Nov 26, 2021

How to Execute a Freemium Business Model

Business Model Innovation
Business Model Pattern
by Maximilian Böger

The rise of SaaS and mobile apps has created a relatively new business model pattern known as freemium, a term that cleverly combines the words ‘free’ and ‘premium’ to perfectly describe the model. Freemium was coined in 2006 by Silicon Valley venture capitalist Fred Wilson and is commonly used by technology companies.

Freemium is a combination of the words ‘free’ and ‘premium’

How Freemium Business Model Works?

The term describes companies that offer services for free, but users are met with a paywall if they want full access to the business’s value proposition. One of the biggest challenges internet-based companies has is gaining sufficient traffic to generate a profit. By offering services for free, freemium companies gain a substantial number of users, more so than if they charged for initial access.

Offering additional features for a fee has proven to be a viable model for companies like Spotify, Dropbox, and Mailchimp, but successfully executing can be challenging. Deciding on the services to offer for free and what requires an exchange of payment can make or break the model. Business operators have to provide enough value to gain adoption and retain users but provide valuable features for a fee.

How Freemium Makes money? - Essentials of a Freemium Model

There are multiple ways to make money in a freemium business model. Some Saas companies offer a baseline of services for users that is beneficial but not sufficient for commercial use. For example, there are countless free SEO tools online that will give you basic analytics on a search term. However, to fully utilize the tool, users will have to pay a monthly fee. The baseline may work but won’t give extensive results needed to execute an SEO marketing strategy. The model works by producing users and converting them once they feel for the tool and see its value firsthand.

Many freemium business models include streaming services that offer their platform with ads for free. The business bets on attracting a user, building a relationship, and converting to a premium membership. This revenue model is a win-win for companies because they can generate income from ads for users who don’t want to pay for a membership.

While there are different revenue models, all freemium businesses offer essential services and charge for additional value.

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Pricing of Business Model Ideas

Offer Basic Level Services

A successful freemium model must focus on their basic level services. Creating a solid relationship with the consumer is key to converting the paid user. Showing the service is worthy of their loyalty is fundamental to the model. The free version should give insights into the UI, features, and usability. The perfect model offers an incredible service with clear limitations that can be lifted after a transactional agreement is made.

Charge for Additional Value

Leaving out critical features is what separates a freemium business model from a free trial. Freemium businesses present a quality service but are strategic to what is left out. Spotify does an exceptional job of demonstrating its value proposition in the free version. Using the music streaming service without paying a monthly fee demonstrates the capabilities; all the content is accessible, but the user won’t fully enjoy it with an ad playing every few songs.

Choosing what to offer for free and what to hide behind a paywall can be challenging. The best approach is to review what has worked for successful freemium companies.

How to Successfully Convert Users

Persuading users to convert from a free to a paid account is the basis of the freemium model. Your baseline product needs to communicate the full potential of your services when also providing functional features.

Build a Strong UI/UX

Focusing on the user interface (UI) and user experience (UX) is essential to building freemium software. If the user doesn’t like how the content is organized, they are unlikely to convert to a paid subscriber.

Your strong UI should display all the functionality available in the paid version. Users should be able to view the capabilities of the application even if they haven’t paid. SEO tools that offer services for free will give data on keyword terms but only show top results. For example, if you search ‘sneakers,’ they will return the search traffic and competition data for the term but leave out long-tail results beneficial to 99% of companies looking to rank pages.

A successful freemium strategy communicates how the premium services offer additional value through the free version; the best way to do this is by focusing on the interface and user experience.

Withhold Key Functionality

Typically, a good conversion rate falls between 1% and 5%. Most freemium businesses struggle to convert the vast majority of their users. Dropbox has a conversion rate of 4%, which generates an incredible amount of income for the cloud storage company and continues to grow. Becoming profitable with the freemium model can mean that most people are using the service for free, but the 1-5% generate enough revenue to turn a profit.

Dropbox has so many users that they don’t need a tremendous conversion rate. The company withholds enough storage capacity that commercial businesses need to pay for their services. The casual user looking to back up photos or share text documents may not need to pay for a premium account.

However, there are exceptions to the norm. For example, Spotify has a conversion rate of over 25%. Part of the reason is that free users can’t download songs to their local storage. Spotify has successfully presented its service without hiding any content but withheld enough functionality to get one-fourth of its users to pay $10 per month.

How to Make a Freemium Business Model

Providing a fantastic service will always be the driving factor for success regardless of the business model.

Making a successful freemium business begins with the product. Offering value is the most important part of the model. Dropbox is so successful because they were one of the first companies to offer cloud storage to the masses. The company’s freemium structure was necessary because most people weren’t accustomed to using the cloud to store their digital property.

Freemium only works if your business offers a hierarchy of services and can afford to give users free access. SaaS companies frequently use the model because they would have to build out the infrastructure regardless of if they were offering free services or not. However, the model only makes sense if you need to drive traffic and provide a hands-on approach to communicating your value proposition.

Discerning if your business should utilize the model is challenging. You may be better off giving new users a free trial to the platform rather than limited access. Looking at examples from companies that experience success using the model is an excellent way to decide if freemium is right for you. In addition, you can compare models with competing companies for the opposing perspective.

Examples of Successful Freemium Business Models

The four companies below are utilizing successful freemium business models examples. Each model gives users basic functionality but requires a payment to experience the true potential of the service.

Dropbox

Dropbox offers users 2GB for free. The first tier of the paid plan bumps up the storage space to 2,000GB, a significant increase in space for $10 per month. Dropbox Plus also gives users access to additional features such as smart syncing and remote device wiping. The extra features are nice to have, but the overwhelming value in cloud storage and file syncing platforms is the amount of space the user can work with. 2GB isn’t much if you want to save images or video.

The cloud storage company also offers free trials to incentivize users to upgrade their account. Dropbox members using a free account can access more storage for 14 days; after the free trial is over, they have the choice of removing their files or upgrading their account.

SugarSync

SugarSync is one of Dropbox’s direct competitors. However, the company doesn’t have near the market share of Google or Amazon. Therefore, SugarSync must offer more value to attract consumers looking for alternatives to the household name tech giants. The free plan gives users 5GB of free storage. While 5GB still isn’t much, it is over double the amount of storage offered by the competitor.

Paid plans for SugarSync are also less expensive and offer a better user experience. To stay competitive, companies like SugarSync must differentiate themselves from the companies with vast resources and name recognition. SugarSync users report that the platform is better organized and makes syncing files much more accessible than Dropbox. However, the company is fighting an uphill battle with the most powerful tech companies on earth.

Zoom

Video calls took off during the COVID-19 lockdowns. As remote work is becoming the norm, companies like Zoom who offer telecommunication tools, are seeing incredible growth. Zoom’s free version is adequate for users looking to chat one-on-one, but group meetings are limited to 40 minutes. Organizations running operations through video conferencing don’t have time to log out and log back in every hour—zoom benefits from being a top solution in their sector but profits off providing business communication solutions.

Spotify

Spotify is one of the most successful freemium models in existence. The streaming platform has secured the largest market share at 32%, doubling its main competitors Apple Music and Amazon Music.

The success of Spotify is mainly due to its accessibility. Apple, Tidal, Amazon, and Google don’t offer access to their platforms for free. Spotify takes advantage by selling ads. The company’s expansive reach has furthered its streaming dominance by attracting exclusive deals with the largest podcasts like “The Joe Rogan Experience” and “Call Her Daddy.”

Advantages and Disadvantages of Freemium

The advantages of a freemium model consist of driving traffic and giving users a feel for your product. Successful models generate a ton of users and convert enough to stay profitable. Countless SaaS companies benefit tremendously if they can afford to support the free users.

The disadvantage of choosing a freemium model is offering services for free and relying on revenue solely from a small percentage of your user base. Building infrastructure to provide for free is a great way to burn through cash. Choosing a free model usually requires a massive capital investment.

While freemium models will generate more potential consumers, adding users creates more overhead. Before moving forward, you have to clearly identify what percentage of users you need to pay for services and decide if it is possible to stay financially viable.