With freemium, MailChimp thrives where many others fail

For many internet startups, a freemium business model is an enticing solution to the problem of revenue generation: let the world taste what you provide at no cost, and once your most avid users are hooked, let them pay for what they've come to love.

It's simple in theory, but for many startups, building a viable business on the freemium model never becomes a reality.

There are plenty of reasons for this. In some markets, it's hard to charge. Period. And oftentimes, paying customers will never pay for the freeloaders. As a result, it's never possible to turn a profit.

But startups might learn a thing or two about building a successful freemium model from email marketing services provider MailChip. In September 2009, the company, which for nearly nine years had profitably charged its customers for its services, decided to do what some thought was foolish: go freemium.

MailChimp co-founder Ben Chestnut joked when he made the announcement:

I just read about this “freemium” approach to web startups. Basically, you build a cool app, make it free, build up a bunch of users, then find a way to “monetize” later. D’oh! Why didn’t anyone tell us about this when we started in 2001? We wasted all this time building a strong, profitable company with an awesome product and over 100,000 users, when we coulda been just giving it all away?  We’ve got to make up for lost time, people!

But MailChimp's results are no joke: the company now has 450,000 users -- five times as many as it did when it went freemium. What's more: the company also increased its customer base by 150% and its profits by 650% over the course of a year. Approximately 4,000 of the 30,000 new users MailChimp signs up every month are joining the ranks of the company's paying customers.

Interestingly, despite the fact that one might assume a freemium model would grow MailChimp's base of small users, but between April and August of this year, the percentage of lists the company hosts which have more than 10,000 subscribers jumped from 12% to 20%. As Chestnut notes, "The fact that we’re attracting larger users, with larger lists, and with more advanced needs, would seem counter-intuitive to most people."

So what's the secret to MailChimp's success? It focused on paying customers before it focused on free users. Chestnut explains:

For eight years, our company never thought about freemium. We didn’t even know the concept existed. For eight loooong years, we were focused on nothing but growing profits.

I think there are too many startups out there who are interested in going freemium because that big “10″ number is so attractive. This is dangerous when they don’t even have the “1″ yet. How will they pay their bills while they figure out how to “monetize?” Answer: they will need to borrow that money.

The numbers 10 and one refer to the general theory that for every 10 free users, a freemium business can expect to acquire one paying customer. Chestnut, of course, is correct that many businesses focus on growing the former before the latter. After all, get free users and the paying customers will follow. Right? If only it were that simple.

By the time MailChimp went freemium, it knew how to sell. It had established the commercial viability of its product (because it had plenty of real customers), and consequently it therefore understood its value proposition to those customers. You can't close a sale without that, but plenty of startups that look to freemium for fortune really can't claim that they know how to close a sale because many of them haven't closed a sale.

From this perspective, MailChimp offers a valuable lesson: 'free' may come before 'premium' in 'freemium', but you might have better luck if you work your business the other way around.