Bart Krawczyk Learning how to build beautiful products without burning myself out (again). Writing about what I discovered along the way.

The freemium model: How to know if it’s right for your business

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The Freemium Model: How To Know If It’s Right For Your Business

In recent years, freemium has become one of the most popular models.

There’s a big psychological difference between products that cost even as little as 20 cents and products that are free. There’s just something in the word “free” that grabs people’s attention more than anything else.

But the freemium model is not right for every business. In this guide, we’ll explain what freemium is, review the pros and cons of offering your product for free, and outline tips to help you discern whether a freemium acquisition model is appropriate for your business.

What is freemium?

Contrary to popular belief, freemium is not a pricing model; it’s an acquisition model.

Pricing is about how much money you want to get from the product. Acquisition is about the way you get users to use your product.

Freemium enables you to give users a taste of your product and then, once they fall in love with it, convert them to paying users. It’s essentially part of the acquisition funnel.

Why does this distinction matter? People who fixate on freemium being a pricing model often neglect the actual monetization.

You have to consider how to charge users (e.g., one-time, subscription, usage-based), whether you can live solely off premium users or need to monetize free users as well (e.g., ads, partnership, data), and how to balance the cost of maintaining free users with the revenue from paying customers.

When you think about freemium, you should compare it with other growth models, not other pricing strategies.

Benefits of using a freemium model

There are numerous advantages of using the freemium acquisition model. Most of them come from an increased user base:

Increased brand awareness

Free products reach more people. With lower barriers to entry, more people try them and talk about them. In the long run, it builds brand awareness in people’s minds.

Think about Google:  everyone knows what Google is, but if it offered only paywalled services, do you think it would be a household name today?

Better virality

Freemium works well with the viral engine of growth. There’s a higher chance that users will refer a free product to their friends and that people will actually accept their friends’ invitations. After all, you’d probably think twice before recommending an expensive product to your family and friends.

Reduced customer acquisition cost (CAC)

One of the main reasons why freemium is so popular is its low customer acquisition cost (CAC). Potential customers don’t need so much convincing — for example, with ads — when it’s for free. The increased virality also contributes heavily.

With the market getting increasingly competitive, CAC has risen by 70 percent in the last five years and is on track to grow even further, making freemium even a more tempting choice.

Easier go-to-market

One of the biggest challenges of a proper GTM motion is getting your first users and the initial traction that comes with them. A free offering makes it easier to reach critical mass quickly.

Income diversification

The freemium model enables additional income streams from your nonpaying customers.

For example, you can display a third-party advertisement or set up partnerships with other companies to cross-reference users. While showing ads for paying customers would be a bit pushy, nonpaying people are used to that.

More data

A free product generally attracts more users. More users mean more data about users. More data about your users means quicker learning. Faster learning leads to a better product.

Easier fundraising

It’s easier to get a funding round if you have 100,000 users than if you have only 5,000. User base size is still considered proof of value by many venture capitalists.

Increased barriers to entry

If you don’t have a freemium model, you leave room for competitors to use it as their competitive advantage.

On the other hand, if you already have a sustainable free version of the product, market entrants must conform or find a different edge to compete with you.

Community building

Product communities are great. They reduce churn (because users are often more reluctant to abandon the community), increase virality, and can even serve as the first line of customer-led support.

With more users using your product, whether they are paying or not, there’s a higher chance for a community to be born.

Drawbacks to using a freemium model

Freemium isn’t a perfect solution, and it’s not for every product. First of all, marketing a product as free_ _has an impact on overall positioning. Having a high number of nonpaying users also poses some serious challenges, including:

Cash burn

Maintenance costs increase dramatically as the number of users grows. It’s especially problematic when those users don’t generate money.

Even though they are not paying, you still must provide these users with some basic support and pay for the infrastructure.

Organizational overhead

In the long run, an extensive user base requires you to hire more people (e.g., customer service) and forces you to tackle more challenges (e.g., support tickets, data processing, etc.).

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The higher the organizational overhead, the lower the overall innovation rate.

Reduced value perception

Although we all love free stuff, we tend to value things more if we have to foot the bill, regardless of the real value that the product provides.

If you want your service to be perceived as premium or luxurious, the free tier won’t help you.

Additionally, we tend to be more invested in services for which we have to pay with our hard work.

Higher churn rates

The aforementioned lack of investment leads to higher churn rates than paid-only products.

Not only is it effortless to resign from a free product, but people are less motivated to use it when they don’t pay for it.

Free mentality

The more you teach your users that your offering is free, the harder it is to charge them later on.

YouTube Premium is a great example. In 2020, less than 0.9 percent of active users paid for premium. It’s no surprise; YouTube taught us for years that its offering was free.

When to choose a freemium acquisition model

Whether freemium is a good choice depends heavily on the context. There isn’t any definitive guide or magic checklist that will tell you when to use a freemium model.

You need to judge how the pros and cons of the freemium acquisition model fit your overarching strategy and whether such an approach would help or harm it.

However, there are a few strong indicators that freemium might be a good pick. You should consider using a freemium model if:

You are entering a red ocean

If you are entering a hypercompetitive space, freemium might be a good pick for one of two reasons:

  • If the competitors don’t have a freemium version, it might be the differentiator you need to win part of the market share
  • If competitors already have it, you will need to conform — unless you create a distinctive enough value offering, but then we’re talking about blue oceans

Virality is your main growth engine

Although you don’t need a freemium product to build strong virality, it definitely helps. It lowers the friction of inviting friends and talking about the product — why would someone talk to their friends about the product they can’t afford?

Plus, virality is all about volume. Assuming your growth engine works correctly, the more users you have, the more users will adopt your product.

Freemium is already an established standard

If a freemium is already an established standard in a given market category, then you should play by the rules of the category.

Of course, if you have a substantial competitive advantage, you might want to try to break the rules. But, in 90 percent of cases, you shouldn’t.

The value of your product increases with the number of users

Social products are a great example:  the more people you have on the service, the more usable it becomes.

Building a chat app or social media platform that’s paid to use would make hitting that critical mass extremely difficult.

The cost to serve nonpaying users is low

One of the main problems associated with the freemium model is the cash burn and overhead of maintaining nonpaying users. However, if the cost is marginal in your case, then most of the cons don’t apply to you.

You can easily monetize nonpaying customers

If you can get positive cash flow even from your nonpaying customers, then, by all means, go out and get millions of them.

Freemium vs. premium: A delicate balance

To sum up, the biggest challenge in building freemium-based products is balancing free against premium options. It’s an art that requires a lot of consideration and experimentation.

Give too little value for free, and you will fail to attract users.

Give too much, and there’ll be no incentive to upgrade.

But, if freemium fits your overall product strategy and you can strike a balance between free and premium versions, then freemium could become a powerful acquisition model for your offering.

Featured image source: IconScout

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Bart Krawczyk Learning how to build beautiful products without burning myself out (again). Writing about what I discovered along the way.

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