A few years ago, everybody was giving business software away for 'free' -- here's why that's no longer the case

In 2010, enterprise software company SnapLogic tried an entirely new business model that was wildly popular in the consumer world: “freemium.”

All the cool consumer apps like Spotify, Skype, and Dropbox were attracting millions users based on this model, where they gave away free software to gain traction and got a payoff from premium follow-on sales.

“Freemium was quite the trend,” SnapLogic CEO Gaurav Dhillon told Business Insider. “We thought we would jump on the bandwagon and give it a try, even though our solution was more of an enterprise platform.”

But it didn’t take too long for Dhillon, a seasoned entrepreneur who also founded enterprise software company Informatica, to revert back to a standard paid-model. SnapLogic mostly dealt with big enterprises who were more concerned about security and reliability than the price or popularity of the software — sapping the need for a freemium strategy.

“They wanted the best, premium offering to get to an end state faster,” Dhillon said. “It was an a-ha moment when we realised freemium was better-suited for consumer offerings or simplified business functionality for smaller needs.”

SnapLogic is an example of how some companies are becoming less exuberant about the freemium model. Once considered a fix-all solution to building a wider customer base at little cost, freemium hasn’t caught on in the business software space as it has in the consumer world. While some of the most successful enterprise software — think Slack, Box, and Yammer — all have some type of freemium products, many other business software makers have become more conservative with the way they think about the free business model.

In fact, according to GetApp, a company that tracks over 3,000 business apps, only 22% of the total follow the freemium model. That number dips below 20% in some categories like sales, finance, and marketing apps. Even in the collaboration space, where most of the popular freemium business apps are, only 35% offer free products.

A recent survey by Pacific Crest and Matrix Partners adds that more than 70% of cloud software businesses are deriving absolutely no sales from freemium strategies. That’s in contrast to the consumer space where over 98% of App Store revenue is coming from freemium apps.

“Freemium was kind of like the silver bullet word in a VC pitch a few years ago. People felt good about it even if they weren’t sure why,” Floodgate partner Mike Maples, Jr. told us about freemium in the enterprise. “But now, you get asked, ‘How are you going to avoid the traps that a lot of freemium businesses have unsuccessfully avoided?”

It’s not replacing salespeople

The basic premise behind freemium in the enterprise is that business users would virally adopt your free software and pay for more robust features once they see the real value in your product.

That way, software makers can build a massive platform without spending much on salespeople — the classic textbook play Slack followed to become a $US2.8 billion company in less than two years.

“We’d all love to do freemium because we don’t have to hire salespeople,” Storm Ventures’ Jason Lemkin told us. “But what we all kind of figured out is there just aren’t enough businesses in the entire world to get to a $US100 million business at freemium.”

Lemkin argues at $US10/month per paid user, and at an industry average 2% conversion rate, you would need at least 50 million organic, active users to get to $US100 million in annual sales. That’s not impossible but extremely difficult, as only a handful of companies have been able to pull it off so far.

Instead, to reach scale, companies end up moving to the traditional enterprise sales model where freemium becomes less important, Lemkin pointed out. Even Box is now getting only a minor part of its overall revenue from freemium, Lemkin said, as it continues to go up market for larger enterprise deals.

“The pendulum has definitely swung back away from freemium to enterprise,” Lemkin said. “Most of the B2B IPOs that have been successful, like Salesforce and Workday, are all enterprise-y. They’re not freemium.”

Not for everyone

Vineet Jain, CEO of the hybrid cloud storage provider Egnyte, was against the freemium from the get-go. The cost to sustain a free business model would have been too much of a burden for him to compete in the cloud storage space, where the infrastructure cost tends to be higher than other software.

“From day one, I was against the freemium model, despite a lot of pressure from investors,” he said.

“If you’re providing a solution where you incur the cost of computing and storage, then it becomes a big factor on your operating expense,” Jain continued. “I don’t think the level of monetisation of the free guys to paid guys makes up for the cost of carrying the growing set of free users,” Jain said.

Box, for example, disclosed in its annual report that from the $US36.6 million increase in sales and marketing costs last year, $US9.1 million, or roughly 25%, was spent on supporting free users. It’s unclear how much of that has actually led to more sales, but Box continues to spend the majority of its revenue on sales and marketing expenses, while being deep in the red.

For Egnyte, a premium hybrid solution targeting large enterprises, becoming a viral product in the low-end market was less important than signing big contracts, Jain pointed out. Egnyte has raised about $US62.5 million so far, a tiny fraction compared to some of his competitors, while reaching over $US50 million in sales — which Jain claims would make Egnyte one of the most capital-efficient businesses in his space.

Freemium also doesn’t work if the product itself isn’t inherently easy to use for the mass market. Qualaroo, a customer survey platform, ditched the freemium model after realising its product was a bit complicated to understand for people not familiar with its industry. Instead, it went with a paid model, focusing on the marketer segment who better understood the need for its kind of service.

“We learned from the freemium experience that making a completely free product didn’t accelerate adoption very much,” Ellis said. “So we just gradually increased the prices, and each time we did, we did not see a slow down in demand.”

“I think companies saw a lot of failures from those who tried to do freemium,” he added. “Ultimately, it has to be implemented in the right situation.”

Not the death of freemium

David Skok from Matrix Partners, however, stresses that freemium is still a very popular model in certain areas, such as the open source software industry.

“Freemium works well in a lot of circumstances,” Skok said. “But people are wiser about it now. It’s just not a panacea for every single company.”

Lemkin of Storm Ventures also notes that although freemium in the enterprise may have shifted away over the past few years, it’s starting to make its way back, as the sheer size of the web continues to get bigger.

He says Slack will get to $US100 million as a freemium product simply because every business and every user is using more and more business software these days.

“The pendulum is swinging back to freemium a bit because the overall SaaS market I would say are five to 10 times bigger than they were in 2009,” Lemkin said. “There’s never going to be 1,000 B2B freemium products to hit $US100 million in revenue. But there will be more now.”

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