User Growth Vs Revenue (Why “Free Only” May Limit Growth)

Last week I wrote about finding the right business model for your startup.  But many startups aren’t convinced they should even have a business model (yet).  They claim “our current priority is growth.”

In my experience, the right business model not only supports sustainable growth in the long run, it can drive faster growth today.  I’ve found three primary reasons for this:

1. “Free only” offering freezes prospective users  Site visitors often face a “what’s the catch?” moment when downloading free software  that doesn’t have a visible business model.  This is particularly the case when users respond impulsively to an advertisement – without the assurance of press or a trusted referral from a friend.  I discovered this dynamic a few years ago when I sent visitors to a landing page that made no mention of our premium product. I had no idea why these users were dropping out of the acquisition funnel at such alarmingly high rates.  Bigger download buttons and snappier headlines didn’t solve the problem.  It wasn’t until we surveyed users from impulse sources that we realized the primary problem was that people didn’t trust our claim of having a free product.  Once we knew the cause, solving this problem was easy.  By simply giving these users the alternative to download a trial of the premium product we were able to triple the download rate of our free product.  This experience demonstrates the risks of a startup that makes no mention of a premium product anywhere on their site.
2. Business customers looking for sustainable solutions It takes time for a business to implement a new IT product or service throughout an organization.  This implementation cost often exceeds the direct financial cost of buying the product.  So when a business sees that you have free offering, they will be hesitant to standardize on your offering if they worry you don’t have a sustainable business.  Even worse, they may fear that you are generating revenue through more nefarious ways such as selling their information.   Business buyers are usually more concerned with eliminating risks than saving the company a few dollars on a free offering. 
3. Hard to get aggressive on unproven assumptions Committing to aggressive acceleration is difficult when your business is loaded with unproven assumptions.  For example, imagine you get an opportunity to bundle with the next release of a popular complementary product.   They want you to pay $4 per user (free or paid) and your Excel model predicts upgrade rates that will give an average lifetime value of $6 per user across your entire free and paid user base.  Great, this looks like a safe bet.  But when the company tells you they’ll drive 1 million new users per month, you start worrying.  If your assumptions are right, you’ll generate $24 million in annual ROI – enough to put you well on your way to an IPO!  However, if your assumptions are wrong, you’ll probably go out of business.  Generally you won’t decisions on this scale, but the example demonstrates why it’s a lot harder to aggressively grow your user base on unproven monetization assumptions.

I realize it can be a bit nerve-racking to implement your first business model, particularly if you have strong organic growth.  But it’s not a moment of truth you should dread – instead it is a baseline that you will work to improve over the life of your company. Business models can and should be honed over time to increase the value of your users whether or not the first iteration is fruitful. 

Of course, if you have an extremely viral product, then a business model may in fact hamper your growth.  But ultimately you’ll still need a business model to monetize this growth, so you might as well figure it out early.