Freeconomic recovery

Remember those free AOL CDs? Bundled with magazines, posted through letterboxes, in special dispensers in shops - they were everywhere. In an era when dial-up modems meant you were charged for a local call as well as by the ISP each time you wanted to use the internet - and you couldn't even make phone calls at the same time! - AOL had decided to offer anyone who could get their hands on a disk (and given the number that were handed out, there were very few people who couldn't) a free trial.

Whatever your opinion of the disks, there's no doubt AOL's strategy, which offered subscribers anything between 50 hours and two months of free use, was a success. By 2002, the provider had almost 27 million users. By the time the company stopped distributing the free disks in 2006, over a billion had been sent out and an estimated 4,000 different designs - aimed variously at children, fashionistas, business owners, travellers, comic book fans and even ethnic markets - had been produced.

Although the company's user base has tailed off hugely since the halcyon days of 2002 (it's now declined to around 5.8m, with little sign of levelling off), AOL had cottoned on to a model used by businesses ranging from cosmetics brands to drug dealers for centuries: Get someone hooked on your service, and you'll have a paying customer for life.

The rise of freemium

But the new wave of internet businesses are increasingly realising just giving away their content for free doesn't always work - even if it's ad-supported. YouTube is a case in point: since Google bought the video-sharing website for a reported $1.65bn (£883m) in 2006, the search company has been struggling to monetise it, reportedly losing half a billion dollars a year.

Even Google's chief executive, Eric Schmidt, is evasive about how the company plans to monetise it: "[The website] attracts an enormous, extremely large set of people who are basically spending an awful lot of time there," he told Wired magazine last month. "We will eventually figure out a very successful business."

Freemium, though, works differently. Like those AOL disks -and like websites such as YouTube and even Facebook, its premise is providing a service for free and getting users hooked. But that's where the similarity ends. Unlike AOL, though, there's no catch to websites built on a freemium model - no limited trial or hidden costs. What's presented as free stays free - instead, it's added, or premium features which are charged for. The majority of people who use freemium services never pay a penny.

US Wired editor Chris Anderson explains freemium in his new book ' Free: The Future of a Radical Price'. "A typical [freemium] site follows the 5% Rule," he writes. "5% of users support all the rest. In the freemium model, that means for every user who pays for the premium version of the site, 19 others get the basic free version."

The term was first coined not, as many people (Anderson included) believe, by US venture capitalist Fred Wilson; but by one of his readers, Jarid Lukin, after Wilson wrote a blog post in March 2006 which outlined the model. "A customer is only a click away and if you can convert them without forcing them into into a price/value decision you can build a customer base fairly rapidly and efficiently," he explained.

Too cheap to meter

The model has proven itself tremendously popular: services such as Skype, where you get free computer-to-computer calls but pay for computer-to-phone calls; Flickr, where you can upload a certain number of photographs but have to pay if you want to go over the limit; and current European tech scene darling Spotify, where you pay to stream ad-free music, all operate a freemium model.

The reason it's so popular, according to Anderson, is because for websites, the cost of supporting a free user is 'too cheap to meter'. With the cost of bandwidth, processing and storage all halving every 18 months according to Moore's law, there's no point charging everyone. The cost per user would just be too marginal.

Instead, web entrepreneurs are using the many - the non-paying members - to attract the few: those who will pay. Which is precisely what Michael Smith, whose games development company Mind Candy launched children's online cyberpet sensation Moshi Monsters in 2007, decided to do.

"[Non-paying users] serve a value to us in a number of ways," he says. "One is that they tell their friends, so they help pull new people into the game, and secondly they increase the value of our network - they make the game more valuable to our paying members so there are more people to chat to and play games with and so forth."

Smith makes it no secret he set out to cash in on the success of Club Penguin, the kids' social network which was sold to Disney for 'at least' $350m in 2007. The site is touted as one of the most successful examples of freemium, which charges $5 a month for added features and has a 25% conversion rate among its users - a level almost unheard of among other freemium businesses.

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