The Wall Street Journal recently published a report on freemium models, “When Freemium Fails.” The report examines the challenges faced by companies hoping to sell a premium product to customers who start out as free users.
Freemium is a portmanteau of the words “free” and “premium” and refers to a marketing tactic that has brought success to companies like LinkedIn and Skype. However, as the WSJ article points out, companies like Chargify and MikenGreg Games, the maker of Gasketball, were nearly devastated by their use of the freemium model.
These companies were on the road to bankruptcy until they placed a pay-wall in front of their formerly free product. It’s interesting to note that this situation appears to run counter to the trend we discovered in our article “Pay to Play vs. Free to Play,” where online video games are increasingly dropping their pay-walls and allowing users in for free.
Suffice to say, the case for freemium is not entirely clear. In some cases, it encourages a large user base and a strong revenue stream. In other cases, it leaves a company with a large user base but little revenue. For those wanting to build a bigger user base through freemium, it’s best to start with definitions and proceed with eyes wide open.
Freemium is not a free trial
Freemium is not a free trial. A free trial allows a user to use a premium product for a limited amount of time, like 14 days or a whole month. Once that deadline arrives, access to the program is denied until payment is submitted (think Microsoft Office).
With freemium, a user can access a basic product for an unlimited amount of time. However, if users want to access premium features, like LinkedIn’s InMail or Skype’s group video chats, they must submit payment.
In some cases, like a LinkedIn premium offer, companies may offer a free trial of the premium product to the freemium users in an effort to convert them to paying customers. But access to the basic program or service is never denied.
The benefit to users of freemium products is that they can set their own timetable. This advantage allows users to familiarize themselves with a product’s capabilities and limitations in the course of normal use. It becomes less of a challenge to convert a user if they have already invested a lot of time in a product and understand exactly what useful features become available by upgrading. Of course, not enough users may upgrade, and that will cost your business in the long run.
The benefit of a free trial is that it creates a sense of urgency in the user to upgrade and results in more sign-ups and conversions. However, users may also feel like they are on the clock to figure out whether the product truly suits their needs. If the product does not suit their needs, they may become frustrated by the interruptions from desktop ads informing them the trial has expired and it’s time to pay. This situation does not arise in a freemium environment. In short, where free trials create pressure, freemium products create enthusiasm.
Freemium is not a business model
Freemium.org describes freemium as a business model where a company gives away a free product hoping to sell a premium product to a percentage of their users.
With all due respect to Freemium.org and Wikipedia, freemium is not a business model because it neither tells you what the product or service accomplishes, nor how it generates revenue.
You will notice two components to Freemium.org’s definition. There is a gift (marketing tactic) and a sale (source of revenue). The gift is a way of advertising the product and creating customer engagement. The sale of a premium product is the revenue source, the way that a company creates sustainability and value.
So, even though freemium is often called a business model, it should not be confused with a revenue source. Only a tiny portion of your free user base will convert to paid consumers (typical conversion rates are 1% to 2%). Freemium is really a marketing tactic, a way to build brand loyalty and create enthusiastic fans.
Understanding your marginal costs will clarify whether freemium is the right choice for your basic product. While software and other digital goods are relatively cheap to replicate and distribute, even on a global scale, there are still costs for supporting a business. There are offices to lease, employee salaries to pay, and other operational expenses in the form of websites, server space, advertising, etc. Without external funding or a solid conversion rate, freemium can make it difficult for a business to keep the lights on in the office.
Examine the market
The next thing to examine is the type of product or service and how it plays in its market. Are competitors offering freemium products successfully? Typically, freemium is a useful marketing tactic if a product or service:
- Relies on advertising revenue to support offering the product for free
- Facilitates interdependent networks, creating crowds that attract crowds
- Constantly has its features refined and has cultivated a large base of enthusiastic users who provide feedback
- Appeals to early-adopting individual users who influence business purchases
The freemium model is not a silver bullet. It is a marketing tactic that your company should consider, but not treat as your fundamental business model. In other words, don’t automatically assume that you can sustain your farm by giving away your crops for free.
Eric Bingen contributed to this blog post
Leave a comment telling the Building Keystones’ community about your experience as a merchant of freemium products.