Is Freemium The Right Business Model? 10 Questions To Answer

Written by:

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, Evernote

Chris 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.

Going Freemium?

Ten questions to evaluate if the freemium model is viable for your subscription business.

Dive in!

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:

  1. Charging enough to be able to deliver the value that the customers deserve.
  2. 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.
  3. 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

Price to Win

Innovative pricing strategies for the relationship based subscription model.

Get it now!

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.

Learn from your peers. Network your heart out.

Join a Subscribed event near you.

View Events