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2 minute read / Mar 25, 2013 /

Why Freemium Negates The Leaky Bucket Myth

If at any time in the past ten years, you might have asked someone at Intuit about the size of the QuickBooks user base, they would have told you the same number: about 4M.

This figure hasn’t grown because Intuit’s customer base, the small-and-medium business market, is a leaky bucket. On the small end of the spectrum, about 750,000 businesses are created each year and about the same number fail. On the upper end of the spectrum, successful medium sized businesses (and the larger, more valuable Quickbooks customers) outgrow Intuit’s products and upgrade to enterprise accounting packages provided by Oracle and others of their ilk. It’s no surprise then that QuickBooks suffers from high churn rates, characteristic of the SMB market.

This leaky bucket market dynamic can be quite unattractive if customers must be acquired through paid customer acquisition. SMBs are notoriously expensive to acquire. Combined with high churn rates, we have a recipe for burning through mounds of cash.

Despite those concerns, it’s difficult to argue with Intuit’s success. It’s nearly a $20B market cap company generating $4.2B annually in revenue of which 17% or $700M+ is derived from this leaky bucket SMB segment.

So how did Intuit build a business of such scale atop a customer segment that looks like quicksand? They don’t pay to acquire customers. Intuit used word of mouth, brand strength and an existing product (Quicken) to bootstrap QuickBooks to success.

Today, it’s easier than ever for startups to target the SMB market successfully. Freemium businesses of scale are feasible because mobile application distribution, web distribution (SEO, social media) and app stores like Intuit or Salesforce or Google amass millions of SMB owners who can be reached at zero marginal cost.

But very few startups and investors pursue the market even today despite these fundamental changes in the market. Part of the challenge is maintaining the discipline to minimize customer acquisition spend, instead focusing on brand building, word of mouth marketing, product excellence and so on. In other words, patience.

In the next five years, I think we will see a segment of SMB SaaS companies achieving very large exits. And though their customers bases will suffer the same leaky bucket economics as Intuit, the customer acquisition strategies afforded to and created by these startups will trump those challenges.

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