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Web freeloaders can breathe easy at Web 2.0 Summit

The freemium model makes more sense than ever in this rough economy.

With warnings of doom coming from Web investors, and CEOs cutting back on staff in order to focus their companies on revenue, I am not expecting the Web 2.0 Summit, which opens this Wednesday in San Francisco, to be the happy and upbeat affair it's been in years past. People at the conference will be taking a dispassionate look at the business models of the services under discussion this year, as opposed to focusing on user growth amd technology innovation.

This will be interesting, since many of the most popular Web 2.0 services are free. Going into the conference this year one might well expect to hear murmurs that the era of freebie software or Web apps is nearing its end. After all, if companies now have to actually make money, they're not going to do it by continuing to give their product away.

Or are they?

If you look at the model, you'll find that the free software and free Web service concept is actually a great, and in many cases necessary, part of the business model for Web apps, and even moreso for software. Freebie apps and services are the best form of marketing a company can do. The question for the companies giving things away is not, why are you doing this? But rather, what's the next step? How do you move users down the path from being a freeloader to being a paid user? And, importantly, how are you tracking your progress and adapting to it?

Two kinds of free
There are two freebie models that work for software and services: Try before you buy, and upgrade ("freemium"). The former is a good model for indespensible business services, and the latter generally makes more sense for consumer services, although other factors always come in to play. One reason for the difference is mathematical: Business products get more paying users regardless of model, but consumers rarely pay up. According to Xobni's CEO, Jeff Bonforte, the ratio is about 100:1 (1%) in the consumer space, but can be up to 11% in business. In other words, if you try to force consumers to pay, you'll lose valuable ambassadors, but for business services enforcing an upgrade can pay off.

On the other hand, Web services can be difficult to maintain as freebies. This isn't necessarily true for software, since once an app is distributed to the user, the cost of maintaining its functionality is zero. Web apps, however, take up processing power and bandwidth, so the perpetual freemium model only works if you can offset the cost of serving a Web app with advertising (a tough revenue model on its own) or with enough paying users.

My discussions in past weeks with experienced CEOs and venture capitalists have led to some fairly obvious and simple advice on making a free-to-paid business model work: First, clearly, there needs to be a paid version of the product. Many great Web 2.0 apps have satisfied users that would pay for the service if they could, in return for extra features, capacity, or support. (As usual, Twitter comes to mind.) But the plans for revenue services cannot be an afterthought. And since it's not a sure thing than any paid version of a service will be a success, it's important the companies begin to experiment -- beta test -- their paid products very early in their existence.

Second, company execs need to be focused on the "conversion" of free to paid users, and be rigorous about measuring which pitches, prices, and paid features are effective in moving people over. This is a game of iterating and tracking metrics, and it needs to be approached with the same rigor that's applied to product development.

There's an opportunity here, by the way. Few small Web 2.0 startups have the in-house experience to create and build effective programs for converting users from free to paid. Companies that make tools for tracking and evaluating these programs could find themselves in high demand.

The key, overall, is not to have an all-paid user base, nor to try to survive on a set of "customers" who are paying you nothing. The successful Web business will have a mix of users, and will be constantly converting a proportion of them from free to paid. The non-paying users are valuable to the growth of a paid service, and need to be treated well -- coddled, in fact -- so they can do your selling for you, and once in a while become paying customers themselves later on.

I expect to hear a lot of discussion at Web 2.0 Expo -- in the hallways if not on the stage -- about how companies are ramping up or iterating their conversion programs. Still, free users are, and will remain, important to the success of most Web 2.0 businesses.

The contrary view by Charlie Cooper: Can the 'freemium' model weather the financial storm?