A Freemium Business Model - Is It Still Appealing?January 17, 2016
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We are often asked by startups whether or not they should consider the freemium option for their business. Should we try it? Is it still appealing? What does it really mean? We decided that the best way to answer these questions would be to write a blog explaining freemium - its pros, its cons and the mistakes you need to avoid.
So here it goes...
The concept of Freemium is now a very accepted and widely used term in the digital apps and SaaS tool world, but before 2006, it was still waiting to find its way into our digital dictionaries.
Freemium, a combination of the words "free" and "premium," is a business model where the company provides a free service or software to customers. This service is usually a basic, scaled down version of what the company offers as a premium paid service.
The phrase was coined by Fred Wilson, a Silicon Valley venture capitalist, in a blog where he explained the process as “ giving away your service for free…acquire a lot of customers... then offer premium price value added services to a customer base”.
Fast forward to 2015, and we are using Freemium services every day– Spotify or Dropbox at home, and Box, Mailchimp or LinkedIn at work.
Freemium: Business Model or Marketing Tactic?
Freemium apps now account for 71% of Apple AppStore revenues in the US, up from somewhere around 50% in 2012. And in the customer management category of SaaS companies, 32% use a freemium model.
Since its increase in popularity, marketers have been labelling Freemium as a ‘marketing tactic’ when in actual fact it is a ‘business model’. What usually tends to happen is that R&D develop a product and during the beta phase it is provided for free to select customers. Then starts the discussion of what should be provided for free for general availability and what should be paid for. What follows is a lengthy process of trial and error of pricing and features packages, in the quest of the holy grail that will hook in enough users for free and convert some to paying.
Why the increase in freemium
With the tough competition on the market, it is almost impossible to get a consideration without offering a free version. Successful companies have shown that freemium models can drive leads, conversion, and revenue.
For example, in 2009, Mailchimp announced that it would be switching to the freemium model. In one year, Mailchimp managed to increase its users from 85,000 to 450,000.
In the same year, Hootsuite launched their social media management platform and chose to adopt a freemium model as a way to tackle their non-existent marketing budget. With 5 million customers in 2015, it seems that this business strategy certainly paid off. In terms of storage and sharing products, Dropbox and Evernote both managed to soar to success by keeping a firm cap on their freemium models at all times, while also providing enough reasons for users to turn ‘premium’.
In the app world, in 2010, 85% of the top grossing apps were paid downloads, in 2014, 80% of the top grossing apps were free. Big difference right?
There’s a number of reasons why this might be the case
- In-app marketing: Developers and their marketing teams have come up with more creative ways to monetize their user base without needing to rely on users making an initial purchase. For example, last year Kik introduced an additional feature called ‘Promoted Chats’ allowing brands to chat directly with Kik users for a set price.
- Advertising: No surprise. Advertising allows companies to monetize their app without compromising the user experience. Of course, extra advertising can run the risk of users getting frustrated with your app and then abandoning… but they can still continue to enjoy the product for free.
- Easiest way to get new users: Whether we like it or not, we have created a chicken and egg scenario where users often see a dollar sign and just don’t want to hit the download button. Users are no longer interested in simply putting money towards an app that they can’t try first. In fact, the survey below indicates that users would prefer a free app with in-app advertising to paying for the initial download.
But freemium isn’t always smooth sailing - startup’s would be kidding themselves to look at freemium only through rose coloured glasses.
Most SaaS companies have a free user to paid customer conversion rate of 25% or less. That means in most cases 75% of free users will never convert. For some companies, that number is closer to 90%. For apps, 95% of free apps are deleted within the first month and 20% of free apps are used only once. These conversion rates do not have to be accepted as an immovable metric.Targeted marketing, email campaigns and re-engagement can boost your conversion rates much higher than the average. However, it is important to know the pros and cons of freemium in the early stage of your startup’s business development and before you jump into the deep end.
The Upsides of Freemium for Your Startup
Potential Paying Customers - Of course, the entire reason why we consider Freemium models is in order to eventually attract paying customers. In essence, Freemium is a version of ‘try before you buy’. Skeptical users will have a chance to see how the product works and how it advantages themselves and their business. Think of companies like DropBox or Linkedin. They provide you with enough of the product to be happy with it, but leave just enough out to leave you wanting more.
Network marketing - What’s the cheapest and most effective form of marketing? Word of mouth. The more readily available your product is to use, the more people are going to try it, talk about it and yes… even blog about. Yep that’s right… people love blogging and sharing their thoughts on new products and the more available it is, the more they are going to talk. We are not suggesting that this should be your only marketing strategy, but it’s definitely worth considering.
Customer Quality - When customers buy an upgrade, they know that your product can help them solve a pain they have. They’ve invested time in working with your product on the free version and are now ready to commit.. On a psychological level they are attached to your product and believe in it. This means that they will value the product more, feel more in control and be less like to ‘abandon’ the product. These customers are also more likely to become your brand ambassadors.
Test Your Product – Freemium increases your audience size, providing the perfect opportunity for you to test product features. You can build and change your product far more easily. It is the perfect opportunity to test different scenarios. Ask yourself: What do my users like and what don’t the like? What features are encouraging them to upgrade? What features are they actually using? A Freemium audience is the best audience to try new features. See? Free really does work both ways.
The Downsides of Freemium for Your Startup
Fixed cost coverage - Users might be receiving your product for free, but they will still be producing the same overheads as paying customers and will usually still be expecting the same customer service. If conversion rates to premium versions are less than 15%, this can have a negative effect on reaching your company’s ROI. Often, the solution ends up being an increase in premium pricing, where prices are raised for paid customers so that they can support free customers. There is a delicate pricing balance that customers believe they are receiving value for money. Increasing premium pricing beyond that level may result in creating an unappealing and unsellable product.
Lowered Value – As stated earlier, customers tend to value products that they have paid for. This means that chances are you will have a higher churn rate your app. On the downside, it also runs the risk of customers thinking that if the basic package is free, then all versions offered by the seller must be worth very little.
Honesty (or a lack of) – Whether we like it or not, people tend to take advantage of free and don’t always treat the benefit as they should. Particularly with Saas B2B products, it is common to find that more than one member of the same company is using the product (which can be problematic in certain cases.) If the freemium version is only offered for a limited time, companies also often use more than one employee to access the product. Equally as challenging can be the knowledge that your competitors are able to sign up and enjoy your product/service for free, increasing competition in the market.
But don’t lose hope!
Marketing Envy’s Tips for Getting Freemium Right – Mistakes Your Startup Must (or at least try) to Avoid
Mistake Number 1: No compelling reason to upgrade.
Nobody will pay to upgrade if they don’t see a good reason to do so. This might happen because:
- a) The freemium version is too good. In other words, you are giving your users pretty much everything they need to get the most out of your product and they therefore don’t see the need to dig into their pockets.
- b) The premium version isn’t appealing enough. You need to make sure that what you offer in the premium version is exactly that…. Premium. Customers need to be getting some golden nuggets in their deluxe product.
Mistake Number 2: Not guiding potential buyers down the road.
The only way they are going to pay for an upgrade is if you gently guide them throughout the process. You need a very clear nurturing process from the moment they sign up or download - welcome emails and sending users ‘tips and guides’ for how to make the most out of your website/app are a must. Deliver high value customer service at all times and continuously advertise the option to upgrade to premium. These may seem like simple or obvious ideas but it’s important to think of strategies to get freemium customers through the rabbit hole.
Mistake Number 3: Forgetting to track the numbers
Mastering Freemium means getting your head around the metrics. Data and numbers abounds and you need to be constantly going back to your spreadsheet to get answers to:
- How many users do I have
- How many sign up weekly/monthly
- Where are they coming from
- Which feature is being used most/least
- How long do people spend on the product
- When are they using it?
- How many are upgrading?
- At which point in the lifecycle?
- Why are they upgrading?
Getting Freemium Right = Finding the Balance
If you decide to go ahead with it, then you need to make sure you strike the balance between offering users something they can’t live without, but also leave them wanting more. As with all startup marketing, think carefully, plan ahead and go with your gut, because real success is truly priceless.