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Freemium Business Model: A Guide for Subscription-Based Companies
What is Freemium?
Freemium is a business model that allows companies to offer their products and services for free, with the expectation that a certain percentage of users will upgrade to paid subscriptions. Think Hinge, Fortnite, or even Trello – all these work on the freemium business model because you’re drawn into the world, and if you choose to dive deeper, that’s where the costs come into play. Ask any parent whose kid has Minecraft, and they’ll explain the nuances of freemium in fine detail.
By offering a freemium version of your service, you also can reduce your customer acquisition costs and build brand awareness for relatively cheap. The free trial is hidden in plain sight, and it’s why so many brands are now adopting this model; people feel they’re in control of how little or how much they want to engage.
Because it’s so malleable to the subscriber’s interests, freemium has a high adoption rate, so there’s no surprise that it’s become quite a popular business model for subscription-based businesses. According to a recent survey of 400 mobile app developers, 54% reported using the freemium model and 33% said that this method generated the most revenue for their business.
There’s plenty of nuance within freemium pricing based on its sheer impact due to its conversion rate. Of course, you’re right to wonder: Will the freemium business model generate similar or better results for your subscription-based business? Maybe. But it’s not guaranteed.
This guide will help you decide if it’s the right move for your business by discussing:
- The pros and cons of the freemium business model
- 6 strategies to convert free users into paid subscribers
- 3 examples of SaaS businesses that use the freemium model
- How to decide between freemium vs. free trial
So let’s get started.
Pros and Cons of the Freemium Business Model
The freemium business model can be a great way to grow your business at a much faster pace. This is one of those customer acquisition models that can make a serious impact – if done correctly. But it may not be the right method for your current business goals. The freemium business model lives within the details and if you can keep luring people to upgrade their services. So, let’s look at the major pros and cons before you decide.
Pros of the Freemium Business Model
- Acquire many users quickly and less costly.
Since there’s no barrier to entry (i.e., users don’t have to pay anything upfront), you can get your products and services into the hands of as many people as possible. This is beneficial for companies that have a network effect, as the more users they have, the more valuable their product becomes. This is also beneficial for startups because it can get a lot of users interested fast because people love a free trial, especially when it doesn’t feel like one. - Build brand awareness.
If people are using and enjoying your product for free, they’re likely to tell their friends and family about it. This increased brand awareness can help you acquire even more users at no cost. Again, just look at how Fortnite took off, the parent company, Epic Games is now worth thirty-two billion dollars – with a B. And they did it all with a freemium pricing model. - Generate high-quality leads.
You don’t have to wonder if the people who sign up for your freemium version are interested in your business – you know they are. Freemium users are to convert to paid subscribers than other leads. This, of course, is only true if you take a strategic approach to conversion.
Cons of the Freemium Business Model
- Some freemium users won’t upgrade. If your free version is too good or not good enough, some people may never feel the need to upgrade to the paid version. You also can’t always predict when a lead might upgrade since there’s no time limit on your freemium offer. Sometimes, we download apps, and they never land with us and next thing you know, that app is deleted from the phone.
- A free version may cannibalize your paid business. Some people who would’ve been willing to pay for your product may instead opt to only use the free version. This issue becomes particularly true if your free version is too good.
- Free versions are not free to maintain. If you hope to convert non-paying users, you still have to offer them high-quality support and cover all the operational costs. With too many freemium users and not enough paid subscribers, this can quickly become a financial nightmare. There needs to be a series of checks and balances when it comes to the freemium pricing structure where it’s attractive to jump on board, but also needs to have a distinct line of where the freemium ends and the paid begins.
- Risk devaluing your brand.
Some people may think that because you offer a free version, your product or service is not worth paying for. You’ll have to put more effort into proving that the real value of your product comes from subscribing to the paid version.
How to Convert Freemium Users to Paid Subscribers?
Despite the potential risks, the freemium model can be a great way to grow your business. But you should know upfront that the conversion rate typically falls somewhere between 2-5% on average. Not every business can be Trello or Fortnite, so keep those numbers in mind. Not every writer will release a best seller, but if the framework is there, there’s a potential for greater successes with the freemium model. If you’re considering this model for your company, it’s a great way to earn customer acquisition. Here are a few strategies to increase your chances of converting free users to paid subscribers.
If you’re considering this model for your company, here are a few strategies to increase your chances of converting free users to paid subscribers.
Ensure your paid version is worth paying for.
The following strategies are worth exploring if you have covered this first. Does your product or service solve a real problem in the market? Does your messaging communicate how your business solves that problem? If your answers to these questions are not a resounding “Yes!”, spend more time working on those things before offering a freemium plan.
Make sure the free version is valuable, but not too valuable.
You want people to benefit from using the free version of your service, but you also want them to see the value in upgrading to the paid version. Your freemium should be functional and practical but have limited features. Make sure you’re also regularly communicating to free users how their experience with your service would be better by upgrading.
Let users experience one or more premium features.
Your free users may only really understand what they’re missing out on once they can try some of your premium features. Consider offering them the option to use one or more of your most valuable premium features for a limited time. There needs to be a clear line where customers can see what they’re missing out on against the basic version.
Provide excellent customer support.
Free users are like paid customers. And every interaction with your customer support team will influence how likely they are to continue using your product and whether they decide to upgrade to a paid version. Every customer touch point counts. Remember that.
Use data to strategically nurture your free users.
Which features do your free users value the most? Is their way of using your service different from your paid subscribers? Collect data to find out. Then, use that data to create a relevant lead nurturing campaign highlighting how your paid version increases the value of those features. There’s a lot to learn from the data, especially where people are converting or if there’s churn. Pay attention to what’s working, but more importantly, if something isn’t.
Make it easy to upgrade to a paid version.
Your freemium users shouldn’t have to start at square one when upgrading. No one likes jumping through hoops. For one, ensure their information gets pre-filled into their sign-up form when upgrading. It would be best if you also offered attractive pricing plans to users who may need more time to fully commit to the most premium version of your service. Everything should be handled with a click. The Software as a Service (Saas) model works for many companies, which is why their adoption is so high.
3 Examples of SaaS Companies Using the Freemium Model
Here are 3 examples of subscription-based SaaS companies that have successfully used the freemium model to gain paid subscribers.
Spotify
Spotify is an audio streaming service that everyone’s heard of. It’s also one of the best examples of a business that offers a valuable freemium version while making the premium version appealing.
Free users of Spotify’s streaming platform have access to all the same audio content as paid subscribers. But, unlike paid subscribers, free users will frequently have their experience with the app interrupted by ads, which generate revenue for Spotify. Free users also can only skip a limited number of songs per hour, which becomes a frequent reminder of the limits of a free account. If you’re trying to listen to Prince’s Greatest Hits, you don’t want to be disturbed in the middle of “Little Red Corvette” with an ad for car insurance.
These limitations are minor inconveniences to the user, but over time they work to convince the free subscriber that upgrading to a premium plan is worth the money. As a result, Spotify has one of the best freemium conversion rates at 46.6% and just about everyone uses it as their go-to for music streaming.
Zoom
With many people working remotely, Zoom has become another popular example of the freemium business model. Anyone can create a Zoom account and use its virtual meeting platform for free. But, of course, there’s a catch.
If an organization needs to conduct virtual meetings longer than 40 minutes and with 100 participants, they’ll need to upgrade to one of Zoom’s paid plans. And since these meetings have become the norm, some businesses see the value in signing up for a paid subscription and converting.
Learn how Zoom scaled users 30X in less than 6 months with Zuora.
Evernote
Evernote is an app that offers free users a virtual storage space to store notes, images, audio files, web page clippings, PDFs, and more. It’s another example of a freemium offer that is valuable but not so valuable that users won’t see the value in subscribing to a paid plan.
For free users, there are limitations to what they can store, how many devices they can sync to, and their options for customer support. But, once users sign up for a premium version of Evernote, they no longer worry about these limitations and enjoy a range of additional features.
Freemium vs. Free Trial
If you’re still not sure about the freemium business model, consider offering a free trial of your service instead.
With a free trial, users can use your product for free (with limited or full features) but only for a limited time. And with that time limit, you can create a sense of urgency that converts users more quickly than freemium users. But, on the other hand, that limited-time offer might also not give users enough time to understand the full value of your product.
So, which one is better? A freemium offer or a free trial?
The answer: it depends on your business, your product, and your goals. If you need help determining which is right for you, try experimenting with both approaches to see what works best for your business.
Try offering a freemium version for a month and then switch to a free trial next month. Or you might present both simultaneously and see which one converts more users to paid subscribers.
There’s no right or wrong answer here if you experiment and choose the one that converts the most.
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Freemium Business Model: A Guide for Subscription-Based Companies
Would freemium be an effective lead generation, conversion, and revenue driving strategy for your recurring revenue-based business? Or, would it be a high risk, dead-end approach likely to burden you with runaway costs and few paying customers? This guide is intended to teach subscription-based businesses how to evaluate whether the freemium model would be a viable strategy to drive revenue and lead generation.
The term “freemium” (“free” plus “premium”) was coined by Fred Wilson, a Silicon Valley venture capitalist, in a blog postabout his “favorite business model.” Here’s his basic outline for it: “Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced value added services or an enhanced version of your service to your customer base.”
In the context of subscription-based businesses, freemium is a business model where a company offers a version of its subscription service to all customers for free. This free version is usually a more basic version of its bells-and-whistles paid service. The idea is that once customers fall in love with the free version, they’ll purchase a subscription for the more robust version and spread the word about it to others.
“The easiest way to get one million people paying is to get one billion people using.”
Phil Libin, EvernoteChris Anderson, former editor of Wired Magazine, was among the first to promote the idea in depth in his book, Free: The Future of a Radical Price,published in 2009. In it, he explores the genesis and growth of the free and freemium model. The strategy has continued to expand since, prompting him to write another, even more high profile book, The Long Tail.
For a service that’s new to the market, offering a freemium version can be a quick way to drive trial because of the low barrier to entry. It also makes a product more shareable to build word of mouth.
In fact, if the right business conditions are met, a freemium model can help drive faster recurring revenue and profit growth than a paid-only model. It’s no wonder, then, that freemium has become a popular model for Web 2.0 companies to market their products. According to a report by Distimo, freemium now accounts for 71% of Apple AppStore revenues in the U.S., up from somewhere around 50% in 2012. And in the customer management category of SaaS companies, 32% used a freemium model.
THE IMPORTANCE OF EDUCATING YOUR CUSTOMERS
Freemium services seem like a great deal on the surface. However, many of them compromise on features, performance, and customer service in order to justify making them free and differentiate them from their premium paid services.
In many cases, it’s difficult to compete with a free product or a product that has a “the first one’s on me” model. Paying customers on freemium sites are often not aware that they’re receiving the same infrastructure as the millions of free customers, which means that, essentially, they’re subsidizing them. Even those who are aware still don’t know what to look for or what to expect.
As more people understand what they need and why they need it (i.e. SEO optimization), they are more willing to pay for it.
There are several key things that all subscription-based businesses should be doing:
- Charging enough to be able to deliver the value that the customers deserve.
- Educating customers on the kind of value that they should be receiving and why it matters, while also pointing out the questionable strategies of the freemium businesses.
- Focusing on the things that you can provide because you charge what the freemium businesses cannot provide (i.e. customer support).
THE FREEMIUM MODEL: 10 QUESTIONS TO ANSWER
Does your service have viral adoption potential?
Viral adoption helps minimize the marketing spend needed to drive free adoption. To what extent do you expect existing users to encourage others to adopt your service?
Freemium All Stars: Yammer and PayPal
Do you have a low cost-to-serve service?
Assuming that you will have a large number of free users, low marginal costs are essential to making this model work. Can you afford to support each free user?
Freemium All Stars: Asana and WhatsApp
Does your service have a huge potential market?
Given that the free-to-paid conversion is typically low, a service that has potential for a mass audience is another way to make it work. Is your service something that a lot of people want or need?
Freemium All Stars: Hulu or Dropbox
Do you have a clear and compelling migration path for your users?
To convert your free users to paid subscribers, you need to make it beyond easy for them to take the leap. Have you invested in creating a seamless migration strategy? Are your calls to action so compelling that people can’t help but upgrade?
Freemium All Star: Spotify
Does the value of your service increase the longer that people use it?
Some services inherently increase in value or stickiness the longer you use them, making it too “costly” to make a switch. Does your service make it hard for people to switch at the drop of a hat?
Freemium All Stars: Evernote and Flickr
Can you monetize even free subscribers?
If you’re going to have a large base of free users, are there ways you can monetize them outside of a subscription fee, e.g. selling ads?
Freemium All Stars: Pandora and New York Times
Do you have the capacity to prevent people from gaming your system?
Wherever there’s a system, there are going to be people who try to game it. Do you have the resources to create a rock-solid infrastructure to keep the freeloaders at bay?
Freemium All Star: ShopRunner
Does your service get stronger when more people use it?
Some services become more valuable to an individual user when there are more subscribers. Is your service powered by a big user base?
Freemium All Star: Match.com and Yammer
Is there potential for two-sided monetization of your service?
For a service with multiple audiences—e.g., corporations and individuals—there can be an opportunity to drive paid conversion in different ways for each. Do you have entry points for revenue building?
Freemium All Stars: Ariba and LinkedIn
Do you have the infrastructure to serve a mass audience?
To capitalize on freemium, you have to be ready for it. Have you got your operations and infrastructure totally dialed?
Freemium All Star: WhatsApp
FREEMIUM IMPLEMENTATION TIPS
If your business “passes” the freemium potential evaluation, the next test is to do the math and pressure test your assumptions with a freemium business case.
At a minimum, the estimated customer lifetime value from a freemium user should at least cover their likely acquisition cost.
To increase confidence in your modeling, it helps to run best to worst case scenarios (or Monte Carlo simulations) on key performance drivers (e.g. free-to-paid conversion, ARPU, churn, etc.) to evaluate the range of potential financial risks and rewards.
If your business passes the above qualitative and quantitative tests, you likely have a viable case for a freemium strategy.
To maximize your chance for freemium success, make sure you:
- Maximize marketing spend efficiency to generate excitement and virality
- Minimize the cost to serve free subscribers
- Fence your paid offers from your free offers in a way that minimizes cannibalization and creates a compelling free-to-paid migration path
- Establish clear, effective calls to action to drive conversion
The Basic Types of Freemium
- Time Limited (Free Trial) – X days free, then user pays
- Feature Limited – Basic version free, more sophisticated paid version
- Seat Limited – X number of people can use for free; any number over X has to pay
- Customer-Type Limited – Small companies use for free; big companies have to pay.
- Storage/Capacity Limited – X gigs of storage come free; more than X requires paid version
DOCUSIGN: A FREEMIUM CASE STUDY
When DocuSign introduced their electronic-signature technology, they knew they wanted to get the service out into the marketplace as quickly as possible, so they launched with the freemium model strategy. DocuSign’s initial freemium version gave users pretty much everything they needed to use the service; so much so, in fact, that initial users didn’t have much incentive to upgrade to the paid version!
So DocuSign reworked their strategy and started offering a “free trial” version (with a 14-day termination deadline) for users who came in through paid search-related marketing. DocuSign realized that these were the people who needed the product the most and therefore would be the most likely to upgrade when the trial was over.
This shift in strategy proved to be a winner and free trials are now DocuSign’s biggest revenue source. They have generated millions of new accounts, and DocuSign apportions part of its marketing efforts (emails, etc.) with a goal of converting those free users to happy and loyal paid subscribers.