United Online (Nasdaq: UNTD) is scrapping its IPO plans for Classmates Media, which includes social networking pioneer Classmates.com and the popular MyPoints consumer loyalty site. What particularly called my attention to this was the analysis of it over at Fool.com by Rick Aristotle Munarriz, which echoes some of the things I had to say about Classmates in our upcoming book, The Emergence of The Relationship Economy. Here’s what Rick had to say:

It didn’t hurt that Classmates.com is considered a social-networking pioneer, at a time when News Corp. (NYSE: NWS) is laughing its way to the bank on its MySpace purchase, and Microsoft (Nasdaq: MSFT) is bankrolling a suspicious investment that values Facebook at a whopping $15 billion.

Investors weren’t born yesterday. They didn’t need an Ivy League college degree to know that pioneer badges can be worthless. So what if Classmates predates MySpace, Facebook, Bebo, or Google’s (Nasdaq: GOOG) Orkut? If rings around the bark are all that mattered, Friendster and Tribe.net would be Wall Street rock stars.
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Classmates blew it long before the IPO got shelved this morning. The site was in the right place at the right time, but it was positioned the wrong way. Instead of embracing the open-ended ways of the real stars of social networking, Classmates spent too much time as a walled community with little to offer those who weren’t willing to pay for access. The site had amassed user registrations 50 million deep over the years, but just a sliver of those were paying customers and active participants.

Here’s what I wrote in The Emergence of The Relationship Economy regarding Classmates and freemium business models:

Many users have criticized Classmates’ highly restrictive free functionality, which allows members to establish profiles, search for other members, and read public message boards; posting messages or contacting other members requires a premium membership. Other sites with similar models, such as Ecademy, have garnered similar criticism. While there is nothing inherently wrong with this business model, it does generate more customer ill will than those with less restrictive free membership functionality.

We recommend that unless compelling ROI can be demonstrated in other ways, companies offer a free level of basic membership that has sufficient functionality to keep people engaged on an ongoing basis. This not only creates customer goodwill but also generally offers increased value to premium members by having a larger pool of engaged users available for search and interaction.

Here’s the ironic part… Classmates knew this was a problem — they just didn’t know what to do about it. Take a look at this excerpt from their S-1 filing:

Although we have recently experienced an increase in the number of paying subscribers, this trend may not continue. Most of our paying subscribers elect to purchase our services as a result of a limited number of features. For example, we believe that our recently introduced Classmates digital guestbook feature is responsible for a significant portion of the increase in our new pay accounts since the end of 2006. If our social networking pay features are not as compelling and we do not stay current with evolving consumer trends, our free members may not subscribe for our pay features. Any decrease in our conversion rate of free members into paying subscribers could adversely affect our business and financial results.

This is a perfect example of why understanding the marketplace and what users will and won’t accept is so critical. Not getting this right has cost Classmates millions.