How Much Is A Free Customer Worth?

A while ago I wrote about a great HBR article titled, “Strategies for a Two-Sided Market” by Tom Eisenmann et al.  The article does a great job describing the dynamics of building out a two-sided market like (job seekers and hiring managers), Google (“searchers” and advertisers), etc.  Apparently 60% of the largest companies in the world have business models with two-sided markets.  Eisenmann writes about how typically one side of the market place is subsidized by another and figure out who is which is key.

Well, I just came across another interesting HBR article that takes things to the next level.  The article from this November’s HBR titled “What is a Free Customer Worth?” by Sunil Gupta et al proposes a framework for how to think about the value of a “subsidized customer” which is useful in figuring out how much you should be willing to pay to acquire them.

For example, if you’re running a professional network like Sermo (largest community for medical doctors) you acquire doctors who join for free and then you sell data and services to Wall Street, pharma, etc.  Of course, the key question is how much should you pay to acquire a doctor?

There are some interesting conclusions, but one that jumped out at me was that the value of “free customers” often decreases as time goes by, sometimes dramatically (the chart at right is pulled from Gupta’s article).  This can be a challenge as often the cost of acquiring these customers can actually go up over time (as marketing campaigns pick up the low hanging fruit).

Gupta does layout specific formulas for calculating the value of free customers taking into account direct and indirect network effects (both positive and negative).  Unfortunately, the working paper in which he lays out these formulae reads more like a physics dissertation than a practical how-to guide.

I’ve got the paper on my to-read list, so eventually I’ll post more on this if I glean anything interesting…of course if you beat me to it, please do share!