The word freemium is a combination of the words “free” and “premium” and is often used as a marketing strategy by early-stage startups and mature technology companies. Typically, the company offers a feature or seat limited version of a product at no cost to the user while access to advanced features, additional seats and services can be unlocked only by upgrading to the premium and full versions of the product. The objective is to “hook” the user to the free version of the product with the eventual goal of turning them into a paying subscriber.
The model is particularly suited to software-as-a-service (SaaS) companies, web and mobile apps as the cost of distribution can be insignificant as long as the free version of a product does not cannibalize the company’s premium products. The freemium business model is used as a marketing tactic by technology companies to grow the user base, create brand awareness, disrupt the competition, and enter price-sensitive markets.
A freemium offering has several advantages. In the first place, customers can try your product to some extent before they actually decide to buy it. In addition, you can uncover insights such as the product features that your users are mostly excited about. Furthermore, you can identify the market segments and the audiences which are mostly interested in your product. The freemium business model can help a company to scale up, gain traction and grow the user base without relying on a sales team or investing on marketing campaigns that require a substantial advertising investment.
The model is particularly suited to software-as-a-service (SaaS) companies, web and mobile apps as the cost of distribution can be insignificant as long as the free version of a product does not cannibalize the company’s premium products. The freemium business model is used as a marketing tactic by technology companies to grow the user base, create brand awareness, disrupt the competition, and enter price-sensitive markets.
A freemium offering has several advantages. In the first place, customers can try your product to some extent before they actually decide to buy it. In addition, you can uncover insights such as the product features that your users are mostly excited about. Furthermore, you can identify the market segments and the audiences which are mostly interested in your product. The freemium business model can help a company to scale up, gain traction and grow the user base without relying on a sales team or investing on marketing campaigns that require a substantial advertising investment.
A startup marketing strategy
For early stage technology startups, freemium may not have much to do with growing revenue by converting free users to paying subscribers. On the contrary, freemium can be used as a startup marketing strategy to build a substantial user base as fast as possible.
Canva, an Australian startup which has created a successful design platform, has become popular thanks to its easy-to-use app which provides free templates for designing graphics for social media, posters, presentations and all sorts of visual content. In its first year of operation, the company managed to have more than 750,000 users. Today, the platform has over 30 million monthly active users across 190 countries.
Canva, an Australian startup which has created a successful design platform, has become popular thanks to its easy-to-use app which provides free templates for designing graphics for social media, posters, presentations and all sorts of visual content. In its first year of operation, the company managed to have more than 750,000 users. Today, the platform has over 30 million monthly active users across 190 countries.
Why freemium fails
Freemium works well for acquiring users and not so much for monetization. Giving a product for free does not assure that users will convert to actual paying customers. All companies, including tech startups, must eventually generate sales to survive and grow. For early-stage startups, this may occur once they have achieved to scale and reached a significant level of user adoption.
A challenge with the freemium model is that while a startup may acquire many users, it can also run out of cash swiftly if its users are not upgrading to the premium versions of the product. A free product offering may also require substantial company resources such as customer support, cloud storage and server space.
In his book titled “Free: The Future of Radical Price”, Chris Anderson explains that freemium works on the 5 Percent Rule where 5% of premium customers support the remaining 95% of free users and also the cost of servicing the free users is close enough to zero.
As the number of free users increases, so can the cost of servicing them. This is why we see companies pivot from a freemium offering to a time limited free trial, drop their freemium offering all together, or adjust their business model to offer the free version of their product to smaller customers (e.g. with limited features or seats, self-service or no customer support) and offer a free trial only to larger businesses who are more likely to turn into a sale.
Docusign, as an example, recognizes that some of their small business users are only using their product to e-sign documents. With the DocuSign free edition, one can personally sign as many documents as they want and access them through their cloud storage but they are limited to three e-signature requests. It is evident on their pricing page that the company is deemphasizing the free edition while putting attention to their free trial offering and subscription plans to generate revenue.
A challenge with the freemium model is that while a startup may acquire many users, it can also run out of cash swiftly if its users are not upgrading to the premium versions of the product. A free product offering may also require substantial company resources such as customer support, cloud storage and server space.
In his book titled “Free: The Future of Radical Price”, Chris Anderson explains that freemium works on the 5 Percent Rule where 5% of premium customers support the remaining 95% of free users and also the cost of servicing the free users is close enough to zero.
As the number of free users increases, so can the cost of servicing them. This is why we see companies pivot from a freemium offering to a time limited free trial, drop their freemium offering all together, or adjust their business model to offer the free version of their product to smaller customers (e.g. with limited features or seats, self-service or no customer support) and offer a free trial only to larger businesses who are more likely to turn into a sale.
Docusign, as an example, recognizes that some of their small business users are only using their product to e-sign documents. With the DocuSign free edition, one can personally sign as many documents as they want and access them through their cloud storage but they are limited to three e-signature requests. It is evident on their pricing page that the company is deemphasizing the free edition while putting attention to their free trial offering and subscription plans to generate revenue.
SEO platform Ahrefs, as another example, is doing something that is unusual in the world of B2B marketing. Instead of offering a freemium version of their product, the company charges users $7 to try their product for 7 days. By doing so, the company encourages only the “serious” users, the ones who are more likely to turn into revenue for the company, to sign-up to evaluate their service (although some may argue that by charging for a trial it might discourage potential customers from trying it out in the first place). As a paying trial user, you are more invested in taking a more serious look at the platform within a short period of time. The “pay to try” approach can also be a tactic to cover expenses from the resources that are needed to service the product during the trial phase. In addition, by asking its potential users to pay a small amount for the trial, the company creates the perception that their SaaS platform is not perceived as a low value product.
Freemium conversion rates
Conversion rates from free to paying customers range for most companies between 1% and 10%, with the average being around 2% to 4%. Of course there are outliers such as Slack which has enjoyed near 30% conversion rates and as such has blown away other freemium enterprise software companies. In fact, twenty months after its launch, Slack had 480,000 paying users, from a total of 1.7 million users acquired, resulting to $45 million in revenue.
Depending on the annual revenue goal, the annual revenue per user, estimated conversion rate, active users, churn rate, and other factors, a company can estimate the number of free users that will need to reach its sales goal. In the hypothetical example below, a company with a 10 million revenue goal and annual revenue per paying customer (ARPPU) at 250 will need 40,000 paying customers out of 2 million total users acquired (on the assumption that 2% of its user base upgrades its subscription).
Depending on the annual revenue goal, the annual revenue per user, estimated conversion rate, active users, churn rate, and other factors, a company can estimate the number of free users that will need to reach its sales goal. In the hypothetical example below, a company with a 10 million revenue goal and annual revenue per paying customer (ARPPU) at 250 will need 40,000 paying customers out of 2 million total users acquired (on the assumption that 2% of its user base upgrades its subscription).
Note: the above calculations are made based on assumptions and do not include churn.
Use the calculator below to estimate how many users you might need to reach your target revenue
How to assess whether the freemium business model is right for your business
There are a number of factors to consider when evaluating whether freemium is right for your business including:
In conclusion, free users are only an asset for your company if they provide actual value. Freemium can be a viable business model and a powerful marketing strategy for some technology companies but it is not suited for every technology company. Above all, before embarking on their go-to-market strategy, companies should never lose sight of the thing that matters the most: creating a top-quality product that meets an important market need and delivers considerable value to its users.
- The Market Size: When deciding whether you should build a freemium company, consider your market size. It could work for a company with a huge market but if your market is not big, freemium may not be the best go-to-market strategy for your company.
- Your Marginal Costs and ROI: Figure out your return on investment. If costs such as servicing your users and acquiring new users exceed the revenue received by your paying users, then a freemium business model may not be right for your business.
In conclusion, free users are only an asset for your company if they provide actual value. Freemium can be a viable business model and a powerful marketing strategy for some technology companies but it is not suited for every technology company. Above all, before embarking on their go-to-market strategy, companies should never lose sight of the thing that matters the most: creating a top-quality product that meets an important market need and delivers considerable value to its users.