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Shrinking Markets: Earning a Dollar by Taking Five from your Competitors

Product-Market fit is the primary element in the success of a startup. Software legend Marc Andreessen defined the product-market fit concept in his great blog post: “The only thing that matters” on which he states that creating a product that can fit into a great market is often more critical than creating a great product or assembling a great team for a market that is not necessarily ready.

From the different types of product-market fit models one of my favorites are companies that have the ability of “shrinking the market”. In basic terms, these are products that earn a dollar by taking five from their competitors. Market shrinking products have the capability of disrupting established market segments established by other vendors. We see it all the time with companies like Salesforce.com, Dropbox or Spotify which have started as incumbents in well-established large markets and have been able to become the dominant players by shrinking-first and then expanding the market.

The beautiful thing about product that have the ability of shrinking the market is not only that they automatically achieve product-market fit but also that they growth comes at the expense of their competitors. In the initial days, every revenue dollar earned by Salesforce.com didn’t go to the established expensive players such as SAP, Siebel, Oracle or PeopleSoft. By shrinking the market, disruptive products are able to force the bigger players in the space to compete in a smaller market that is typically more favorable to the new players. Similarly, if  a product or company is able to shrink the market and shift it in their favor, they will have the potential of capturing a bigger portion of the smaller market compared to their competitors.

Let’s illustrate this concept with an example.

Suppose that a startup is building a product competing in a well-established $20B market. The size of that market has been established by a set of vendors that charge a significant price for their solutions. Let’s say that the average deal in the space is typically X dollars. Our startup offers a simpler and technologically superior alternative to the competitors which, priced at X-M dollars, becomes accessible to companies that couldn’t afford the previous solution. Looking at those factors, we can initially think that our startup can capture $500M of the $20B market. However, if the technical superiority and pricing model of the product causes the market to shrink to let’s say $10B, our startup has the potential of earning 20% ($2B) of that market.

The interesting thing is that while a disruptive product can initially shrink the overall market size is will also expand the space based on the number of users or customers which can translate into a market expansion after certain point. The following figure illustrates this concept.

Bottom line, as a startup, if you are playing in a well-established market with a well-defined set of vendors and technologies, carefully evaluate whether your product has the potential of shrinking the market. If it does, you can be on your way to disrupt an entire industry segment.

 
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Posted by on July 9, 2012 in Uncategorized

 

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Enterprise Software Lessons: Does Freemium Really Works?

Yesterday I had a very interesting discussion with a friend about the different pricing models in the new generation of enterprise software. Obviously, the bulk of the discussion centered on the viability of fermium models in the enterprise. Having written about this topic before, I decided to post some content from a previous blog post that capture some of my ideas about this topic.

Despite the proven effectiveness of the fermium pricing model in internet products, enterprise software vendors are just beginning to experiment with those models. Certainly, in the most traditional enterprise software circles, the term fermium is associated with “you have no idea of how to make money with your product” Below are some of the most common arguments that are typically presented against the fermium model

  • Customers should pay for the product…
  • What’s wrong with offering the software in a trial period?
  • Are customers going to take us seriously?
  • Are people going to try to gamble the system and take advantage of the free offer?
  • Are customers likely to upgrade after using the software for free?
  • How does this change our sales model?

The arguments above are not only valid but certainly expected. If you think about it, until now freemium models have, for the most part, been associated with consumer technologies in which user volume is sometimes more important than the revenue model. When it comes to enterprises, the old mindset of long sales cycles, proof-of-concepts or trial periods, and armies of nicely dressed sales guys still prevails when it comes to enterprise software.

Despite the previous arguments, we are seeing some very inspiring examples of enterprise software companies relying on freemium models to attract large numbers of customers. ZenDesk, Box, and Atlassian are just some examples of companies that have challenged established vendors in the enterprise software space and reached massive levels of customer adoption by leveraging freemium as the center of their revenue model. These companies are capitalizing on a very unique time.

We are living in really exciting times in enterprise software. The emergence of mainstream computing models such as cloud infrastructures and virtualization, the increasing presence of alternative connected devices as well as the new wave of social communication methods are fomenting unprecedented levels of innovation in the space and are allowing small companies to challenge established vendors such as SAP, Oracle, IBM or Microsoft. In my opinion, these technical revolutions are also opening the door for flexible pricing and commercialization mechanisms to be adopted in the enterprise software world.

A freemium pricing model definitely offers a lot of interesting opportunities in the enterprise software space but there are some serious factors that need to be taken into consideration before adopting it.

Where Freemium Works

Having a large number of customers is always exciting and can definitely help position your company as a leader in a specific market. However, if that customer adoption comes at the price of real revenue you better have a very solid strategy about how to monetize your product. In the consumer world, there are some established mechanisms such as advertising that offer a clear path to monetization once you have an established user base. That equation is not as clear in the enterprise world in which, most of the time, you have to find a way to have some of your customers pay for your product regardless of your user adoption.

In that sense, you must do a very detailed analysis of the characteristics of your product and market to make sure it is a good candidate for a freemium pricing model. Based on my experience, I can list a few factors that need to be present in order to have a chance of success with a freemium pricing strategy:

  1. Great product quality: This one is very simple, if you want customers to pay for your product after using it for free, your product should offer an impeccable experience that justifies the upgrade.
  2. Large market: The only reason for embracing a freemium model is to have a large number of customers using your product. In that sense, the market has to be big enough to give you access to tens of thousands of customers and/or millions of users.
  3. Scalability and monetization unit: Number of users, servers, devices, api calls, storage capacity, etc are some of the metrics you can use to model your pricing structure. In any case, you have to have one or various units to scale your product from a free base.
  4. A broad spectrum to upgrade the product: When going freemium, you have to assume that a significant percentage of your users are just not going to upgrade from the free version in the current version of the product. Even if your target market is large in terms of the number of potential customers, you have to make sure is also broad enough that will allow you expand onto new areas with new products or features that will keep expanding your user base and number of paying customers,
  5. Simple to install and use: In addition to providing a great experience, your product needs to be simple to install and deploy within an enterprise environment.
  6. Simple pricing structure: If you expect customers to give you money after using your product for free you have to provide a pricing structure simple enough that won’t impose major challenging from the budgeting perspective.

In addition to the aforementioned points, there are other elements that could make your enterprise technology an ideal candidate for a freemium pricing structure. Intrinsic virality or the ability to building a strong user community around the product are probably some of the hardest aspects to accomplish but if you get there your product will be in a position to experience high and consistent levels of growth.

The Advantages of Freemium

If the conditions are created, a freemium pricing model can offer very tangible advantages over traditional pricing structures. Here are some of the ones that come to mind:

  1. Large customer base: Having a large number of happy customers can be one of your biggest assets, which will open the door for all sorts of interesting opportunities.
  2. Different sales cycle: Freemium can improve your sales cycle by only dealing with customers which are already using your product vs. having to start with a traditional enterprise sales cycle.
  3. Bring freedom to IT: I know it sounds cheesy, but I can’t avoid feeling satisfaction knowing that offering your product for free empowers IT users to make their own decisions and try to use the best products for the job without having to play IT politics at the very beginning of the technology acquisition process.

Regardless of the clear advantages and undeniable hype around freemium pricing, there are still some serious considerations in order to determine whether it will be successful in the enterprise. If you are founder CEO considering embracing a fermium model in your product, I will encourage you to do some serious analysis about the pros and cons from your specific commercialization model. In the end, once you make the commitment to offer your product for free you might not be able to rollback without damaging your brand.

What do you think? Does freemium work in the enterprise?

 

 
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Posted by on July 6, 2012 in Uncategorized

 

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The Half Ass Consumerization of the Enterprise: Flexible Pricing Models

In a previous post, I detailed some of the main elements needed to transform the ”consumerization of the enterprise” into a mainstream movement. This time, I would like to focus on one of the most important aspects of the new generation of enterprise software: pricing models.

For years, selling software to enterprises has been a privilege of the traditional enterprise software vendors. Armies of professionally-dressed, not very tech savvy sales people and ridiculously long sales processes is what we’ve known is required to convinced organizations to adopt your software. Those dynamics has drastically change in recent years with the initial renaissance we are experiencing the enterprise software industry. Technology movements like software as a service and efficient software delivery mechanisms such as application stores have provided organizations with the necessary flexibility to embrace the new generation of enterprise software packages. However, there is an essential ingredient that is required to simplify the software acquisition processes in the enterprise: flexible pricing models.

Capitalizing on the more efficient software distribution models at our disposal, the new generation of enterprise software has adopted new pricing structures based on the combination of two fundamental elements: subscription-based and fermium models.

New Enterprise Software Price Model = Subscription-based + Fremium

This formula seems to make perfect sense, whether the fermium model allows organizations to adopt the software at no cost the subscription based structure enables them to scale as the use of the software increases. I talked about the advantages of the fermium model in the enterprise in a previous post. While both the fermium and subscription-based elements should be foundational to new enterprise software packages are far from being sufficient to convince customers to adopt your software. Thinking otherwise, is clearly underestimating the complexities of the software acquisition processes in the enterprise.

At the end free is just free and cheap is just cheap ;)

Establishing the correct pricing model for you and your enterprise customers is far from being a trivial endeavor. I’ve spent a lot of time thinking about this problem and I still manage to make a few rookie mistakes. While there is no direct pricing formula that guarantees success, there are a few key recipes that any successful enterprise software price model should include:

  • Find a way to acquire customers at a minimum cost: If you are going to offer your software for free, it is vital you find different engines of growth to acquire customers at minimum expenses. See my post about engines of growth in enterprise software for more details.
  • Provide a clear conversion unit and value: In order to convert your fermium customers to a paying model, you need a clear unit of measure and an easy transition path. Additionally, it is important that there is a clear value proposition for customers to upgrade to a paying edition.
  • Answer all questions and mitigate risks up front: If you want enterprises to give you money for your software you need to provide a clear and easy way to answer the traditional concerns with enterprise software packages in areas such as security compliance and other traditional policies in the enterprise IT.
  • You are going to need a sales staff: The no sales guy organization is one of those fantasies in the new generation of enterprise software that has no foundation. If you want to acquire big customers and are serious about becoming a winner in the enterprise software world, at some point you are going to establish a sales organization that can help navigate the complexities of the enterprise software process.

Certainly the elements listed above are not exclusive but I believe you will find most of them as  part of any solid enterprise software pricing model.

 
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Posted by on June 11, 2012 in Uncategorized

 

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