Disclaimer: I have been running this website on Digital Ocean for several years now. Opinions expressed in this post are solely my own™.
I’ve been seeing a lot of Digital Ocean’s “free 60 day trial with $100” promo for several weeks now 1, 2. This was a significantly larger credit compared to most other providers (aside from the big three) so I was curious why they chose this marketing strategy and what kinds of customers that they would attract. Let’s take a closer look.
First of all let’s see what alternative VPS solutions are available and how do companies get the word out to customers:
- Digital Ocean (DO) is giving $100 for 60 days by using promoted tweets on Twitter.
- Amazon, Microsoft, and Google all offer varying amounts (some up to a full year) of free credits accessible directly from their website.
- Linode is a long-time sponsor on many podcasts and offers $20 in free credits, which equates to 4 months on their lowest-tier plan. 3
So the question is: from a business point of view, which marketing strategy is the best? I would like to name a couple of these customer segments specifically in the context of this article so we can better understand how each is targeted. Hobbyists are people who have an idea, are familiar with programming/technology, and are looking to start building their product as a side project. Upstarts are startups who have an MVP and are looking to grow their product (which usually requires scaling their servers). Enterprises are established businesses with large computing needs wanting to take advantage of a cloud-hosted environment and want the piece of mind provided by a well-known provider.
[Hobbyists] Linode’s $20 free credit
One way to look at the $20 free credit is that it attracts hobbyists who are just hacking on a side project. By offering this specifically to podcast listeners, Linode can more easily target those who just that final push of starting a project. When they finally do decide to take the leap, the hope for Linode is that customers remember Linode and use their coupon code instead of some other service.
Since hobbyists will most likely be working in their spare time, it may take several months to build an MVP). This matches perfectly with the 4 months of free hosting. But is it possible for Linode to profit from this promotion?
That’s where economies of scale kicks in: Hobby projects usually have low performance requirements and often sit idle most of the time. Since these VPS run in containers, it is possible to run many many containers on a single physical machine. This means the cost during the free trial is fairly low and the operating margins are relatively high once customers start paying. Thus the main determinant for success in this promotional strategy is the conversion rate from free trial to paying customer. (This is not to say that Linode only has small customers.)
[Upstarts] Digital Ocean’s $100 for 60 days
The other way is to give a larger promotional credit, but explicitly limit it to two months. This incentive targets people who are looking for higher compute requirements (eg. a $50 monthly plan) to try out their platform. These customers might have already built out their prototype or are looking to switch providers. If this is the case then eventually customers will be paying around $50 per month, 10x of what Linode would receive. However keep in mind that these customers will most likely be fully (or close to) utilizing the VPS instance, reducing the number of instances run per physical machine, and leading to a lower operating margin compared to Linode.
Now, another outcome is that the customer scales back to a lower tier after their trial ends because they don’t need so much power. In this case it is most likely that the server was not fully utilized to begin with so the cost to Digital Ocean during the trial was also lower. Although these customers are on a lower tier, DO is still able to convert a customer, as well as consolidate their VPS in a manner similar to Linode. Overall, this strategy is mostly about the trade off of obtaining higher volumes albeit at a lower margin.
[Enterprises] How can companies offer 1 year free credit?
Amazon offers 12 months of free compute along with other goodies, while Google offers a $300 credit for 12 months in addition to always-free App Engine platform, and Microsoft Azure also runs a similar promotion. These comapnies enjoy top-of-mind consumer awareness which gives them a marketing advantage.
But you might be wondering is this even sustainable? Let’s pick on Amazon since they segment out their AWS financials. In 2017 Amazon AWS had net sales of $17.5 Billion, with an operating margin of 24.8%. Keep in mind however that free credits are treated as expenses for accounting purposes, so it wouldn’t be part of the operating margin.
Amazon provides 12 months of 750 hours of t2.micro compute which has 1 “vCPU” and 1 Gb RAM. Notice this is bits, not bytes. The free tier that Amazon offers provide one-eighth the RAM at a price 55% more expensive than what DO and Linode offers. This additional restriction in RAM further helps in allowing it to consolidate VPS instances to a single machine.
Thus Amazon is able to take the economies of scale to the extreme 4, which can significantly reduce the cost of their promotion. If customers do decide to start paying, the retail prices it charges are higher than that of independent providers. Nonetheless, I would assume that the vast majority of AWS revenue comes from enterprises who deal with significantly higher volumes or require one of the extensive line of services offered. The one year free trial is just a low-cost marketing spend to attract some new customers, but mainly to put pressure on competition to offer promotions (which drive down competitors’ margins more than the effect on Amazon).
There is a fair amount of competition in online hosting but all signs point to continued growth in the overall industry. Thus it is vital that companies be able to attract these new customers by offering free promotions. Thanks to the economies of scale allowed by the consolidation of multiple VPS instances to a single server, the cost of promotion can be reduced. Linode is targeting the Hobbyists segment where the large idle times provide a relatively higher margin. DO’s promotion targets a more established company looking to scale, allowing for higher revenues compared to hobbyists, but at a slightly lower margin. Amazon has significantly better scale and is able to acquire both enterprise customers who contribute higher volumes of revenue, as well as higher margins from idle machines.
Now if only I can stop seeing these Twitter ads because they probably have gotten about all they can out of me, but the nature of online advertising is essentially spray and pray. I just hope I won’t regret seeing whatever ad that becomes the successor.
1 ↩ Looks like their ad works because now I’m writing about it :P
4 ↩ I mean, I heard Amazon sells a lot of e-books so they must need a good CDN