The biggest threat to an established premium only software business is the arrival of a fremium player. The best way I can think of to demonstrate this is through the following hypothetical scenario:
You’ve built a premium subscription software business model. Your sales dwarf competitive premium offers because you have very efficient customer acquisition and a great product with strong customer retention. Your marketing metrics are strong. You have 1 million customers, for which you paid an average of $50 each to acquire. The average projected lifetime value for each customer is $100 with a typical subscription length of three years. So you paid $50 million and will eventually generate $100 million. Your marginal cost of providing the software is minimal, so you are now focused on acquiring as many subscribers as you can for around $50 each.
Now imagine a fremium player enters the space. At first you don’t notice much decay in your business. You’ve got a marketing machine that’s generating enough cash flow to efficiently outspend the fremium competitor 10:1. And you have the benefit of a high lifetime value to justify the high customer acquisition spending. The fremium competitor only has an average lifetime value of $10 per user (averaging their free and premium users). Their average acquisition cost is a fraction of that because of high response rates to their “free” advertising messages and strong word-of-mouth.
Fast forward a year or two. The premium only company starts to see retention rates plummet. A few subscribers are going for the competitors ½ price premium version but most just choose the free version. It’s only a matter of time until the entire Premium only installed base learns about free offer.
What should this premium only company do? If they launch their own fremium version, they will sacrifice much of their paid base to their own free offering. They paid a lot to acquire these users with the expectation that they would recover the cost through a high lifetime value. A fremium offer at this point become pretty hard to swallow.
If you believe Chris Anderson’s recent Wired article – this scenario will play out in every software category. If you are thinking about launching a premium only software product, consider going fremium now. It will be a little harder to get traction, but you will have a much more defensible business down the road.