Going Freemium: Will This Model Work for Your Business?

The "freemium" business model is a pricing strategy in which you give away your core services for free and then offer premium services for a fee. This tends to work well for companies (often, software or Internet companies) where the free product can be shared cheaply and widely; you simply restrict your services for the free version, offering limited features, capacity and support.

Skype, for example, is a freemium service that enables users to place audio and video calls over the Internet for free, but then charges for additional features like voice mail, calls to land lines, handsets and more. Microsoft bought Skype for $8.5 billion in 2011, even though only roughly eight million of its 124 million active monthly users paid for service at the time.

Why Use the Freemium Business Model?

If you have a strong product people will want to use, this model could be for you. Think about LinkedIn, Evernote and SurveyMonkey—the more time you spend on any of these platforms, the more invested in the product you get, and the more likely it is that you will pay for premium services.

In fact, in a GigaOm report on the 2010 Freemium Summit in San Francisco, Dropbox's CEO Drew Houston said DropBox offered a product that people didn't even know they needed until they tried it. Without the freemium model, users might not have known they were annoyed with needing a USB drive or email attachment to share files between devices. Now, they have a cloud-based file-syncing business with more than 200 million users.

You will face challenges when transitioning free users into paying customers, so be sure of a few things. You have to have a big-enough potential market, so you make money even if only a small percentage of those users pay you. You also need to have low marginal costs and few sales and marketing expenses to service the free users, or else you will end up spending more money on them than the value you derive from their potential conversion into a paying customer.

Tools to Implement a Freemium Model

Pandora's chief technology officer Tom Conrad knows the difficulty in transitioning free customers to paying customers. At the summit, he said once Pandora asked free-trial listeners for their credit card, they would "wander off into the wilderness." If you already have a large number of paying subscribers in your database, consider using a company like Chargify to manage your recurring revenue business as well as your trial period-ending options.

Hootsuite's move into the freemium model caused them to lose both free and paid customers, and they realized they needed to better analyze their data. Instead of pulling your internal resources away from product development to focus on business intelligence, consider using a service like RJMetrics. They can offer you insight about your average revenue per customer, lifetime value, churn and your marketing funnel to help you structure your business to optimize your bottom line.

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