Traditional software was initially sold by perpetual license. Then in the mid-00s with the advent of SaaS, the market shifted to per seat per year pricing. And simultaneously, freemium marketing strategies blossomed. Freemium companies provide software for free temporarily to entice users to try and use the product. Eventually, these users cross a threshold and convert to a paid subscriber. This threshold can be based on number of people using the product (Expensify), number of documents signed in a month (HelloSign), or additional product features needed by users (Yammer).

Today, we’re seeing a new segment of the SaaS ecosystem move to free - the SaaS Enabled Marketplace (SEM). SaaS Enabled Marketplaces, like Contently, charge for both software (content management tools) and access to a market place (of content producers). Chris Dixon has a catch phrase for this type of business: come for the tool, stay for the network.

The free SaaS enabled market places (FSEM), of which Zenefits is the most prominent, also build software and provide access to a market place. However, unlike traditional SEMs companies, FSEMs never charge for their software, preferring to generate revenue from transactional or lead generation fees from their market place. Zenefits provides free benefits software to businesses and generates revenue from commissions when employers or employees buy insurance plans through the platform.

This go-to-market strategy benefits FSEMs in three important ways. First, good free software spreads quickly, enabling rapid customer acquisition. In competitive markets or when pursuing customers that have been expensive to acquire, free software creates a clear, and often defensible, competitive distribution advantage. Incumbents often can’t compete with free without cannibalizing their current business.

Second, this free software builds an important data asset. FSEMs software captures information about the user and often, other key data like company size, activity and growth rates, which can be used to inform a market place. After all, on the other side of the market place, suppliers want to pursue particular types of customers. The data from the free app can also be used to prioritize the leads for the FSEM’s inside sales teams, among other things.

Third, the software usage can be used to bootstrap a market place and develop liquidity. Once a market place has developed liquidity, it’s very difficult to unseat. Most market places have winner take all dynamics, meaning the business’ position is all but unassailable.

But, FSEMs implicitly trade great distribution and data assets for an arguably less attractive revenue model which has smaller gross margins and often less predictability. Unlike traditional SaaS companies which charge subscription fees for software and operate between 70-80% gross margins, FSEMs’ primary revenue streams often are lead generation fees for providing business to the other side of a market place. These fees can range widely but often generate around 30% gross margins. Additionally, transactional revenue isn’t as predictable as subscription, which for SaaS companies with 12 month annual subscriptions is contractually guaranteed.

FSEMs can be incredibly disruptive businesses. They can grow exceptionally quickly, erect substantial defensive moats and jumpstart marketplaces. While we won’t see FSEMs in every category of SaaS, because only a small subsegment of software categories can benefit from a market place, where they do take hold, FSEMs will be powerful forces to be reckoned with.