Freemium Business Model: an In-Depth Guide

With a tremendous shift toward online businesses that drive changes in strategic approaches and tactics applied, optimal business models and potent marketing tools that make a success tend to change too.

Thus, dating back to the 1980s, the freemium business model is enjoying its hour of triumph now and dominates the market of online projects and digital startups. If you’ve ever used Linkedin, Spotify, Dropbox, or Hulu, you’ve already experienced this model in full play.

In this article, we’ll take a close look at the major concepts, principles, and methods of the freemium model and consider how Internet companies can take the advantage of it and implement it in their businesses.

Freemium: What Is It?

The term stems from two words “free” and “premium” and stands for a type of business model, marketing tactic, and pricing strategy that offers a basic product or service at no cost. That basic version usually embraces an entry-level set of features and capabilities.

And to access full-fledged functionality, a customer will have to get a payable version.

Also known as the Internet business model, it is most commonly used by Internet startups and app developers. It is also favored by such industries as media and gaming.

The idea behind the freemium model is to draw an extensive user base using the free product and service versions, and then, convert those users into customers by coming up with premium features that will bring the user experience to yet another level and that users will have to pay for.

This model gets more and more popular in the software industry since it ensures quick scaling for businesses by providing low-barrier entry for potential customers and still enabling companies to generate revenue from those users who are willing to pay for add-ons.

How Does the Freemium Model Work?

A standard approach to business and commercial activity is to make people buy your product or service. This is how it usually works, and the whole sense of any business is gaining profit.

In general, the final goal of the freemium business model is the same, yet, the strategy is somewhat different. Today, marketers strive to establish strong brand awareness in the first place to hit a larger target audience, achieve higher recognizability, and build a solid trust-based customer pool as a result.

It’s a product-driven marketing tactic supported by the freemium model as well.

To be more specific, here is a simple step-by-step freemium algorithm describing how this model works:

  1. Free offer covering a stripped-down product or service version, which is limited in useful features and capabilities;
  2. Premium features upsell is meant to offer more perks and benefits for a fee, thus, delivering more value and getting users hooked by the top-tier add-ons;
  3. User conversion into paying customers implies that free users will like and get used to a free version enough to upgrade to the premium;
  4. Monetization through other means works to make users become paying customers through advertising, sponsorship, or selling user data if they are not eager to upgrade to the premium.

The freemium model seeks to win customers’ trust by allowing users to try the products or services and estimate their values. Such an approach is aimed at persuading the user and intrinsically pushing them to purchase.

Freemium vs Free Trials: How They Stack up

At a glance, freemium resembles free trials. Do they use the same principles? Or are they different? Let’s figure it out.

While a freemium approach provides unlimited free access to a limited set of features, free trials unlock premium access for a limited period of time. Normally, a trial period ranges anywhere between 7 and 30 days.

Marketers use free trials to show their products or services to the best and let users get a firsthand experience and make use of all the advantages. This way, customers could “feel” the whole potential of the product or service offered and better understand if they need payable extras.

This tool is a great option for marketers that provide complex professional solutions.

Free trials make users decide upon turning to a paid plan faster. Hence, companies using this tactic generate revenue quicker, with an average user-to-payable-customer conversion rate of 30%.

The downside, though, is that a given trial period might turn out to be not enough for the user to grasp all the pluses of the product or service and make a decision in favor of the purchase.

Overall, for startup projects and simple products struggling to win over a large customer base, a freemium strategy is a more suitable and promising alternative.

Freemium Pros and Cons

No business model is perfect. So is freemium. It comes with a number of benefits and a few drawbacks you should be aware of before implementing it for your company or project. By weighing the pros and cons, you’ll be able to make a well-reasoned decision and get the most out of it while smoothing over the difficulties.

Pros – The Freemium Appeal

In the era of online businesses, the freemium model owes its increasing popularity among software companies and Internet startups to the following benefits:

  • High customer acquisition potential: A user will be neither required to provide credit card data nor pushed into buying anything over time. This approach breaks down any customer barriers showing the vendor’s interest and eagerness to establish long-lasting relations with customers-to-be. Users who are hesitant to pay for something they are not familiar with will get a chance to test the product. And vendors will acquire customers in a more natural and less stressful way;
  • Lower customer acquisition cost: Many companies come up with discounts, bonus programs, benefits, and other bells and whistles to acquire customers. A product-driven business growth model, though, uses the product itself from the start as an incentive and the major attraction. Users feel that they are treated fairly and are given an opportunity to try the relationships before making any commitments. And companies can greatly save on time, energy, resources, and marketing efforts they’d need to acquire customers;
  • Improved customer retention: First attracted by a zero price, users get used to a product or service over time and become reluctant to switch to something else. This helps build brand loyalty and trust, and results in higher customer retention rates;
  • Revenue generation: Once users are engaged with the product, they might be more likely to get a paid version for additional features to match their needs. Besides, popping up ads for free users might push them into buying an ad-free plan, thus, enabling companies to monetize on other marketing methods;
  • Competitive advantage: In crowded markets, it’s vital to stay ahead of the competition to succeed. Free-of-charge products or services will let the company stand out among the rivals in its niche and gain a valuable competitive advantage;
  • Testing and feedback: A free version can act as a testing ground for new features and ideas enabling marketers to gather feedback and iterate on the product or service before releasing it to paid users. A data collection function will let companies stay on top of customer needs and timely enhance their product profiles to match them.

Cons – The Drawbacks to Consider

With a bunch of benefits to it, the freemium model has a few weaknesses or flaws as well. Though they don’t outweigh the pluses, marketers should take them into account when planning to use this model as a base for their ventures.

  • Revenue risks: You can’t be 100% sure about the part of free users that will turn to premium. Hence, the revenue generated can be unpredictable making it difficult to plan and manage finances. Besides, the reliance of the company revenue on a smaller group of paying customers can create a risk of revenue loss if those customers leave;
  • Conversion difficulties: Converting free users to paid customers can be challenging, especially if they don’t see the value of the premium version or the price doesn’t fit their budgets. In addition, they might be reluctant to switch if the premium bundle doesn’t meet their expectations. In this case, they might also feel dissatisfied and even leave negative reviews;
  • High maintenance costs: Though free users will function as your promotion team in a way, they also need to be maintained. This will affect the resources your company will have to allocate for customer service and technical support;
  • Negative brand perception: If a free version is too skimmed, lacks important features, or is of poor quality, it can negatively impact the overall brand perception leading to the loss of trust among potential customers.

Freemium Model Use Cases

The freemium model is not new. The whole concept emerged decades ago and got up steam only in recent years after its adoption by a number of global giants that took the most out of it. Here are a few examples of freemium use by Internet-based companies.

Skype

Skype connects millions of users across the globe allowing them to communicate via text messages, audio or video calls, or even online conferences. The software is free and the use of online functions is free as well. However, they also offer advanced services such as calling landline or mobile phone numbers.

Notably, the rates are lowers than conventional phone company and mobile operator charges. Hence, the payable phone service is of great use for international calls.

Spotify

Both free and premium users have access to the same music resources. However, a free subscription comes with built-in ads and a limited number of “skips” on songs. While some users don’t care about those limitations too much, true music lovers appreciate the music quality and flexible control options they get with a paid subscription.

The company is one of the most successful freemium model users. They boast an impressive 45% conversion rate, and in 2019, their global pool of paying subscribers accounted for $100 million users.

Dropbox

In 2008, Dropbox appeared as a file backup service. Actually, it was one of the first cloud storage as we know them today. The company owes its success to the freemium pricing model to a great extent.

They offer 2G free storage to new subscribers. Besides, they have free trials for top-tier subscription plans too which gives customers an opportunity to try all bells and whistles of the premium service. As they reach the storage limit, many free users would rather prefer to continue with a paid subscription than switch to another platform.

With a 4% conversion rate, Dropbox lags behind Spotify, yet, this rate is excellent for the tech industry. As of 2023, the platform has 700 million users, and 15 million use premium accounts.

Zoom

Predominantly a tool used by office workers across their workplaces, this video conferencing platform gained a totally different meaning during the pandemic. It became means of daily remote communication for billions of people in the world.

The platform offers free service and even allows for video meetings with 100 participants. However, the session duration is limited to 40 minutes. Paid plans, though, start at $150 and offer more capabilities for businesses.

An interesting fact is that despite predominantly free service, the company has increased its revenue by 326% between 2020 and 2021.

Canva

It’s yet another representative of the high-tech world that took an advantage of the freemium model. Today, the IPO valuation of Canva is $40 billion. An alternative to Adobe Photoshop, the software is a comprehensible and functional tool for non-professional graphic designers. And it’s free.

For those who have already honed their skill and seek professional add-ons, the company offers a Pro plan at $13 per month and an Enterprise plan at $30 per month. The latter is a choice for businesses.

How to Convert Freemium to Premium?

Conversion is one of the freemium factors you can’t be sure about. And this is one of the key aspects determining future revenue growth and profitability. So, how to reap the best marketing and networking effects of the freemium model and avoid the risk of poor conversion?

Though there is no one-size-fits-all solution, there are a few tips that will help companies develop the right freemium strategy resulting in conversions:

  • First and foremost, the more feature-rich your free version is the lower the chances for conversion. Make sure a free product is a quality one yet avoid including too many features that will make premium offers less attractive;
  • Let your users see the difference between free and payable versions and show how they will benefit from premium features. Use emails or in-app notifications to give more info;
  • As free users use a free product or service, come up with personalized offers based on their needs and preferences. Not only will this show your dedication and care but also will entice them to use paid features;
  • Use adverts in your free app or software versions. While this will help you monetize on other marketing tools, it will also push free users to buy an add-free version since most often than not, we don’t like online ads consistently popping out here and there.

When it comes to an optimal conversion rate, it falls anywhere between 2% and 5%. It’s worth noting that a too-high conversion is not always good since it might signalize the poor quality of an entry-level product. And moderate conversion rather indicates consistent long-term growth.