Is the freemium business model right for your tech start-up?

High risk and dead-end or the route to leads, conversions and revenue? A closer look at the fine art of making money by giving things away

Having the right pricing strategy has always been one of the most powerful tools for driving revenue growth.

But in today’s world – where recurring-revenue streams are invaluable to business success – getting pricing right is more important than ever.

For both consumer and business industries, the ‘freemium’ pricing model has become the norm in recent years.

The term “freemium” (“free” plus “premium”) was coined by Fred Wilson, a Silicon Valley venture capitalist, in a blog where he explained it as:

give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc, then offer premium priced value added services or an enhanced version of your service to your customer base.”

In 2015 we use freemium services every day – Spotify, Dropbox or Match at home, and Box, Yammer or LinkedIn at work.

Freemium apps now account for 71% of Apple AppStore revenues in the US, up from somewhere around 50% in 2012. And in the customer management category of SaaS companies, 32% used a freemium model.

Successful companies have shown that freemium models can drive leads, conversion, and revenue. But at the same time, freemium has also been portrayed by some nay-sayers as a high risk, dead-end approach likely to burden businesses with runaway costs and few paying customers.

How can you know if freemium is right for your business?

Giving your service away for free?

In the context of subscription-based businesses, freemium is a business model where a company offers a version of its subscription service to all customers for free. This free version is usually a more basic version of its bells-and-whistles paid service.

The idea is that once customers fall in love with the free version, they’ll purchase a subscription for the more advanced version and spread the word about it to others.

For a service that’s new to the market, offering a freemium version can be a quick way to drive trial because it significantly reduces barriers to entry. This in turn makes the product more sharable, helping to build word of mouth.

Companies such as WhatsApp, Evernote, and Spotify grew their user bases unbelievably quickly because they gave core elements of their service away for free.

Spotify is one of the best examples of this journey. Right out of the box the company focused on building a loyal customer base through totally disrupting how we consume music overall.

Its free adoption model meant its service was almost totally driven by word of mouth, with consumers across Europe encouraging each other to sign up to the service.

Monetising your user base

The key question however, is how to convert free users into paid subscribers. Will consumers pay for digital content? Of course they will and they already do. Look at the Wall Street Journal, Financial Times, even Netflix.

If the right business conditions are met, a freemium model is more than just building out a user base – it can help drive faster revenue and profit growth than a paid-only model.

To monetise its burgeoning user base, Spotify needed to convert its free users to paid subscribers. To do so it presented them with a clear and compelling migration path, and focused on making this journey as easy as possible.

Through clear communication of the premium benefits such as unlimited, ad-free streaming, Spotify has successfully ensured that a significant portion of its users converted from free to paid subscribers.

At the start of 2015 Spotify had 60 million users including 15 million paying subscribers – more than 80% of these subscribers started as free users.

Headspace, a meditation and mindfulness app, is another great example of how a small company can succeed with a freemium business model. The app includes a free 10-day programme where users can learn the basics of meditation in just 10 minutes a day. If they enjoyed the sessions and want to learn more, they can subscribe to get access to lots more content.

The importance of educating your customers

Despite the success of companies such as Spotify, LinkedIn and Box, freemium models are not always easy to get right. They can often seem like a great deal on the surface, but compromise on features, performance, and customer service under the bonnet to justify making them free, and differentiate them from their premium counterparts.

Paying customers on freemium sites are often not aware that they’re receiving the same infrastructure as the millions of free customers, which means that, essentially, they’re subsidising them. Even those who are aware of this fact still don’t know what premium features to look for or what additional benefits to expect. But if they do, they are more willing to pay for it.

Customer education is key to this journey. They should understand the kind of value that they should be receiving through paid subscriptions and why this matters. You should also make it beyond easy for them to take the leap to become a premium subscriber.

By investing in creating a seamless transition strategy, and making calls to action so compelling that people can’t help but upgrade, the freemium to premium transition can become seamless.

Tamsyn Attiwell is VP global services EMEA at subscription technology and consultant company Zuora, which earlier this month secured a $115m investment.

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