Freemium Model, Why Your Company Should Be Looking Into This Model

By Nicholas Barone
Published: 10/22/21
definition backgroundFreemium Model- Why Your Company Should Be Looking Into This Model

Both a business model and a pricing strategy, the freemium model has become increasingly popular in more sectors over the past few years, in particular video games and SaaS, even though having a free product or service and profit margin seem incompatible.

Except the freemium model can be a major source of revenue for your business, as long as you understand what it is exactly, and what kinds of risks it includes.

Definition

The term freemium is made up of two terms, free and premium. It is therefore an economic model and a commercial strategy that allows users to access your product or service for free, in order to attract the largest number of users possible. All of this is in the hope of selling them a paid version later down the line.

However, a free service can also mean a limited one, particularly in:

  • The number of features: often in freemium or base plans the service provider limits the amount of features to a couple of key functions, instead of the broad range that a premium version usually offers.
  • Characteristics: found mostly in video games, for example if you need to buy add-ons for your character in the game, those probably won’t be included in the free version.
  • User experience: a lot of free versions of service, in order to generate revenue, include ads which hinder the overall customer experience.
  • Storage capacity: specifically for cloud services, like Google Drive
  • Technical support: companies tend to offer better customer support to those who have a paid subscription
  • Number of licenses: many free versions are perfectly suitable for personal use, but that’s different when you have to use it in a business setting, where you’ll probably need to pay for multiple licenses to be able to use it.
  • Use time: some video games limit the time that players can spend playing, for example.

The objective, therefore, of businesses with a freemium model is to lead users to subscribe to or buy a premium version of the product or service. As mentioned before, businesses do this by limiting the number of features included in the free version. Because even companies can still generate a certain amount of revenue from the free version, their main stream of income is subscriptions.

This is why freemium is a balancing act, companies have to maintain the perfect ratio between premium users and free users so that the model is profitable.

Examples of Famous Freemium Models

Streaming Platforms- The Spotify Example

The Spotify economic model is one of the best examples of the freemium model. While the free version of Spotify allows users to start to get familiar with the service, the premium version:

  • Has no ads
  • Gives users the ability to listen to music offline
  • Allows users to use the platform on multiple devices

Video Games- League of Legends

Freemium is highly prevalent in the universe of video games, you might know the model by its other name, Free to Play, or F2P. F2P allows users to play for free, but make them pay for certain add-ons. The model in video games is also known as pay to win, because the way you play is less important than the amount you spend to win.

League of Legends, is a key example of free to play, has become the most popular free competitive game. However, players can buy “champions”, personalized elements and exclusive content that allow the makers of the game to make money.

Social Media- LinkedIn

Most users who use LinkedIn today, use the freemium version, however there are premium versions, depending on the target audience, that give users real added value. For example, people who are looking for a job on LinkedIn can, with the Career version, communicate directly with recruiters, and see who looked at their profile.

Freemium Model- Advantages and Disadvantages

Advantages

Market Penetration

Free is attractive, by offering a free service you attract a much larger customer base at an affordable price thanks to low production and distribution costs thanks to the internet.

Having a freemium model also differentiates you from your competitors, which can be a major advantage in saturated markets.

A solid base of customers that know you, and your service, thanks to the freemium model can turn into advocates of your service. The notoriety of will most likely increase thanks to word of mouth marketing from your original customer base.

Experimentation

Customers have the opportunity to test your product or service, with the free version, before moving on to buy or subscribe to the premium version.

By testing your service with the free version, customers understand the kind of added value that the premium version, with the full array of features, will have in their life, without thinking about:

  • A price tag that could seem too expensive at the beginning
  • Pressure to buy

If we take the example of software, it takes time and money to convince a prospect that they should adopt it. However, if they have already formed a habit with the free version, they’re much more likely to buy the premium version instead of looking for another program.

Customer Database

Users that subscribe to your free service can also be profitable for reasons other than monetary ones. Once they subscribe and put in their information, what their needs are, what they’re looking for, their profile, etc. All of that information enters into a database, which then can be used to target prospects with similar profiles.

Continued Improvement

If you put your service out for everyone to try, you will inevitably get feedback. All that feedback will let you create a better experience for users, based on what they actually want.

Disadvantages

Conversion

As we mentioned before, a lot of people associate the internet with free. To get them to pay for a version of something they’ve been using for free is a big challenge.

Return on Investment (ROI)

Premium clients finance, in a big way, the services that the freemium option provides. As a consequence, it’s not always easy for a company to find the right balance between free and premium customers, let alone convert them.

Brand Image

Most of the reviews you’ll see on a freemium service or product are about the free version. So you’ll inevitably have some users who point out issues that have nothing to do with the premium version, for example a lot of users complain about the ads on Spotify.

Not Always Replicable

The reason why the freemium model works is because there’s a large volume of users from the start, which also explains why the conversion rate is so low. Therefore, it’s not adapted to all sectors, like niche markets, and is still relatively hard to replicate outside of the internet.

Tips

Target a Large Market

As we mentioned before the conversion rate for the freemium is low, between 2-5% according to Harvard Business Review.

Therefore, the only way for the model to be profitable is if you target a large market.

Work on the Value-Added of your Offer

You’re going to have to find the right balance between:

  • An attractive free offer to attract the maximum number of consumers. One way to identify if your free service isn’t working is if you see that the conversion rate is too high. This could mean your actual offer isn’t attractive enough to bring in a big customer base.
  • And a premium offer that’s enticing enough to upgrade. One way to do this is to create a sense of frustration among users, they really like the free version but they can’t access more features, take advantage of more possibilities, etc.

You have to find the perfect middle ground, and adjust your offer and value proposition according to the needs of users by changing your models, features, etc.

Optimize Your Operating Costs

Think about ways you can reduce your operating costs for your freemium offer. Most companies try to distinguish their free version from their premium one by taking away features, which also reduce costs. Some companies, in their free version, will replace their customer service with bots instead of actual humans, reserving that for their premium version.

Your model must therefore be based on a basic offer that’s not expensive to develop. In the case of the premium version, a high subscription rate is essential in order for the whole model to be profitable.

Anticipate and Define Your Model Before

Before diving in, define the model and the cost structure, as well as the ratio of free users to paid subscriptions.

We’d recommend stating your target conversion rate before, by doing this even if the rate is a bit too high will let you know when you’ve hit your objectives. By doing this, you’d also be able to calculate the amount of initial users you have to hit in order to get to the target balance.

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