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!