The Freemium business model has been around since the 1980s, but it has recently gained more popularity. The basic premise is that a company will offer a free version of its product or service, but the company will also provide an upgraded version of the same product for a fee.
The free version might come with disabled features or less support than you would receive if you paid for the service. There are several benefits to using this business model, including increased cost effectiveness and improved brand recognition. We’ll explore whether a freemium model could be suitable for your organization.
What is a Freemium Business Model?
The term “freemium” is a combination of the words “free” and “premium.” It refers to a business model where customers can use a product or service for free, but there’s an option to pay for additional features or access.
The idea behind this model is that, by offering some of its features for free, you’ll get more people interested in what you’re offering—and hopefully some will decide to pay for more. The freemium business model works for new companies by establishing and building strong relationships with customers. It works best for internet-based service companies.
Freemium vs. Free Trial
The freemium business model should not be confused with a free trial. Many times, companies will offer a product or service of theirs for free for a set period of time. The access to the full range of features can last for seven days, one month, or even six months. With these trials, the expectation is that the customer will be charged at the end of the free trial period.
A free trial gives the customer an opportunity to test a product that they intend on, or have thought about, purchasing. The customer also feels a sense of control, since they know that they can cancel their free trial at any time. Many times, companies will allow the customer to continue using their product or service even after they have canceled but before the free trial end date. This is done in hopes that the customer will change their mind and continue the subscription after using the product for an extended period of time.
A freemium is different in that it does not assume that the customer will be charged unless they choose to take advantage of other features. They can always opt-in or out of using premium features.
Here’s how it works:
- Create your product or service
- Make the initial version of your product available for free (the “basic version”)
- Offer premium versions of your product that include additional features, services, or virtual goods (the “premium versions”)
- Encourage users to upgrade by providing incentives, such as discounts on upgrades, through social media campaigns or email notifications informing them about new features
One of the most common examples of this type of business model is in online games, where users can play for free but are offered the opportunity to purchase virtual goods that enhance their experience and functionality within the game. Some other examples include:
- Online storage services (Dropbox)
- Music streaming services (Spotify)
- Music streaming services (Pandora)
- Networking Platform (LinkedIn)
- Workflow Automation (Zapier)
Pros of the Freemium Business Model for the Customer/User
1. Low Risk
One of the greatest benefits of the freemium model for the user is the level of risk involved. With no up-front cost, users feel more at ease signing up for a product or service.
One of the reasons that users of a subscription-based product cancels is the lack of return on investment. Users decide that the product or service they are receiving does not meet their expectations or their needs. When this happens, many users will ask themselves, “Is this worth it?”
With a freemium model, the decision to use or not to use the product is not a monetary one. Instead, users can make a decision based on how much they like or need the product. Without any financial risk involved, the user can enjoy the product without needing to evaluate if they are getting their money’s worth.
2. Customizable experience
The freemium model also gives the user more control. A good freemium model will give users and potential customers options on how they would like to enjoy the product or service. This is usually done by offering different tiers.
A product could have a basic or free version, an upgraded version, and a premium version. The different tiers allow the customer to choose what features best meet their needs. A user could love the free version of a product but six months later, decide that they are ready to upgrade because of features not available in their current version.
So now that you understand the pros and cons of a freemium model for the customer, what are the benefits to the business?
Pros of the Freemium Business Model for the Business
1. Opportunity to Test Your Product or Service
A business can use a freemium product or service to gauge their user’s interest. Since this would be a free version of the product, there would be no need to invest too much money into it. Testing the product as a free version allows you to see what kind of customers your product attracts. At that point, a decision can be made as to whether or not you should pursue the current product or launch something else.
It can also save costs associated with developing certain types of products, such as software programs that require extensive development time before being ready for market launch. Once built, these products usually must be updated regularly with new features/functionality over time, which adds even more up-front expense costs versus developing one-off products, such as books whose content doesn’t change much after the publication date.
2. Customer Acquisition
The freemium model is more about acquisition than it is revenue. Because the product is free, you will be able to attract a much larger audience, even if the product was set at a low price.
“Free” is always an attractive selling point. When customers flock to a free product, the business now has a relationship with the user. The company now has the opportunity to turn those free customers into paying ones.
3. Customer Loyalty
Building customer loyalty is important for cross selling and user retention. Loyalty makes it easier to sell additional products to your customers and your customers will tell others about your product or service, which will also help you acquire new users.
The freemium model allows people to try, use, and judge how good your product or service is. The more they like and use the product, the more they are more likely to continue using it.
This is really important with software as a service companies (SaaS). A company may produce a software that is free for businesses but will charge once that business has exceeded a growth metric, such as email subscribers or the amount of invoicing allowed per month.
Cons of a Freemium Business Model for the Customer
1. Limited Features
One downside of the freemium model for customers is the limited features available for the “free” versions of your product. This limitation can sometimes be frustrating to the user, who would like to use the product or service casually but may need extra features from time to time.
2. Continuing Costs Instead of a Fixed One
With some freemium models, the customer needs to use the product in order to continue using it. This is easily seen with free-to-play video games. These games require the user to continue paying to play the game after a certain level has been reached.
Free-to-play games generated an estimated $98.4 billion in 2020. The freemium game model is much different than buying and owning a physical game and playing it whenever you want. The downside for the customer is that it is harder to keep track of how much money, and time, has been spent on the game.
Cons of a Freemium Business Model for the Business
1.Challenge of Converting Free Users Into Paid Users
It can be challenging to convert free users to paid users. Your conversion rate is the percentage of people who become paying customers after using your product or service for a certain amount of time. If you do not have a high enough conversion rate from your free users, it will be difficult for your business to survive.
It can be hard monetizing free users—they may not spend much money on your app even though they’re using it every day. But remember: every little bit counts—you need enough money coming in from ads and special offers so that at least some kind of profit can be made each month.
2. Need a Large User Base to Succeed
You need a large user base if you want this model to work for you. It would help if you had a large pool of potential new customers available each month to continue growing and bringing in revenue through advertising or special offers on new products or services (or both).
3. Operating Expenses are Still Necessary, Even Without Revenue
It may feel great to attract a lot of users but if the majority of them are not paid, you may experience a few issues. One of those issues may be cash flow.
Operating any kind of business comes with costs. There are monetary costs, such as data storage or time costs with handling customer questions. Without revenue to pay for those costs, as well as to pay yourself and your team, the product will ultimately suffer.
There is no doubt that the Freemium model has been successful for several companies. Weighing the pros and cons will help you decide if the Freemium model is right for your business. We’ve looked at the most important things to consider before choosing a freemium model. It’s a great way to attract new users and encourage growth, but it may not suit every business. If you need help determining which business model is right for you, check out our article on the different types of business models with examples here.
Co-authored by: Ralph Paul