The best business models focus on user value

Fred Wilson just wrote a post called Free versus Paid. In it he says:

It’s much better, in my opinion, to go with the freemium model, give a version of the service away for free to all comers, get a lot of users, get good market feedback, then develop a premium version of the product/service for sale to enterprise customers. If your free version is popular with a lot of users, your customer base is the target for the upsell and you might be able to live without an expensive sales force initially. And, of course, keep your costs really low until you start to get revenues.

In summary, freemium is far from dead, in fact it may be the business model de rigueur.

Fred’s look on Freemium works in the consumer market too.

In my opinion FREE work best when it is not mixed with advertisement, especially if you are in the social media or social networking business. FREE is just a cleverly concealed trap. It doesn’t focus on user value. It focuses on having a large user base and ensuring the value is monetized on size. It’s an indirect business model that by default makes it hard for the service provider to provide real user value to the user. It might give a service provider distribution because the service is free. But the advantage of distribution is diminished by the lack of revenues and the negative impact advertisements have on the user experience.

“Hey, you get a free service so you’ll have to put up with advertisement” somehow doesn’t feel right as a business model. And if you do the math then you will find that few companies make lots of money in on-line advertisement. Google takes more than 75% because they alone have a free ads based model that actually provides the user direct value. MySpace and Facebook take a few % and the rest is spread as leftovers for the thousands of companies running the same business model.

I prefer a business model where the user gets value, and you monetize on that value. It’s the cleanest and best business model there is. Ask yourself this. Would you prefer a few hundred thousand enthusiastic customers that pay for the value that they receive, or would you prefer millions of users that get a free service, aren’t really getting the value they deserve and end up with advertisement too because you need to make a living? Investors and entrepreneurs wanting to rule the world or become a “new”  Google or Facebook, will use the second model. anyone else should focus on the first.

I feel Freemium has a good chance of revenue creation. It focuses on user value, creating a community of enthusiastic users, and eventually adds more value to that community by delivering paid premium services. It is not the easy road to success. It may not easily scale to millions of users or “sound” good to investors. But maybe times are changing now. Maybe investors and entrepreneurs will step away from the default and start experimenting with new business models.

Right now the basic business model is to grow as fast as you can (focus on size and provide the service for free), advertise to give “old media” the feeling that something important is happening out there. Finally get some “old school” media company to pay way too much money to take over the company, which then allows them to find out that earning advertisement revenues is something very few companies are able to get right. It’s a lose-lose scenario. The user loses because the focus of the business model is on growth instead of user value, and the sucker that ends up paying for it loses because it will never generate enough revenues.

The Free Ads based business model has another problem. As if focuses on growth it doesn’t answer the most important question technology needs to answer for any user: “what does it do for me”? I call that the First Use experience. It’s dead simple to understand, but incredibly difficult to get right.

First use is about creating the best possible user experience when you deploy your service for the first time amongst your target users. First use is about answering the question,”Is a user willing to put in the effort to learn about this new technology and incorporate it in his current habits”?  The answer in any case is that willingness is related to either solving a problem or creating another type of value for the user. If this isn’t obvious from the start, then the user is not committed to put in the effort of integrating this technology into his life.

A startup that uses a business model that focuses entirely on monetization of user value needs to address the First Use question. It might not get it right immediately, but through interaction with its user community it will get there in the end. I hope that the FREE advertisement based business model is slowly replaced by business models that focus on user value. Freemium is just one way of doing that. But it will help us build a User-Centric web.


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10 Responses to The best business models focus on user value

  1. fred wilson says:

    first use is critical. getting that right makes everything else possible

  2. Fred, I fully agree (but you know that already 😉 ). I also think that advertisement models often lure us away from answering First Use questions.
    These models are mostly growth or network oriented, not user-value oriented. Growth is something that will occur naturally because you create user value. It shouldn’t be the other way around.
    Freemium is the best way to do that. It builds a fanatic customer base that will help you to improve your service and it allows revenue stream that directly monetize user value. The simplest and best business model there is.

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  4. Mukund Mohan says:

    The alignment of user value to monetization is a good point, and no doubt the best freemium companies (Skype, Flickr) do this very well.

    The thing about advertising is that most companies need some cash coming in while they determine the best alignment for their users and the “free” portion of the product. During that time, when they research and think about the model is when you see advertising.

    Other companies that do not need that revenue, are the ones that consistently get pounded on “not having a business model” – e.g. Twitter.

    Its kinda dammed if you do and slammed if you dont.

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  9. I agree with you that Freemium is best when it is not mixed with advertisement. It provide the real value to the end user.

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