Freemium business model: benefits and pitfalls to avoid

- by Valeriu Braghis

Predicted_outcomes

Freemium business model is relatively new, but at the moment we can see a huge wave of adoptions and hear success stories from across the software industry. So what is freemium and what makes it successful? Let’s try to clear this out.

Generally, the Freemiums are segmented in the following categories:

Value based – The most successful type of Freemium strategy. The more a customer uses the product, the more value it derives. At some point the user will hit a usage limit and convert to a paying customer. Mailchimp, Balsamiq, Dropbox and Evernote are great examples of this.

Characteristic based – For example offering the product for free for one user (so it is based on company size for instance). Let’s think about a B2B application. If I’m a freelancer, I will use the application forever and I will never have to upgrade. If I’m a 3-person company, I can’t add more users and try the application for real and hence might not get to the point where I see the value in using it.

Free Product for a Cross Subsidy – Give one product for free and charge for complementary products.

Lower Cost of Sales

Predicted_outcomes

The freemium business model has its own advantages when it comes to user acquisition; reduced cost of sales is one of the main ones. This is achieved by offering a self-service product to the users, giving them a chance to try the product. From that point they have a chance to figure out the product’s value on their own, instead of spending tons of money on an army of salespeople who will be explaining and persuading the value to the prospects. In the good old days, software companies would spend half of their revenue on sales, passing these costs onto customers. It didn’t take long before they figured out that they were paying twice as much as they needed for something that had little value once the product was installed. The software companies have been striving to reduce the cost of sales ever since. When this is achieved, the software companies can direct the saved energy and resources into delivering that awesome product they originally had in mind.

Make freeloaders pay

Predicted_outcomes

Another aspect that just can’t be overlooked is the constantly declining costs of hosting and bandwidth. This makes the marginal cost for most Internet products close to zero. In other words, companies can now afford to serve a large number of free users and it is one of the main factors, which made the freemium model possible in the first place.

This also creates a challenge for producers; even if the cost to serve the users is almost zero, they still need to either make money from them or save money. There are two ways to go: either save on marketing costs and drive referrals (Dropbox or Candy Crush Saga can be seen as two bold and shining examples), or make money on ads or data (Pandora, Evernote, Mint are just some of the examples) In fact most of the mobile freemiums are a perfect example of this practice.

According to various studies, around 95% of freemium users don’t pay and will never pay. This is why driving value from the huge number of free users is vital for a freemium product’s survival. Although these users are not paying for your product. they still have to pay one way or another, either by watching ads inside the app or by driving referrals.

Conclusions and Takeaways

Before jumping on this idea and switching your product to Freemium business model, there are a few things you might want to know to figure out if it’s really worth it or suitable for you:

  • Virality – The extent to which new users are acquired by referrals from existing users
  • Retention – The extent to which users return to the product and show long usage sessions
  • Monetization – The extent to which users spend money for in-app items
  • Organic growth – The extent to which new users are acquired free of charge without referrals or prior connection to the product

Last, but not least, while writing this article, I noticed a certain pattern among the freemium examples I came across; they are all brilliant products that deliver amazing user experience. If your product doesn’t create a great value to its users, no tactic in the world can make a Freemium strategy work for you.