The 3-tiered revenue model for hosted web services
For years, pundits have been saying that software as a service will replace licensed software. But it’s a tough business. For a hosted web service (especially one tuned for business problems), think about having three tiers in your revenue model.
- Free, ad-supported version
This is what 99% of your users will choose, and where maybe 5% of your revenue will come from. Sounds like a bum deal! But we know the threshold where a customer will part with their money for software is high (just look in the mirror). You need to have them use your stuff, understand you, believe in your value, trust you, and rely on you before it’s worth their while to pay you. On the bright side, the cost of providing this free service largely serves as your marketing budget. This is your cold-call salesforce. These are your demo/sample units. And nothing grows mindshare as quickly as the right service, offered at an irresistible price.
- Premium ad-free subscription
Maybe one in every few hundred users will find your service useful enough, important enough, that they want to get serious and lay down their dollars to get more. Get rid of the nonsense (advertising). Know that you have their back today, and tomorrow (service level agreements). And provide some extra features to give them their money’s worth. This might be where 25% of your revenue comes from.
As a customer, it’s wonderful to have someone else hosting your software — not having to worry about installing, maintaining, etc. And you don’t have those big, up front licensing fees. But it’s like giving your car keys to a stranger. It’s a no-no having corporate data floating around on someone else’s servers, on the Internet, and out of your control. You have a firewall, and you want your corporate data to stay within it. So the hosted web service is a great way to play with the software and see what it can do for you. But at that point, you want to be able to say “sell me your backend software, so I can deploy it on my corporate network”. Or, perhaps better, make it an appliance or a VM. And this is where 70% of your revenue as a “hosted services software company” will come from. Back to the future.
Companies that use this 3-tier approach are everywhere. How does VA Linux (LNUX) make money on sourceforge? Why does Google sell an appliance search box? But there are still plenty of companies that stop at tier 1 or 2, and they may be leaving most of their opportunity on the table.