In this post, we will define the freemium business model with examples and discuss its advantages and disadvantages or pros and cons for businesses. We will also discuss methods to make this model work and things to do before trying this model.
What is freemium?
Freemium is a type of business model in which businesses provide their customers the basic features of their product/services for free and additional/special features for a premium. Freemium is made from two words: free and premium. It includes both the features – free and premium. This business model is mainly used by online businesses and grown especially popular among SaaS and other internet-based businesses. If the popularity of freemium business model has grown among a certain class of businesses, it is because of its special advantages. It is also a marketing technique used by SaaS businesses to improve brand awareness and acquire a large customer base faster.
Freemim has also acquired special popularity among gaming businesses. There are many games that users can play online for free. However, a premium subscription allows them to unlock special features that are not available to free users. In some games moving beyond a certain level will not be possible without a premium subscription. Some games offer a monthly premium subscription while the others charge only for the features you buy. In case of most of game businesses, it has generally worked well since the charges are mostly small but some features can be so lucrative for players that they do not mind spending extra on them. The popularity of the freemium model proves that this model has some important advantages over the other models. However, it does not mean that there are no risks involved. Businesses need to move carefully in this regard and evaluate both the pros and cons before adopting this business model.
- The term freemium was coined by Jarid Lukin of the Flatiron portfolio company Alacra.
One thing is clear about freemium business model which is that while it works in the case of some businesses, it is not sure it will work for just any business. Like its advantages, the freemium business model also has its own flaws that businesses must consider before going for this model.
Advantages and disadvantages of the freemium business model:
The freemium business model is popular and perhaps the most important reason behind its popularity is that it allows businesses to acquire an initial set of users very fast. The word free has a special appeal for the customers. Customers are attracted more towards apps and services that have something to offer for free. So, if a business wants its app to stand out from the crowd of apps, it will have to do nothing but to offer services for free. Many businesses offer a free trial of their service for a limited time like a month or two. That is different from Freemium. However, free still works in terms of marketing and user base for businesses offering free trials, albeit not as effectively as in case of Freemium.
When it does not cost anything to use an app, users will not have any problem trying it. It helps companies grow their brand awareness fast and acquire an initial set of users, some of which may convert to premium users. Apart from that, the company will also have access to data that can help it understand usage behavior. This data can also be used to improve the application or to understand what drives higher conversion. It can be highly effective in the case of startups and businesses that are trying to build a following for their product. While on the one hand, it will cost them next to nothing, or they will get a lot of publicity and brand awareness for free, the company will not need to invest much in providing customer support either.
One of the best examples of this model is Spotify. Spotify has used the freemium model and now it is the largest brand in the online music streaming sector where it competes against the likes of leading tech brands – Apple, Amazon, and Google. Spotify is a global brand and has the largest user base in its sector which has grown at a very impressive rate over the past several years. Spotify offers free and premium accounts. It also uses differential pricing and the charges differ from market to market as well as from one user group to another. The free accounts are monetized using advertisements. However, the free accounts also act as a gateway for the premium subscribers since most of the premium users on the music streaming platform have come through this route. The company mostly converts its free subscribers to grow its user base of premium subscribers.
However, it is not just Spotify but there are many more well-known names like Dropbox, Skype, Evernote, and the famous game Candy Crush (developed by King) which use the freemium business model. Some other names include Slack, Cloudflare, and Canva. In the case of these businesses, the freemium business model has worked, but that does not guarantee that it will work for all online businesses and startups. It is because the freemium model is also fraught with challenges. There are also some cons or drawbacks of the freemium business model that it might not be a suitable choice in all the cases.
Freemium is not effective in all the cases as a market entry strategy since in some cases, it can lead to high costs of operations and negative positioning. In cases, when companies are unable to achieve a satisfactory conversion rate, the freemium model might not work or stifle the business. If the conversion rate is low, it can lead to losses and ultimately failure. The company will also need to support too many free users which will drive costs higher and deplete its financial resources faster. The company will need to spend to convert free users into premium users. Spotify spends on advertising and promotes its paid subscriptions to convert free users into paid users. However, if a business has acquired a large user base by adopting the freemium business model, its chances of converting will also be higher. The challenging part in terms of conversion is that it still requires time and financial resources.
One cannot sit back and hope the free users to convert. So, the challenge before the businesses is to find a balance between spending and user acquisition. Businesses also need an alternative plan to monetize their free users. Spotify’s free accounts are ad supported and premium accounts are ad free. Unless the business can find an alternative method to monetize free accounts (either through ads or by other means), the business might fail. If users do not see obvious benefits from upgrading to premium, they might not be willing to upgrade. It is also important for such businesses to get their pricing strategy right to make the freemium model work. So, while the freemium model has some great advantages in terms of marketing, customer acquisition and sales, it has some drawbacks which make it essential for a company to think about the challenges it may face before adopting this model
Examples of freemium business model:
Spotify is among the leading examples of the freemium business model. The company has experienced solid growth in its subscriber base over the recent years. It has entered several new markets in 2021 and the freemium model continues to drive faster growth for the online music streaming platform. At the end of 2021, the company had 406 million monthly active users, which included 180 million premium subscribers, across 184 countries and territories.
The company offers both free and paid accounts. Its free accounts include nearly the same features as the paid accounts except that the free accounts are monetized with ads while the paid subscribers have an ad free experience. The users that want an ad free experience can upgrade to the premium accounts. Apart from it, there are some other limitations on the free accounts too including number of skips on songs and audio quality. While a large group of subscribers are content with the features provided in the free accounts, those who want to get better audio quality and higher control upgrade to the premium account and the ad free (interruption-free) experience can be worth it.
Spotify has focused on several important factors to make the freemium model work in its favor. One of them is the use of technology to improve the user experience. The company maintains a strong focus on innovation and is among the first in the industry to use a recommendation model that suggests songs to users. It is among the leading attractions of the platform that works to drive higher engagement and customer loyalty. It found a way to monetize its non-paying users through ads. The company has also continued to improve its user experience with time. Spotify has not remained limited to just a few markets but has expanded worldwide to 184 markets. Another important thing that the company does to make its freemium model work is differential pricing. It does not charge all users across all geographies the same price. While it offers different plans for different user groups that suits their needs and pocket, it also prices its plans differently for different geographical areas based on the purchasing power of consumers. It has helped the company achieve higher popularity, sales, and customer loyalty. The freemium model already works to drive higher brand awareness and over the past several years, Spotify has experienced manifold growth in its user base.
Candy Crush Saga:
Another business that was among the earliest to use the freemium model is the maker of the famous game Candy Crush saga, King. The game is available to users worldwide for free who can play it on their laptops or mobile devices. They can save their progress and sync across various devices. While the basic features are free, users may need extra lives or extra moves to cross some tougher levels, which come for a premium. This model has been adopted by many more games that came to the market after Candy Crush.
A third online business that has successfully exploited the freemium model in its favor is the web performance and security company Cloudflare. It offers most of the basic features for free which small websites and apps can continue to use without paying anything. It offers several services for free including CDN, DNS, SSL, firewall and analytics with some limitations. The premium users can gain access to additional features that are targeted at accelerating websites and apps, providing higher security, mitigating attacks and some more features. However, there are several premium features that are available for small charges like Argo smart routing which allows you to globally accelerate your traffic with a click. Faster loading times generally lead to higher engagement and better conversion. However, the number of page rules available with pro, business and enterprise plans is also higher whereas in the case of the free accounts the number of page rules is limited to just three. Pro users can have 20 and business users 50 page rules. There are several attractive features that growing websites and apps can find useful and which are worth spending on. Cloudflare also offers preoptimized settings for the Wordpress websites which are available for a small charge of $5 a month. The freemium model has worked well for Cloudflare and the several features the platform offers, many of which are essential for growing businesses or large websites and apps, and drive higher conversion. Cloudflare also leverages its community of users for providing first level support. Premium support is available for the premium users. The most important reason that the freemium model has worked for Cloudflare is differentiation. It offers something that not every rival can offer as cost effectively and it has not many rivals in the market operating at its scale. So, basically the product or service is an important factor that will drive adoption and conversion in case of the freemium model.
Some questions to ask before adopting the freemium model:
- Why should we offer the product for free?
The first question before the business is that if there is really a market for the product or service. The service must be able to deal with high demand and a large customer base. Is it right to offer the product for free.
- How will your business benefit from freemium?
Will the free plan improve your customer acquisition. What is the main benefit of offering freemium? Will it lead to increase in costs since the business will need to spend on resources for the free customers? Is it really good to acquire as many free customers in terms of financial viability.
- What will drive higher conversion?
What features will drive the free users to become paid users. Are there special attractive features with the premium plan that will drive conversion? If there are no new and attractive features available with the premium plans, why would any user upgrade to premium? Are the features available with the premium plan worth spending extra on?
- Can you monetize the non-paying users?
Is there a way to monetize the free users? Is it possible to advertise in these accounts for monetization? Businesses will need to focus on their pricing strategy in this area. Even if the free users do not become paying users in every case, many of them might be willing to spend extra on feature based add ons. Such simple add ons can also drive revenue growth from non paying users. A user might like to keep a free account but use some premium features as add ons based on his need. However, there are more ways to monetize a user base of free users.
- Can you gather actionable market intelligence from the users including free and paid subscribers?
It is an important question for the business. The free users also bring abundant data which can be used to understand user behavior and to improve the services. However, if the users interact with the system but do not generate any valuable data or revenue, then the business will not succeed.
A few last words:
The above examples show that the freemium model has worked in the case of some businesses quite well. All the examples discussed above are online businesses and enjoy solid brand awareness and popularity. While product and product quality are at the core of any business and important in terms of customer experience, even the freemium model cannot work if your services are not distinguished in terms of quality and user experience. Just any business cannot go for the freemium model since despite its attractions, it carries some heavy risks that can ruin your business. So, how would you know if the freemium model is the right choice for you? Businesses must consider several models before selecting the one that fits their business the best and will drive superior sales and profitability. The success of freemium model for your business depends on first the product/service and then on many more factors. Businesses must evaluate these risks before adopting the business model.
One thing that is essential for a business using the freemium model is conversion. Freemium will not work if the conversion rate is too low. This is where pricing comes into play. You do not need to bundle all the premium features together and sell it at higher prices since that will affect the conversion rate. You can offer them singly and only what the users need as Cloudflare or Candy Crush do. This will also drive higher revenue growth. So, even the most hesitant free users who do not want to convert may want to purchase a few features that they may find quite useful. While freemium can be great in terms of marketing, you need to have attractive and useful features for your premium subscribers to drive higher conversion. Why would any user buy a premium subscription if there is nothing valuable in it? The freemium model will work when the premium services are worth paying for.