I was recently asked to look into churn rates for subscription models. I found it tricky to find real industry numbers, but here are the fruits of my digging.

First of all, how we define churn:

Total Subscribers = (Total Subscribers * Loss Rate) + Acquisitions

To get a churn rate, you need to compare your total subscribers from one period with the amount of change within the base.

Of course, you have to be able to know when a customer leaves. For the purposes of this post, I’m talking about specific subscribers to a paid service. Churn on a free service is, I believe, harder, because you have to decide on some activity rate beyond which you feel that user is gone. Could a week, month, two months, three months…

Second, some things that affect churn:

Your rate of acquiring customers is obviously affected by how viral your service is, and your marketing and promotional efforts. Your subscriber cancellations will always be a percentage of your total user base, and that percentage will be affected by things like the quality of your service, how easy it is to cancel, the competitive situation and so forth.

Getting beyond point of no return

At some point, your customer growth flattens because you can’t add subscribers fast enough to counteract the number of customers leaving. That’s when a focus on customer acquisition and churn reduction is critical, and/or you have to spend more to keep growing at the same historical rate.

Some churn rates I found are below. Naturally some are audited and some are not; some are free and some are not! So take it for what it’s worth!

Michael Port seems to think so. He believes it’s all about the conversation. Showing your passion with a back and a forth. But I have heard so, so many people totally fail at answering the question “so what does your company do?” in a way that’s brief and coherent, I still think it’s critically important to have that simple, reliable statement.

If you, or anyone in your company, can’t communicate your value proposition instantly, quickly, and correctly, you’re in trouble.

OTOH, Michael’s list of what you should be able to answer is good:

1. Who you serve (your target market)
2. What they need and desire (problems they have and things they want)
3. What solutions you offer (products and services)
4. The big, bad result they get from your products and services (the money shot)
5. The deep-rooted core benefits they get from that result (financial, emotional, physical or spiritual ROI)

Thanks, Michael. That list I like. But I’m still going to try to stick with an elevator statement at the beginning. It’s a good forcing discipline.

Been working with a client recently on the gnarly problems around how much to pay to acquire a customer. Thought it would be useful to share this nifty calculation with represents one way to look at the issue.

Traditionally, companies look at a marketing/sales expenditure to be 15-20% of each revenue dollar. But you may have different models. And, frankly, with almost all the companies I work with, there’s only a very slim marketing budget available. So let’s look at it from the perspective of the lifetime value of a customer:

Lifetime Value equation:

LTV = (Frequency of Purchase) X (Duration of Loyalty) X (Gross Profit)

– How frequently does your customer buy? (say, 12 times a year with a monthly renewal plan)
– How long does your customer stay with you? (let’s say 1 year for argument’s sake)
– What is your profit? (let’s say $5 a month)

Take the average for each of these three questions and plug that into the LTV equation and you have your Lifetime Gross Profit contribution of a customer.

From there you can answer the question “How much can you afford to acquire a new customer?”

A traditional rule states 1/3 of the LTV can be spent to acquire a new customer. Using the numbers above, here’s how the equation plays out:

(12 x 1) x ($5) : one third equals $20 to acquire each new customer.

This assumes you have a retention rate within normal ranges—most companies experience 20-25% attrition of customers each year. If it’s more, then there’s a different problem — no brand loyalty.

I’d be curious to know your feedback and experience in similar equation models.

Is it a formula? Luck? Rohit Bhargava’s “Influential Marketing Blog” describes the winner of the International Cannes Film Festival‘s award for a great marketing campaign: a marketing campaign called “The Best Job in the World” for a little-known island off the Great Barrier Reef. It’s a good story, and worth reading.

He whittles the successful components to a great marketing campaign down to the following key items:

1. Make it believable
2. It’s not about how much you spend
3. Focus on content, not traffic
4. Create an inherent reason for people to share
5. Don’t underestimate the power of content creators
6. Give your promotion a shelf life

Read his blog post. It’s worthwhile, and the list is one that I’ll think about when I put together my next campaign.

Everything that Seth Godin writes gives me pause. Make sure he’s a staple of your media diet. Just read “The CPM Gap.” He believes advertisers consider their targets as victims to be interrupted. That doesn’t feel good.

Advertising on the Internet is still too much like ads in a glossy magazine. Not relevant to the context. Something you have to flip beyond to reach the rest of the story. Occasionally attractive to look at, but not the reason you came to the magazine. (Unless, of course, it’s Vogue magazine — which is basically a magazine of ads.)

Tomorrow’s advertising will be entertaining, educational, relevant, honest and content-rich. It will be integrated into a site’s user experience in a way that doesn’t distract the user and doesn’t make them beg for a close box. How much do I hate the ads that float across my screen? A very great deal. I hate them so much that to click on them would be an anathema. And to consider buying the product they promote? Never. Ever. Ever.

Driving back from the Revenue Boot Camp this afternoon, I listened to an interview on NPR.Org with GM’s Vice Chairman, Bill Lutz. He said it was his job to convince 300 million Americans that GM wasn’t all about building gas guzzling cars with lame, tacky interiors. And he’s been in sales and marketing in the auto industry since 1963!

I seriously don’t wish to disrespect Bill Lutz. But let’s get real. Surely you knew that your audience perceived you as a maker of gas guzzling cars with lame, tacky interiors a year or so ago? Well, actually a decade or so ago? Didn’t you even talk to your users outside Grand Rapids or Flint? And you’re NOW going to be the man to fix it?

Bill Lutz also said that they were going to ‘experiment’ with selling cars on eBay. eBay?!?! Errrmmm. Welcome to web 1.0, General Motors.

Someone needs to turn GM upside down and shake all the crumbly old men out of the corners. It’s a new world. The creators of the old world ain’t going to fix GM’s image.

Thank you to Guillaume Cohen of Veodia.com for providing me some more details about YouSendIt’s freemium conversion rates. See this link on Gigaom from 2006 that indicates that YouSendIt has 2.5M registered users, and around 9M visitors per month. It expects $1M in revenue this year, based on advertising and has 12,000 paying users. Mr Cohen provided me this link to Bambi Francisco’s video comment about YouSendIt as a good acquisition target for FedEx. Mr. Cohen estimates that YouSendIt has 9M registered users in 2009, with 100K paid subscribers and around $1M in revenue per month.

I’m looking forward to participating in the Garage Technology Ventures’ “Revenue Bootcamp” on July 10th, discussing, amongst other things, freemium business models, digital goods, and affiliate programs.

What is Freemium?
A business model where a company combines both free and paid services. The free can be:

1. A feature-limited version of the site, with a feature-rich version available for upgrade
2. A “try before you buy” version of a product, with a required time-period to buy the product
3. A customer-type limited version of a product, where certain customers qualify for a free version, and others must pay
4. A seat-limited version of a product, where a certain number get the product for free and over that number, payment is required

Examples in the real world:

1. Feature limited, versus premium: Photobucket, Flickr, LinkedIn, YouSendIt and many, many others.
2. Trial version: Quicken.com, Audible.com, Rhapsody.com, Pandora.com
3. Customer-type limited: BizSpark from Microsoft
4. Seat-limited: SocialText free for up to 50 users

I’m going to focus here on the first type of freemium. That’s the one I’m most familiar with, and the model adopted at Photobucket.

In my experience at Photobucket, having a free offering, and a super-simple, quick registration process, allowed the company to welcome tens of thousands of new users every day, day-after-day. This large registered user powered a terrific network effect. The free offering at Photobucket is subsidized by advertising and print services.

When does freemium work?
A freemium business model can work when the following conditions are true:

• You have a free service that offers enough real value that you build a large, active user base of free users that you can market to
• You have a good balance between free and paid features. (As Josh Kopelman of First Round Capital says “Too many freemium models have too much free and not enough mium.” So watch out for this!
• The price point you choose for paid features match the willingness your target premium user segment are willing to pay (see “What to charge for premium” below).
• You practice good marketing techniques at every decision point to convert free users to paid users — it’s like a friendly “bait and switch.” Hook them for free but work hard to ‘sell up’ to paid.

Some advantages of a freemium model:

• There’s a reduced risk for the buy – it’s free! Users will try it because it’s easy to commit.
• Free has shown to be a great way to get lots of customers in the door! Photobucket has over 80 million registered users for their freemium service – that’s a big base to market to!
• The free service becomes a fantastic test-bed for new features and building a better product – early on, users have a high-tolerance for bugs if they know it’s free. However, conversely, when a free product becomes mature (certainly in the case of Photobucket) high standards are expected by users. At Photobucket, we used a totally different site – www.tinypic.com — as a feature test-bed site. Photobucket had become so mature that our users didn’t want to be experimented upon too much. So we tried things out on Tinypic, and, if they worked there, moved the code to Photobucket.

Evaluating freemium: Revenue
It’s mandatory to clearly calculated advertising revenue to your free base, to your other sources of revenue. Some calculations to make:

• Active user rate, or the percentage of your registered user base active in a month.
• ARPU (Average Revenue Per User). To get your average monthly net revenue per free and paid subscriber, divide your net revenue in that period by the average number of subscribers in that period.
• Churn, or how many users you are losing in a period. To get your churn rate, divide the number of subscription terminations by the total subscribers at the beginning of the period. For example, if you get 10,000 subscribers on January 1st, with 100 terminating in that month, your churn is 1%.
• Your advertising revenue/user, compared to premium. For example: Your site has $1.00 CPM. That’s $0.001 revenue for each user’s visit. Say a user visits an average of 4 times/month (or 48 times/year). That’s $0.048 in revenue/user/year from advertising.

Once you have these numbers, look at your active user rate as a percentage of your overall users Then estimate upgrading 1-2% of your active users to premium as a start, and model the result.

Evaluating Freemium: cost
Do you have a break-even, or close to break-even model for your free users? In other words, is your advertising revenue pretty much offsetting the costs of offering your free service to your users? You have to know this. It’s healthy when you are pretty much keeping your marginal costs close to zero (costs are offset by advertising) because then you can really focus on your premium services as your money-maker.

If your marginal costs are significantly above zero (it costs more to offer the free service than is offset by advertising), then you have to look at your free service as one big marketing funnel to drive people into the premium service. In this scenario, you may look at free service more as a cost of acquisition, and a cheaper cost than other methods. This can also be healthy, but it’s critical that you focus major efforts on pushing people up to premium.

Expected conversion rates
Historically, people have considered getting 1% of your installed base to upgrade has been healthy. But many companies are seeing much higher percentages of upgrade. Longtail.com reports these interesting numbers:

• Club Penguin: 25% monthly uniques pay, $5/mo per paying user
• Habbo: 10% monthly players pay, $10.30/mo per paying user
• Runescape: 16.6% monthly uniques pay, $5/mo per paying user
• Puzzle Pirates: 22% monthly players pay, $7.95/mo per paying user
• Flickr: 5-10% monthly users pay, $29.95/year
• Ning: 3% of its 500,000 social network creators pay for premium
• Xing: 8% of its 748M user base upgrades to premium services (see Xing profile below)
• Shareware: typically less than 0.5% of users pay

Encouraging upgrade to premium

• Don’t make the “free” version too rich
• Survey your most active users, and find out the features they find most valuable on the site
• Get in front of users and talk to them! Any way you can. In person. Via Twitter. On profiles. Ask them what they’d pay for.
• Be up front, and explain why some things are charged for. Most users understand that free can’t include everything. You’ll lose some users who will never, ever pay. But you’ll endear yourselves to those users who are willing to cough up a buck or two if they understand why.
• At every decision point — even at first registration, educate on the fact that there’s an upgraded, premium service and what’s in that service
• Testing, adjust, test again to find out the messaging that is working — do your users want to be identified as a premium user to the world, do they just want the feature, or both? Keep iterating.
• In lists of features and functions, try ‘greying out’ the features that are unavailable to free users — they see the feature, but they can’t ‘get at them’ without upgrading
• Make sure users know when they’ve reached their limits, or are close to reaching limits; at Photobucket, if bandwidth is exceeded, then all images posted on other sites are replaced by a “bandwidth exceeded; upgrade now” message. Harsh, but effective.

What to charge for premium?
Here are some simple ways to start the decision-making process:

• Review your competitors, as well as products in adjacent spaces; compare pricing models
• Consider opportunities for more than one tier of offering; can you do three-level price point? That may be complex enough for a start: free, medium, and high-end. Give yourself the flexibility to move features around as you measure your user behavior and feedback
• If you already have free users, conduct a survey of those users. Pricing surveys can set you back tens of thousands of dollars — hard to swallow for a small startup — or even a large one. Take a look at some of the templates available through Mineful, or SurveyMonkey and try them out.

Bloodhound tracking … sniff out every metric that makes sense
The article here “The metrics we track and report: example for freemium products” by BuzzGain is a good place to look at the kind of metrics you should consider tracking. This should become a monthly published dashboard of its own. (See post in this blog “What’s on your dashboard?”)

Profile: YouSendIt
YouSendIt has been successfully marketing with a Freemium model since 2006, and claims 100,000 paid subscriber. In this interesting case study of their freemium model provided by Andrew Chen, they provide the following advice:

• Adopt the freemium model wholesale and focus on it success. Don’t just consider your model a free service with an ‘optional’ premium offering. Devote your energies to pushing users up the funnel.
• Users may call you a ‘sell out’ if they’re never prepared to pay. Users who are willing to pay will likely encourage similar users — a healthy thing.
• Measure everything you can! See metrics section in this post.
• Work on your pricing model. See what to charge section in this pot.
• Look for lots of 1% conversion lifts. They’re easier to find than 10% conversion lifts!

Profile: Xing
Xing is a European competitor to LinkedIn, and a public company. So we can look at their reported results. In Q1 2009, they reported revenues of 10.8M EUROS, with their number of Premium users counted as 8% of their user base of 7.48M users (600K premium users).
They have the following revenue streams: upgraded premium accounts, Xing job services, and advertising. While their advertising revenues suffered the same decline almost everyone is feeling, other revenues grew for the company. Job seeking is big business in a down economy!

Profile: LinkedIn
As they are not (yet!) publicly traded, it’s harder to get validated figures about LinkedIn, though a number of articles put their revenue at a profitable $100M, with revenue approximately equally divided between their three revenue streams: upgraded premium accounts, hiring services, and advertising.

You can see how they compare features for free on their site. They clearly focus on making sure connecting is unlimited (thus growing the user base), but if you want to really lean on the email and messaging features, you have to pay for it.

Profile: Socialtext
SocialText, now free for up to 50 users. Press release: (June 23 2009). Their new free offering aimed at mainstream user for up to 50 people in an organization to collaborate using Socialtext’s social software platform.

Reading “Favor Enhancement: Real gratitude can be profitable. How, then, to create it?” in the New York Times magazine. In this article, the author Rob Walker highlights a new program by Hyatt Hotels whereby staff members ‘randomly’ perform acts of generosity towards their customers. Hyatt may pick up your bar tab. Or your massage bill. Or maybe your super-expensive, but much needed late night Snickers bar.

The idea behind this marketing campaign is that customers who feel you have been unusually generous will become loyal, repeat customers.

I have had this experience personally. A un-asked for act of generosity by British Airways made me a lifelong customer. I was in a terrible car wreck on my honeymoon in Italy (not a brilliant start to married life). After a wobbly few days in Venice, I called BA sobbing “I want to go home now!” They not only changed our flights for no fee, they also upgraded us to first class, and the airline staff were unusually gracious. I was hooked as a customer, and have been ever since.

Robert Palmatier, an associate professor of marketing at the University of Washington and author of a coming paper in the Journal of Marketing tells us that making a customer feel truly grateful directly correlates to opening their wallets. For me, I’ve spent thousands and thousands of dollars on flights with BA in the 16 years since my honeymoon, flying my family of five back and forth between San Francisco and London.

In what ways can you make your customers feel grateful?

• Do you know their birthday? Send them a virtual gift, a coupon or even a card.
• Do you see a customer with a problem on their blog, or on Twitter? Answer. Respond. Fix it. Give them their money back. Without being asked.
• Do you ship goods to your customers? Include a little freebie or two. I buy product from a Yon-Ka retailer who always includes goodie samples; I go back time and again to the same retailer so I can get those teeny-tiny free goodies that are perfect for two-day business trips.

Could Hyatt’s program backfire? What if someone hears about the program, and their bar tab isn’t picked up? Will they feel that’s unfair? I think not. I would like to think doing the right thing, being generous, and taking care of your customer on a personal level will generate goodwill and good word-of-mouth of the best kind.

Update on July 24, 2009: OMG, I’m loving this story about Triscuits: “How to create a culture of buzz” by John Jantsch. What’s your equivalent of sending Triscuits to Fiji? That’s what I’m talking about! In the “old days” such acts of generosity wouldn’t have gone far beyond Suva. But today, your generosity could be talked about anywhere in the world.

Oh heavens, how I love this. A perfect example how one crazy out-there dude becomes a movement. The video is the perfect embodiment of how trends take off! See this post from Seth Godin.

Postscript April 2010: Check out this video at TED about how this same video is used as an example of how one guy starts a movement.