Business Model 101: Understanding Churn… and why Freemium is not a very intuitive marketing model

This post is part of a continuing series on The Freemium Business Model.

Continuing from the previous blog post on the conversion funnel and on the customer acquisition metrics, it is worth understanding how all this translates to marketing for a Freemium business.

In general, any business is about keeping cost drivers low and revenue drivers high. If you look at Freemium businesses, you would note the following:

Paid users drive up revenues

Active users (paid or otherwise) drive up costs

While these 2 statements are rather obvious, it is important to note their application. For one, it means that we need to have a good balance between paid users and active users so that the paid users can make enough money to offset the cost of the active users. Hence, it implies two things:

1. Paid users should be a healthy % of active users: This takes us back to the point on the conversion funnel. You need to figure out how much money you make per paying user and how much money you burn per active user to accurately know the minimum conversions that you should be driving.
2. Paid user churn should be minimum: While the conversion to paid is important, it is equally important to ensure that a paid user continues paying across multiple cycles.

How bad can churn be? Imagine the ARPU is R. Note that this is the ARPU (Total Revenue /Total User Base) and NOT the revenue per paying user. Also, assume for the sake of simplicity that this revenue continues to be the same year after year. If the churn is C%, the ARPU over time will map out as:

Year 1: R
Year 2: (1- C)*R
Year 3: (1-C)^2*R
Year 4: (1-C)^3*R and so on

If you sum up the series, it comes to R/C. This sum is also the Life Time Value (LTV) of the user (not discounted over time to keep it simple). Clearly, the more the churn, the lower the lifetime value of the user is going to be.

So why is all this important for a business owner?

Too often, you hear about businesses saying, “We’ll get the customer base and we’ll think about a way to monetize it later!” Personally, I’m not a big fan of this logic! For a long time, most websites on the internet were content-driven and got down to aping the media monetization model which advocates getting the eyeballs and monetizing them.

All this is fine if you’re a media business but this model breaks down in Freemium. This is because Churn is a much bigger concern in a user-paid model. You can combat churn in a media business to some extent by driving additional traffic to the site but combating churn in a Freemium business is very difficult. Owing to the various drop-off points, the amount you ultimately spend to acquire a monetizable user is very high in Freemium. Hence, that amount makes sense only if the user continues to pay (I.e. if there is no churn). On the other hand, in an advertising-run site, getting monetizable users is cheaper (since you don’t have that crazy conversion funnel) and getting substitute users, while not optimal, is not prohibitively expensive.

Since user acquisition costs are higher in Freemium, it is important to change marketing plans accordingly:

1. Focus of campaigns should be on getting the right users rather than getting the numbers. Lower traffic with better conversions is cheaper than higher traffic with lower conversion for the same revenues.

2. While the UUs and PVs may be the right metric to judge your marketing team in Media, it is very difficult to get to the right metrics to judge your marketing in Freemium. The right metric in Freemium would obviously be the cost of paid customer acquisition, but the cost of paid customer acquisition is not just about marketing budgets or the kind of campaigns executed, it is also a function of the site design and the product. Hence, marketing is not a very standalone function in Freemium and needs to work hand-in-hand with product and design.

At the end of the day, driving usage of your Freemium site is not just about launching the product and driving the traffic. One needs to address all possible issues with in-product conversion and churn to be really successful.

About the Author: Sangeet Paul Choudary is a leader in the New Ventures group at Intuit Asia-Pac