The freemium revenue model is the go-to-market strategy for many web-based software solutions. Unfortunately, it can turn into a costly trap for the service provider. We saw this happen in June of this year with the Photobucket freemium to fee-based service migration debacle. Let's delve into what went wrong with Photobucket's fee introduction and contrast this with the lessons to be learned from Meetup's successful migration to a paid subscription model.

Photobucket - an introduction to tiered pricing

To provide some context, Photobucket Inc. is a web-based image-hosting platform, widely used by bloggers, online forums as well as small businesses who sell through Amazon and eBay. The service launched in 2003 and up until now has operated on a freemium model, offering 2GB of storage for free or 102 GB of storage at $100 per year. At the end of June, Photobucket abruptly changed their terms and conditions with very little notice to their customers and introduced a tiered pricing structure. The main channel of communication was a short blog post on their website. Under the new pricing structure, embedding (hotlinking) and photo sharing services are no longer available to free users. To keep this functionality they have to migrate to the most expensive paid tier at $400/year. With hotlinking no longer available, blogs, online forums, charities and online marketplace listings have been left in the lurch with error messages showing in place of images, leading to severe customer backlash and Photobucket being accused of “extortion” and "holding user’s photos ransom."

Freemium can be an effective marketing strategy to drive user adoption, but in order to be sustainable in the long -term:

There has to be a migration strategy in place to convert users from free to paid, or
There must be additional revenue streams or monetization strategies to support the cost to serve free users, and
The cost to serve should be low enough to support the free user base

Since 2003, Photobucket has grown substantially and now claims 100 million customers and a database of 15 billion images. Freemium models inevitably experience growing pains and it is no different for Photobucket. In recent years, they have been dogged by a stagnant and largely inactive user base that has not grown significantly since 2013.

So there was a need to find new ways of revenue generation from their existing customer base, as their cost of operation was no longer sustainable through the freemium subscription model and advertisement revenues only. However, suddenly slapping their lowest tier users with a $400/year fee was not the way to do it.

Meetup - a successful fee introduction

Let's look at another example. Meetup is an online social networking portal founded in 2001 where users can join groups based on specific interests. The groups then schedule in-person meetings and activities. Meetup needed a more sustainable revenue model and in 2005 decided to go from free to charging only the meeting organizers $19/month. There was severe backlash from users initially, and the site lost 95% of activity. Prior to the fee introduction, about 2% of the Meetup groups were active, but within 6 months of the fee introduction, half of the groups were active and the company’s revenue more than tripled. Today Meetup boasts 46% active members and an annual revenue in the vicinity of $25 million.

So why is Photobucket being labelled “ransomware” when the Meetup transition was so successful?

1. Understand how you create value for your customers

If you are going to ask someone to pay for your product or service, you must have a very clear understanding of why your product or service is valuable to your customers and connect your price to value.

Meetup : They realized that their value was derived from quality not quantity - that is, active groups and the quality of the scheduled meet-ups. Under the free model, there were too many inactive users who signed up because it was easy to do so. This devalued Meetup’s service offering. Migrating to a fee-based model incentivized organizers to be more active in attracting and keeping members as well as organizing quality events. The fee was a win-win as it acted as a quality filter.

Photobucket: They made the mistake of clumping everyone under the “user” category. Not all their users derive value equally from their service offering. Photobucket should have taken the time to understand why they have so many inactive users, which user segments derive the most value from their service offering, and how they derive value. For instance, the longer you use the image hosting service the more valuable it is to you. So a longtime blogger whose site is reliant on Photobucket's image hosting would be more receptive to paying a reasonable fee than an inactive user.

2. Customer Segmentation and Willingness-to-pay:

Don’t be greedy. Manage expectations. You will not be able to able to convert everyone to a fee-based model. Charging an unreasonable premium for a high-value segment is not the answer either. Different groups of customers will derive value differently and you have to be mindful of their price sensitivity and willingness-to-pay.

Meetup: Today 85% of Meetup’s revenue is generated from user fees, yet 99% of the people who use Meetup don’t pay anything. Meetup charges meeting organizers only, who derive value from the quality of the meetups. This is segmentation and identifying customer willingness-to-pay done right.

Photobucket: The big problem with freemium models is getting free users to convert to the paid model. But making an across the board price increase, failing to communicate and provide new value for this price increase, and not giving people warning, migration paths or options, is a recipe for disaster.

You want to shed free-loaders but not at the expense of those that truly derive value for your product. Segment your customer base and gauge their willingness-to-pay against value derived and additional value-added services provided. Instead of jumping to a $400/year price tag, Photobucket should have introduced prices iteratively for select customer bases. This should be a slow learning process.

3. Communicate, Communicate, Communicate:

You must be able to communicate the value of your service offering to your customers.

Articulate why you are now charging the customer a fee
Communicate the value of the product or service offering
Connect your price to value derived
Demonstrate added benefits that the customer will derive because they are paying a fee

Meetup: The CEO explained very clearly to their customer base that the fee was going to be introduced only for organizers, and how it would translate to better service provided to the customers.

Photobucket: was not upfront with their customers regarding the free introduction and hid it in their terms and conditions.

Customer backlash is inevitable, and hiding from it by introducing prices in an underhanded manner only makes things worse. It is better to make the customers a part of the migration process and brace for the storm. If your product or service offering creates differential value for the customer, and the customer understands this, the storm will eventually pass and you will have a sustainable recurring revenue model catering to the right customer segment at the right price.

Let’s face it, asking someone to pay for something that you have been offering for free is very tough! But it can be done. It requires a deep understanding of the value of your product or service offering, a deep understanding of your customer segments and their motivations, and more than a little finesse.

The SaaS Freemium Trap - Photobucket vs Meetup