Freemium has become a popular business model for Internet based companies over the last couple of years. A Freemium business model is where a product or service is provided free of charge, with the option of upgrading to a paid for version of the product with extended features or increased usage.

Freemium business models are usually implemented for digital products or services where the cost of adding an additional user is negligible. Cloud Storage, Online Games and Productivity Software as a Service are typical examples of products that use a Freemium business model.

A Freemium business model works because the revenue generated from the small percentage of paid users is enough to sustain the usage of the entire user base. Freemium is an attractive option for product developers because it reduces the barrier to entry to a product, allowing customers to try for free. The challenge is therefore to convert a large enough amount of free users to premium users.

The term Freemium was coined after this 2006 blog post by Venture Capitalist Fred Wilson, My Favorite Business Model.

Variations of the Freemium business model

The Freemium business model comes in a variety of forms.

Advertising supported content

The most common version is simply content that is supported through advertising. This is obviously not a new online business model as banner advertising has been around for years. However, it is going through a renaissance period with the likes of Facebook, Twitter and Tumblr integrating contextual advertising through the activity stream.

Time or usage based

The second oldest form of Freemium is the time or usage based plan. This is where a user will get access to the full product for either a limited amount of time, or a limited amount of usage.

Advanced features, capacity or “seats”

With a lot of modern Software as a Service products, pricing plans are usually defined by the available features, capacity or the “number of seats”.

Typically a user will have unlimited access in terms of time and usage to a product but the available features or capacity will be reduced. This allows the user to become invested in the product so that upgrading to a paid plan becomes inevitable through their continued usage.

A product that is based on “seats” would typically be a Project Management or team based product that would be used by a business. This enables the business to increase their licences as they grow larger, or reduce their spending if they reduce their staff.

Virtual goods in-app purchases

With the rise of Zynga and the ability to make one tap payments in smartphone applications, in-app purchases have become extremely popular. There is now an opportunity to create a game and aim for a large amount of users with a free product. You would then look to monetize the power users with in-app purchases.

Freemium success stories

Two of the largest Freemium success stories are DropBox and Evernote.

Both DropBox and Evernote give their users the opportunity to register and use their full product for an unlimited amount of time.

This allows their users to sign up for free and use the product without restrictions.

Once the user has used all of their free capacity, they can opt for a paid premium plan. Obviously by this stage, the user is more than happy to pay for a premium version of the product because they are already so invested.

Why does Freemium work?

Freemium works for a number of reasons.

Try before you buy

Firstly, it allows users to try a product before they need to make a commitment. If your product is something of value like productivity software, it’s important for a user to be confident that it will fit their purpose. In the case of DropBox, it allows a user to quickly solve the problem of transferring files between computers.

Greater user acquisition

When your product has a free plan, you will likely experience better user acquisition from cold traffic to free users of your product.

It is extremely difficult to convince someone to make a purchase when they are landing on your website for the first time. If you are able to convert cold traffic to free users, you are more likely to be able to convert that user eventually into a paid user.

Network effects

If you can integrate Network Effects and a growing your Viral Coefficient you can acquire user’s through your current user base. This is far more efficient way of acquiring users because you are leveraging your current users for free.

Why Freemium doesn’t work

There are also many reasons why Freemium doesn’t work.

Incorrect Product DNA

Freemium only works for a limited type of products and services. Unless you have a product that already has the ability to restrict certain advanced features or capacity in such a way that encourages usage and conversion to a paid plan, you will struggle to make Freemium work for you.

It shouldn’t be difficult to see how your product would fit into a Freemium business model. Ideally, you should plan the business model from the outset because it is extremely difficult to iterate yourself into something that works.

No Network Effects or a low Viral Coefficient

Pinning your hopes on user acquisition through Network Effects can be difficult because it is hard to find the right product and opportunity to fully take advance of it.

DropBox grew very quickly early on because of it’s “invite a friend” scheme. DropBox incentivised it’s users to invite their friends by giving them more capacity for every friend they introduced.

If you want your users to actively recruit new users for you, you need to offer a similar incentive program that adds real value to their user experience. DropBox is essentially giving away the value they hope to monetise. There is no point incentivising users with something they do not care about.

You need a large market

In order to really create a sustaining business from Freemium, you need to be able to acquire a very large number of users. Typically you will need to have over a million users to grow a company if only a couple of percentage of your total users convert to premium users.

Freemium doesn’t really work with niche products because you wouldn’t be able to get those types of numbers. If you product is niche, you need to be converting a much higher number of users. However, even then, the potential growth of your company will be limited.

When looking for a business opportunity to attack with a Freemium business model, you should go for a universal problem that is experienced by a wide variety of demographics and has a large number of use cases.

It is not a solution to no traction

If your product has been live for a while now, and you are experience very little traction, a Freemium business model is unlikely going to be the fuel that grows your business.

If you are really struggling for traction, you should take a hard look at your product to see why it is not wanted by the market.

A Freemium business model might increase your user acquisition by allowing people to try your product for free. However, this is futile if your product is not good enough to eventually convert that traffic into paid premium users.

Freemium is still a lottery

Freemium is not an easy solution to the “What’s my business model?” conundrum. Freemium relies upon rapid user acquisition and market dominance. If you already have a strong competitor that is acquiring customers at a quicker rate than you, you are in trouble.

The problem you are solving needs to be clearly defined if you want to succeed. With one strong market leader, you need to be in a position to be the first company in mind when a user needs to solve your problem.

Freemium is very much still a lottery and is not an easy business model option. If you think you are going to struggle to become the undisputed market leader, perhaps it’s better to aim for a more conservative Software as a Service subscription model that does not utilise free as a option.