A few interesting posts drew my attention this morning. First there was Dave Winer who predicts that on-line advertisement will be dead. Not because it will completely disappear, or that it’s growth will slow down considerable. But because it will be replaced by something more valuable, commercial information. Interesting thought. I’ve always felt that on-line advertisement only makes sense when the advertisement itself has value to its user. Dave takes that thought one step further and explains why commercial information is more relevant.
Erik Schonfeld at Techcrucnh shows statistics that advertisement growth is grinding to a halt. He uses the results of the 4 major advertisers (Google, Yahoo, Microsoft, AOL) to show that growth is slowing down considerably. Together they still create a staggering $ 8,2 Bln revenues per quarter, but what would interest me is to know the total market value right now. It would most likely show that more than 90% of all advertisement revenues are generated by these four companies. Why there are so many startups still executing the free advertisement based business model is beyond me.
Chris Anderson explains about the metrics behind a business model I like a whole lot better, Freemium. In this business model you provide most of your service for free and generate revenues from a small part. The model works only in cases transaction costs are nearly zero. You can have a huge distribution at near-zero costs and at the same time convert some of your users to paying customers. As your user base grows and you become more effective converting some users to paying customers you can have a successful business model.
Chris provides some market statistcs on this:
But that was just a hypothetical percentage split, to make a point. In the real world, what’s the right balance? The answer varies from market to market, but some of the best data is in the games world.
In online free-to-play games, companies aim to structure their costs so they can break even if as little as 5-10% of the users pay. Anything above that is profit. Which is why these numbers from Nabeel Hyatt are so impressive:
- Club Penguin: 25% monthly uniques pay, $5/mo per paying user
- Habbo: 10% monthly players pay, $10.30/mo per paying user
- Runescape: 16.6% monthly uniques pay, $5/mo per paying user
- Puzzle Pirates: 22% monthly players pay, $7.95/mo per paying user
As the blog notes, that compares very well to the 2% of the casual downloadable game market that pays, or a 3-5% that a lot of “penny gap” free trial web startups get. Estimates for the number of free Flickr users that convert to paid Flickr Pro range from 5-10%. Ning says 3% of its 500,000 social network creators pay for the premium version. And shareware software programs often see less than 0.5% of users paying up.
If you can get 5% of your user converted to paying customers then your business case can become profitable. As your business keeps scaling (due to the FREE component), 5% quickly becomes an interesting number of paying customers and a healthy stream of revenues.
What I like best bout Freemium is that it combines the best of both worlds. You have excellent distribution possibilities while at the same time you ask customers to pay for the value they receive . It is the most straightforward business model there is. So those of you that are thinking about starting a new business, why not forget about the FREE advertisement based business model and concentrate on Freemium instead. not only is it a proven business model. But it will force you to think and act in terms of user value instead of network value. And that strategy is better for your customers and therefore better for your business. To me, Fremium is better than Free advertisment based business.
@vanelsas 
I do agree that Freemium is a more sustainable business model. However, with Freemium you could have the advert based system too.
You offer your service for free with advertising and the people who upgrade to your premium product will get to use it without the ads.
This ensures you still have a steady flow of income from the ‘freeloaders’ and you get the financial benefits from paying customers.
Hi Daan, while this is perfectly true I personally would be very careful with such an approach. The reason for this is that Freemium imo provides users value, and they end up paying for that value. If you position advertisement as one of the drivers to pay, then you aren’t really paying for value, you pay to get nuisance taken away. It will work, but it may be more powerful when you do not serve ad in the free version.
This is how Ecademy has survived for 11 years.
Well – nice blog – however this is nothing new – you give out information to educate and most businesses have a small percentage of their customers providing most of the revenues – if you take the retailers as an example – they need a lot of cusumers to walk through the door, make phone calls and visit online before they get a sale -only those that buy from them regularly understand the quality, the speed in which they receive the article and the price point and if they can find it when they want – buy from them buy from them a consistent basis – it is called “servicing the customer”.
Good thoughts –
Hi Jan,
you are right, but n the web it is defnitely a model that needs more attention. On the web Free advertisement based models have been used most often. These models inherently have more focus on the network (the number of customers), than on the customer itself.
Freemium has focus on the customer, it needs network effect, but it can only be successful if you provide customer value. tha is why I like the model so much 😉
“Freemium” is well-known in the open source and SaaS – that’s how they make money actually.
Fair point Alexander, although I wasn’t trying to say the removal of advertising was the only reason to get a premium subscription. Obviously additional value would have to be offered, like the way Flickr does for example
Completely agree Alexander, however that was not what I was suggesting. I agree that simply removing ads is not enough to base a premium service, and more value would be required. A service like Flickr is the prime example of how this business model can work.
Years ago Webshots.com achieved runaway success offering free screensavers on an ad-supported platform. They were generating about 500,000+ downloads of their software each week at their peak.
I worked with Webshots who successfully evolved the screensaver model into a photo sharing community model – before Facebook and MySpace spurred talk of communities – and then launched a premium, ad-free version that many of their members embraced.
Webshots proved the efficacy of the combined ad-supported free and premium models.
So which is best – freemium or hybrid ad/premium? I think your model choice also depends on the tone you want to convey with your audience. You might find they will accept ads, or perhaps not. You won’t know without asking and testing some options.
Ads populate the world’s most popular websites. They often annoy me, but they don’t drive me away. I would personally prefer freemium, but running a business means generating and sistaining revenue. And if users love your service, they should be willing to participate with you in ways that perpetuate the benefits they’re now enjoying (for free). And if they want to eliminate ads, that (plus enhanced features and services) might inspire them to migrate to a premium version.
Great read–well argued. Do freemium models or web apps really convert at 5%? Even though I think thats on the optimistic side–especially with people being lured by the word “free”–I still tend to agree with your conclusion.