Ways to Monetize
Paid, Free, or Somewhere in Between?
Jovi Tan was the Managing Director for DEV in FY21. Previously, he was a Project Manager and a Software Engineer for the team.
There’s no way around it: building custom software is expensive. More often than not, whether it's e-commerce or software as a service (SaaS) platform, there’s always going to be a sunk cost for both designing and developing the software to bring your product to market. With tons of software companies out there offering free services, how can new startups compete with the incumbents?
One way is to begin by charging up front. Often, this may come in the form of a subscription, or one-time payment that would allow users to begin accounts on your platform. This is commonly known as a paid model, and is popular because it helps cover costs immediately after launch. Users won’t have access to any paid content until they put the first payment down, and businesses can simply calculate the cost of acquiring every new customer against the amount they pay for the service. This traditional model works particularly well for software that has a very clear or unique value proposition, or if the competition in the particular sphere is low. Traditional businesses that already have a steady consumer base but are now moving their services to the web might also find this model most beneficial.
On the other hand, there is a strong case for new startups to begin by charging nothing. The free software model is a little counterintuitive -- especially considering the high costs of developing the software to begin with. Yet, there are a couple of very important reasons why your soft launch should be free. The most probable reason is that your app is simply not ready. An incomplete app might not have the full feature set that would complete the user experience might actually turn away potential paying first-time users. Another important reason might be that an initial free launch could open up avenues for users to give feedback on the value that the software delivers. Think of it as paying for customer feedback -- your customers are the best people to tell you what the value of your product is, and where your product can be improved.
But most startups cannot continue to offer their services for free indefinitely. If you don’t intend to sell ad space on your platform, offering services for free would not cover the costs of providing it. New models have emerged for startups. The freemium model allows a majority of users to test out the application for free -- or to use the service, but in a limited way. The premium (or full) service is limited to customers who are willing to pay for it. Spotify, for instance, allows free users to play songs but with advertisements scattered in between free plays. Premium users enjoy ad-free listening. Payment tiers also further stratify the customer base. Monday, a project management software, charges different tiers for different numbers of users and projects on that account.
The Hidden Costs of Freemium
Overall, while it may seem like a sweet spot -- to charge some users but not others -- there could be a risk of confusing early users with complicated payment tiers. Moreover, the balance in what features to include in the free tiers and what to classify as premium features is a difficult one to strike. Leave too many freebies in the free tier, and there is little incentive for users to switch. If there are too few features in the free tier, then users will not get a full experience of the application and might not be willing to switch into the premium tier either.
Furthermore, the freemium model can actually take focus away from the genuine, paying pool of customers. For instance, the feedback coming from free tier users may be less pertinent to the product than the narrower base of paying customers -- but the team will have to wade through both kinds of feedback to find which are the pertinent ones.
Even with the increasing popularity of Freemium payment models, it is not clear that any one of those models are the best for any situation. It really depends on the type of product and the make-up of the market. Traditional payment models are great for businesses that make large margins and can commit more resources into marketing for customer acquisition. Free models are great for products that scale well and dominate large enough parts of the market that advertisers might even pay for the traffic. Freemium, while increasingly popular, requires a lot of forethought and might not work for all situations. For all of these strategies, it is important to weigh the costs and benefits before jumping into any payment decisions. In general, default to the free model in early stages to get as many customers interested as possible -- it is easier to get a committed customer to start paying than to get a stranger to begin paying right off the bat.