Freemium: The Business Model Taking the Internet by Storm

In the past decade, the freemium business model has gained significant popularity among internet start-ups and smartphone app developers. By offering basic features at no cost and richer functionality for a subscription fee, freemium has enabled new ventures to scale up and attract a user base without expensive ad campaigns or traditional sales forces. This model has proven to be a sustainable source of revenue compared to the advertising model prevalent among online firms in the early 2000s. Freemium companies are more successful than 30-day free trials or other limited-term offers as customers find indefinite free access more compelling. However, despite its popularity and clear benefits, freemium is still poorly understood. In this article, we will explore the six questions that start-ups considering a freemium model should ask to make sure they get the most out of the model.

What should be free?

Start-ups must decide what features to offer for free and what to charge a fee for. If free offerings are not compelling enough, then it can be challenging to attract new users. On the other hand, if free offerings are too rich, it may limit the number of people who are willing to upgrade to a paid version. Thus, finding the optimal balance between traffic and paying customers is crucial, and companies should be prepared to tweak their strategy over time.

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Do customers fully understand the premium offer?

Communicating the benefits of the premium version of the product can be challenging. If customers don’t clearly understand what they would gain by upgrading, start-ups will monetize fewer users than they otherwise could. Companies that are successful in communicating the differences between their free and paid offerings can monetize more users.

What is your target conversion rate?

The percentage of free users who have upgraded to a premium plan is the conversion rate. A conversion rate of 1% is probably too low, indicating that the free product is giving users little reason to upgrade. A very high conversion rate isn’t necessarily good, as it can limit the potential acquisitions. The best long-term strategy is to aim for a moderate conversion rate coupled with a high volume of traffic.

Are you prepared for the conversion life cycle?

Conversion rates typically dip as the user base expands to include more price-sensitive individuals. Early adopters are less price-sensitive, so they are more likely to upgrade. This means that companies should be prepared to make investments in server space and customer service, which can be costly. Companies that don’t understand these realities may feel a cash crunch as the number of free users grows, and the cost of servicing them increases. Start-ups should be prepared to pivot if necessary.

Are users becoming evangelists?

Companies should recognize the value of free users, as they can help attract new members who become subscribers. A free user is typically worth 15% to 25% as much as a premium subscriber, with significant value stemming from referrals. Companies can increase the value of referrals by carefully managing referral incentives and communications.

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Are you committed to ongoing innovation?

Freemium should not be viewed merely as a customer acquisition tool. Companies that want to keep increasing upgrades must keep increasing the value of their premium services. Smart companies view freemium as a commitment to innovation.

In conclusion, the freemium business model is a powerful tool for start-ups to attract new users and generate sustainable revenue. However, it’s essential to ask the six critical questions mentioned above to ensure that the model works effectively for your business. Companies that successfully balance traffic and paying customers, communicate the benefits of the premium version, aim for a moderate conversion rate coupled with a high volume of traffic, prepare for the conversion life cycle, recognize the value of free users and are committed to ongoing innovation, will have a higher likelihood of success.

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