I’ve chimed in once or twice on the free vs. paid debate, and I’m firmly in the camp that you should charge customers money. You get money, they show some commitment, the expectation that comes with their money means you have an incentive to produce higher quality, and it gives you the funds and resources to sustain your business. Better yet, if they pay you repeatedly, you have predictable revenue and a baseline to measure the effectiveness of business-growing activities like marketing and advertising. So there’s the full disclosure of my preferences.

Now you should definitely take my opinion with a grain of salt. I’ve neither succeeded at a paid business nor failed with a freemium business. I have never actually started or run a business. But I am good at listening to lots of people and figuring out who’s telling the truth, who has an agenda, and what assumptions lie behind what people are saying. And now I’ll apply that skill to Mark Evans’ latest post Freemium is Not a Business Model.

[For those who don’t know, “freemium” is where you have a trial or limited version of your product that still does enough to provide some value, and a premium version with more features or capacity or X that some fraction of people will pay for. The hope is that you make enough money off the premium customers to support the many free ones.]

Mark’s point is that many Web2.0 companies are using freemium as an excuse not to make something valuable. It’s not a long article, and this quote sums it up pretty well:

For consumer-focused companies, however, freemium is fool\’s gold…and, most important, it\’s not a business model to create a viable and vibrant company.

Your business model might be to make something good enough that people will use it for free, get a big audience, then sell your company. But then you’re not really creating a product customers, you’re creating a product on spec to sell to another business. If you know beforehand that that’s what you’re doing (Paul Graham recommends this approach), it’s fine; just don’t fool yourself into thinking that your users are actually your customers.

I don’t think that giving things away is inherently bad, but it has to be put in context. The point of giving your product away is to make impressions on potential customers. There’s another name for this: marketing. If someone is ever going to buy your product, they have to a) know about it, and b) trust it.

People who don’t know something exists will never buy or use it. Period. It’s exactly the same as how people never buy things that don’t exist. If a potential customer doesn’t know about your product, then to them it doesn’t exist. Giving the product away lets people use it, and others can see people using it, users tell other people about it, etc. Those impressions are the same or better than the ones you have to pay for in advertising, hence the appeal of the free sample.

When people use your product, they can tell if they like it and want more. For instance, there are a million different calorie tracker websites and programs out there. It’s not a hard programming problem, it’s a data (why isn’t the food I just ate in here?) and interface (this takes too long, forget about it) problem. Those are things you can’t determine from a sales website, and definitely not from the claims the seller makes. So I went for a couple years before I found a situation where I trusted one enough to try it. I got a recommendation for Gyminee from someone I respected, and since it was free, I gave it a try. I found it easy enough to use, with a combination of fairly good food database and extremely easy to use interface, so I’ve stuck with it and recommended it to a few people. There is a Pro version that offers things like meal and workout planning that I’m not currently interested in. But if I do get more serious about my fitness and nutrition, there’s about a 99% chance that I’ll keep using Gyminee and about a 1% chance I’ll switch. Letting me use the free features turned a single impression into a potential customer. (plus it made me happy enough to plug it to everyone here)

Is it worth it to Gyminee to have me? Is this a success (because I use and recommend it) or a failure (because I haven’t paid them anything) of freemium? We can’t tell! Without knowing their expenses and conversion rates, we can’t say whether this is good or not. Let’s play with some numbers and see.

Here are some wild guesses about their business:

• Monthly hosting: $70 for a month for a 1GB slice from Slicehost
• Startup living for 3 people in Hunstville, AL: $3,600/mo
• Office, internet, etc: $1,300

This would give them roughly $5,000/month expenses. Gyminee Pro costs $5/mo, payable in 3 month chunks. So they would need 1,000 Pro customers to break even. If they convert 2% of signups into Pro accounts, they would need 50,000 registered users. If they have $50,000 in funding/savings/etc, then they have 10 months to get to that point.

What does this mean? Nothing! Even in this simplified model of their business, it’s a complex multivariate relationship. If they’re not where they want to be, they can do lots of things to improve it:

• raise more money
• reduce their expenses
• raise prices for Pro accounts
• create another set of features for a more expensive “Arnold”-level account
• sell either the meal OR workout planning as a sub-Pro account
• create more leads and registered users
• improve their sales process so they improve the percentages in their customer pipeline

You know what’s even better? They can do ALL of these things, within the limits of their time and resource constraints. For instance, since it seems like a young product, most of their costs have been related to designing and building the site. That is a fairly fixed cost that is already spent, so their best bet now is probably to get more and more customers to reduce the per-user cost of that upfront design work. Once your product is mature enough to be competitive, sales becomes more important. This is not some inherent quality of sales – when engineering makes the product better, sales becomes a relative weakness. When your sales grow fast and you enter new markets and people become used to your product, engineering becomes a relative weakness and that’s a good time to improve your product. You can improve your overall position by improving whatever is weakest in your business.

So if freemium isn’t when you should use freemium or not. These are the questions to ask:

1. Are there enough people willing to pay for my product to support my business goals?
2. Is there a subset of features of this product that’s enticing enough to stand on its own?
3. What percentage of my paying market will be satisfied with that subset and decide not to pay?
4. Based on my customer pipeline, what is my customer acquisition cost?
5. What is my cost to support each free user?

So if (revenue lost in #3 + (#5 * # of users)) < (#4 * # of paying customers), then you should consider freemium.

Done? NO! This is not a one time calculation! You have to periodically reevaluate each of those to determine if that relationship still holds. So any changes you make should be temporary, so you can test the effects and decide if it is worth it to continue that change. It’s up to you to decide whether it’s fool’s gold or real gold.

Fortunately, there is a good place where we can see this in action – the iPhone App Store. It’s the one redeeming quality of all the mercilessly annoying whining about price changes in the comments: you get a record of different prices at different times. I’ve seen lots of examples where a company has lowered the price, made a lot of sales, shown up on the “What’s Hot” list, become popular, and then raised the price again. Sometimes, like for AirSharing and MotoChaser, where they have a free or low introductory price, then raise it. This serves two purposes: getting a feel for demand at different prices, and getting some free publicity.

Follow any discussion board for entrepreneurs, and there will be articles and conversations about pricing strategy every week. The reason people say it’s an art, not a science, is because the optimal pricing strategy is different for every business, and it changes as the business changes as well. Consider options, make informed guesses, and experiment until you find what works for you.

Or you could do like me, and work on creating free content that you have to pay to use. It’ll make sense soon – subscribe to stay tuned!

UPDATE: Dries Buytaert at Acquia and Mollom wrote a similar article about he uses a combination of freemium and open source to not only drive business but get valuable development contributions. Thanks Dries!

A few weeks ago, Google Chrome was released with much fanfare, press, celebration, comic books, and praise (with the usual skepticism and contrarian views thrown in for good measure). People wondered if Google was getting into a browser war, an OS war, a land war in Asia, whatever. I kept waiting, kept waiting, kept waiting until finally … oops, no finally, just more waiting. No one pointed out the biggest strategic benefit of Google Chrome.

First, some background. Google makes a lot of money. Like, they didn’t have enough bathtubs in the Googleplex to put all the money in. They were going to build swimming pools to put their cash in but all of the pool contractors in the Bay Area were already committed, so they’re working on damming and draining part of the San Francisco Bay to make a pit big enough to put all of the coins, bills, doubloons, and gems that those little blue text ads deliver to Mountain View. Meanwhile, Larry and Sergey are impatiently waiting to fulfill their dream of swimming through it like Scrooge McDuck.

So Google = Money = Good. But they make ALL (like 99+%) of it from advertising, about 2/3 from search ads and 1/3 from contextual ads on other websites. So although they completely own this market, making more money than all of their competitors combined and more than anyone imagined was possible, this single-source-of-revenue thing scares the crap out of a lot of people (just ask anyone who has lost a job). That’s the only criticism of Google as a business that has any real substance.

What are the biggest, juiciest targets for a behemoth that needs another revenue source? Let’s look at the cash cows in the computer industry and how attractive they would be to Google:

• Hardware: a total non-starter. While Google might run the best data centers in the world, it is also one of their major competitive advantages, both in cost and performance. Selling or sharing it is out of the question. Other fields like PCs or servers are too low margin compared to their current business. Besides, hardware involves atoms, and Google has no experience with atoms.
• Operating Systems: Sure, Apple and Microsoft make a ton of money and high margins off of their OS products, but they also have decades of accumulated advantage, installed base, and brand equity. And they got to build those things back when people PAID for new operating systems.
• Office Software: Someone at Google is at least as smart as me because they went through the same process of elimination and ended up here. So they’ve built and bought their way into Google Docs, which does enough of what people expect in an office suite that it is considered a plausible alternative to MS Office.

They built it, some businesses have adopted it, but they’re not making billions of dollars off of it. Why not? Let’s ask Joel. His Strategy Letter III is probably the most important business lesson that people don’t get.

The only strategy in getting people to switch to your product is to eliminate barriers…Think of these barriers as an obstacle course that people have to run before you can count them as your customers. If you start out with a field of 1000 runners, about half of them will trip on the tires; half of the survivors won’t be strong enough to jump the wall; half of those survivors will fall off the rope ladder into the mud, and so on, until only 1 or 2 people actually overcome all the hurdles. With 8 or 9 barriers, everybody will have one non-negotiable deal killer. This calculus means that eliminating barriers to switching is the most important thing you have to do if you want to take over an existing market, because eliminating just one barrier will likely double your sales. Eliminate two barriers, and you’ll double your sales again.

(Incidentally, he used Excel as his example, pointing to the last time a smart aggressive software company with one revenue stream was looking to diversify. Maybe office software is just more usurpable than operating systems.)

Google is facing a whole different set of barriers to adoption than Microsoft faced when attacking Lotus 123. What are some of the barriers to adoption facing Google Docs?

1. Storage space is limited.
2. MS Office has office has more features.
3. It’s slower than installed apps.
4. It can only be used when online.
5. People are used to opening programs, not websites to work on documents.
6. IT Departments won’t upgrade their browsers beyond IE negative three.
7. [UPDATED] Some companies will NOT store their docs online – they only want them on their own machines/network (government, confidential, corporate secrets, etc)

Pre-Chrome, it looked like only #1 and sort-of #2 could be solved. Google, home of the original 1GB email account, isn’t afraid to offer more space when their products are mature. They have great developer resources to add whatever features are necessary, but the JavaScript foundation put a cap on the kinds of features that could be delivered with acceptable performance. The rest just seemed out of reach.

How does Chrome change this?

• The V8 JavaScript engine greatly improves the performance, basically solving #2 and #3. Coupled with the size and bloat of MS Office, Google Docs on Chrome is pretty comparable for speed. Also, now Google can control the entire stack between the OS and the office apps (browser, renderer, JS engine, software, etc) so they can optimize in ways that they couldn’t do on other browsers. Both Google Docs in Chrome and MS Excel take 1-2 seconds to open on my computer, while Firefox 3 took about 4 seconds and went through several ugly partial rendering states.
• Google Gears is pre-installed, which should speed up adoption of Gears and solve #4.
• The “Create Application Shortcuts” feature means that you get a nice desktop link that gives you an applicationesque window with either the list of all your docs or a specific doc, which can also be easily synced for offline access. Take a look:
• Bye bye, #5.
• And last but not least, the $50 billion question, what about #6? Imagine a version of Chrome with a different installer that a) included an IT controlled whitelist, b) automatically ran the offline setup after installing, and c) created appropriate shortcuts. This means it can be centrally installed, restricted from general browsing, and treated like an installed app. IE6 or 7’s role isn’t changed. That would get the seal of approval of many more IT departments because of the greater control they would have over it vs a standard browser app.
• [UPDATED] If there was an option to store documents offline only, that would solve #7. This would negate one of Google Docs’ biggest strengths (collaboration) but giving companies that option just might be worth $50B.

So in one move, Google addressed all but one of the strongest obstacles to Google Docs, paving the way for a much bigger, more profitable expansion and the coveted second revenue source. Can you think of any other obstacles to the wider adoption of Google Docs that Google needs to address?

[UPDATES: Thanks for the suggestion Evan!]