ensures every customer you sign up brings in X more customers. This lowers your cost of acquisition to such a level that you can turn a profit eventually.
The problem is that pulling off a viral loop is extremely difficult; you either have to be an expert in doing so (a la Peldi, Sean Ellis, or Matt Inman) or get really lucky…or both. And I hate basing a business on luck and outlier-class talent.
Adjust the Funnel
So yes, your intuition that paid acquisition strategies are not going to work with a low LTV are correct. However, if you look not at every user who signs up, but only those who sign up for your paid plan, you will have a higher LTV (though a lower conversion rate).
Instead of thinking of it as “I can only spend $1 to acquire a free user” you can think of it as “I can spend $50 to acquire a paid user,” and look at optimizing that funnel.
Also, keep in mind that some of your freemium users may convert over time…Dropbox indicates they get a decent percentage of their users converting to paid within 12 months (I think it’s 3%?). The problem is that you need piles of cash to sustain yourself while you wait them out. And you need to have funds to support the other 97% who never convert. Both of these typically require some kind of funding.
If you are in a business where everyone else is freemium I would encourage you to think about charging for your product. Go upmarket or figure out a way to differentiate. What can you build that will provide your customers with $19, $39 or $79 per month of value?
Unless you have a large bank balance, I’m not sure how you can begin to compete with free unless your product is very, very different from your competition.