Freemium math: what's the right conversion percentage?

In my original Wired article on Free, I described Freemium as the opposite of the traditional free sample: instead of giving away 1% of your product to sell 99%, you give away 99% of your product to sell `1%. The reason this makes sense is that for digital products, where the marginal cost is close to zero, the 99% cost you little and allow you to reach a huge market. So the 1% you convert, is 1% of a big number.

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.

But others companies are able to do much better. Intuit, for instance, offers basic TurboTax Online free for federal taxes, but charges you for the state version. Company officials tell me 70% of users opt to pay for that version. That's a special case--practically everyone has to pay both federal and state taxes--but it's evidence that some very high conversion rates are possible in the Freemium model.

For the typical Web 2.0 company planning to use Freemium as its revenue model, my advice would be to set 5% as break-even, but balance the mix of free vs. paid features with the hopes of actually converting 10%. More than that, and you may be offering too little in your free version and thus not maximizing the reach that's possible with free. Less than that, and the costs of the freeloaders start to get significant, making it difficult to make money.

Comments

[Hashim]

At Ning only 3 percent pay for premium services:

http://playersearch.wordpress.com/2008/10/07/ning-provides-data-point-for-free-mium-pricing-model/

But the other 97 percent are monetized through advertising.

[Bertil Hatt]

One can consider a classic economic model, with a rational decision to go freemium, based on the structure of social ties around the objects considered. By offering a free option, the producer shifts:

* from a sub-set of rather heavy user, a k-core — with k being the number of friends using the service to justify the price, proportional to k; a k-core is a set of people with k friends in the set, and it is, smaller with k large;
* to a wider network, k'-core, with k' justifiying only the curiosity to fill the form and try; only certain users would contribute (say, with honnest users, those in relation with more then k'' users — k'' justifying the premium bill: because those k'' do not have to be in the small k''-core, but in the larger k'-core, it's larger group, especially on a complex network; costs increase (slowly) with success but so should revenue (fast). Therefore, a stable ratio of paying members depends on how much users with many potential friend users are connected to users with not-so-many friend users (homophily). The same reasonning can be applied to more or less intensive users.

Strong homophily drives to higher payment ratio (freemium doesn't change much of the model); weak homophily or strong network externality (e.g. having families using the personal version of my anti-virus really improves my professional security solution) makes freemium a very blod move, and lead to more skewed payment ratio.

Photo-sharing can be well segregated between professionals or hollyday pictures: those two a rather segregated, so Flickr gets a rather high ratio — and more generally, the photo services are segregated by how serious you are about sharing: just storing (Yahoo! Photos), sharing with friends party pictures (Facebook), sales-oriented pro (SnugMug), all with high payment ratio, or no free option at all.

For Club Penguin et al., it's about having something your four friends don't have: high ratio, for the same reason; for shareware, there is no network effect, so freemium won't drive massive turnouts, etc.

[Osma Ahvenlampi]

Chris, the long tail model in fact applies very closely to the free-to-play, pay-for-stuff games model. Based on our experience with Habbo, I wrote about this two months ago in a bit more detail at my blog, link below

[Dan Scherlis]

Nice posting, but I'm sure you'll want to correct your sourcing, Chris. The posting you saw on MMPOW was republished, entirely, from Nabeel Hyatt:

http://nabeel.typepad.com/brinking/2008/09/theres-been-som.html

Nabeel's the CEO of Conduit Labs in Cambridge MA, and an excellent analyst of free-to-play (F2P) games.

[Chris Anderson]

@Dan: Thanks for the catch. Corrected.

[Jim Ciallella]

Dries of Drupal fame wrote a very related post about his recent freemium experience with Acquia and Mollom and the quest for more answers. - http://acquia.com/blog/freemium-business-model-giving-away-pays

I wondered if you have worked with Dries. If not, it seems his ventures could benefit from your freemium research, and vice versa.

[Francesco]

Interesting since it gives some harder numbers to your talk in Belgium last thursday, which I was happy to attend.
And it comes exactly when I am working on a new venture to get launched and first time I will use freemium as a business model.