Why free product wins!
This post is part of a series in which I extract patterns from a data set of thirty-nine SaaS companies that filed for IPO from 2018 to 2020. The previous discussions in this series are:
- Pricing & Packaging and the developer buyer — 4 insights from SaaS IPOs
- Benchmarks for Key SaaS metrics from SaaS IPOs of 2018–2020
Last time, in the pricing & packaging discussion, I discussed the least friction package (“LFP”).
What is the least friction package? Companies offer three archetypes of packages: free, trial, and sales demo. Naturally, a customer experiences the least friction in evaluating the product for free, then trial, and lastly sales demo. When a company offers multiple packages, each of a specific archetype, the LFP is the archetype that minimizes friction. For example, Slack offers free and sales demo. Slack’s LFP is free.
There is a 25%-50%-25% division between free-trial-salesdemo. In other words, a quarter of companies offer free as LFP, while a quarter only offers sales demo.
In this post, I will answer a reader’s question: how does the choice of LFP affect a company’s growth rate?
Here is the summary:
- Insight #1: The average total revenue YoY growth rate at IPO for companies with free LFP is 65% vs. 35% for companies with demo LFP. This 30 points difference is statistically significant
- Insight #2: Free LFP gives a higher revenue growth rate despite higher revenue at IPO. Free LFP companies’ ARR at IPO is, on average, $44m higher than sales demo LFP companies.
- Conclusion: there is a correlation between free and high revenue growth rate, not causation. I offer a few possible explanations for this correlation.
- A word of caution: it is hard to add free if you didn’t start with one.
Insight #1: Total revenue growth rate at IPO
65% revenue growth rate for free LFP companies is insane! Having this growth rate at IPO time is impressive. For context, this is a full 30 points higher than the 35% growth rate for companies with sales demo LFP; an impressive growth rate itself.
Can this difference be explained by chance? No. I ran a t-test that gave a p-value of 3%, which gives me confidence that this difference is statistically significant (cannot be explained by chance).
The differences between trial and sales demo or free and trial are noteworthy, but they are not statistically significant. In other words, the difference could be explained by chance.
The conclusion is this: Offering a free package is correlated with better revenue growth rates at IPO than only offering a sales demo. Offering a trial is still better than a sales demo.
Insight #2: Free LFP gives a higher revenue growth rate despite a lower base revenue at IPO
Common sense dictates that it is easier to have a higher growth rate at a lower revenue. It is easier to grow 65% YoY at $10m ARR than with $100m ARR. Could free LFP companies have a higher growth rate than demo LFP companies because they IPO at a lower revenue? No. Free LFP companies IPO nearly $45m higher in ARR than companies with sales demo LFP:
Revenue growth rate depends on three factors: 1) base revenue, 2) new revenue 3) expansion revenue. This chart shows that base revenue does not explain why free LFP companies have higher revenue. Thus, free packaging impacts growth rate through higher new business and/or upsell.
I do not claim that a free package “causes” a higher revenue growth rate. I only point out a correlation. Additionally, free does not work for every company or market.
I offer some explanations & takeaways for this correlation:
- What is the value of one person trained on a product, even if they are not paying for it? Logically, it is high! Such a person may refer a friend, praise you on Twitter, or take the product with her as she switches jobs. With a large number of free users, your product becomes the market standard. Takeaway: free gives a sustained advantage by creating a large pool of trained users which results in a higher revenue growth rate.
- A free product forces the product team to build best-in-class onboarding. If the product is simple to use it positively impacts close rates, and hence, revenue growth.
- Developers are the perfect audience for free. The average developer distrusts sales; every developer company in this data set offers free or trial. Selling to developers is also a great business independent of free; the average revenue growth rate of this cohort is 60%! Thus, sales demo LFP may exhibit a lower revenue growth rate because there are no developer-oriented companies in that cohort. I do not love this explanation because it downplays the value of other buyer types. Takeaway: if you are selling to a developer audience (including VPE), only offering sales demos is a non-starter.
- A free package may protect a company from attacks from below market. Especially if you are #1, #2, or #3 in the market, you can shut out the #4 and #5 players by offering a compelling free package. This protects your TAM and helps you grow faster. Zoom is a great example of a company that stormed its market with a compelling free package and displaced #1-#4 players.
- Lastly, it is not necessary that free lifts growth rate as a revenue stream. It could simply be a great lead generation option. A great example of this is how downloads of Apache Kafka serve as leads for Confluent.
A note of caution: it is hard to add a free package later on
So, should you add a free package to your product? If you don’t have one already and you’re sub-$100m in ARR, no. Here’s my personal story behind this answer.
I started Split in 2015. Four years later, motivated by the buying behavior of developers, I added a free package.
By the time I left Split, free weekly active users and accounts outstripped paid. We had a large base of users trained on our product. This was huge. Free to paid conversions contributed to our quarterly revenues and served as a lead gen source.
However, I wouldn’t call this free package a runaway success.
In hindsight, the reasons for this are simple. I built our GTM team to focus on the enterprise. Getting to scale on one motion is hard enough, doing it on two different motions is next to impossible. I considered free an important long-term bet, but the reality of meeting quarterly revenue targets meant that it was not one of my top 3 strategic priorities. I did not give free the resources or the attention for it to have an outsized impact.
I learned that for free to be successful, it has to be part of your DNA from day 1. By DNA, I mean the people you hire. Otherwise, the gravitational pull of feeding the GTM engine and building the most enterprise-friendly product is too much to resist.
I suspect this is normal for most CEOs of early-stage companies with limited resources.
However, this “no” is not forever. As a company scales (my guess: $100m ARR), it has the resources to hire a team to solely focus on free. PagerDuty, JFrog, and Atlassian followed this path.
If you started with free, then keep at it. You will see its impact in your growth rate.