Freemium Business Model: Definition, Types, Pros and Cons

As more entrepreneurs look to launch business ventures in increasingly crowded and competitive industries, many owners realize that using innovative business models can mean the difference between success and failure. The freemium model, which originated in the IT space, is one approach many startups are using to adapt to this fast-changing market. 

Contrary to popular belief, freemium (a term that combines the words “free” and “premium”) is not based on giving away all of your products and services for free. Freemium products simply provide users with the basic functions of an application or a limited number of service features at no cost while charging a fee for additional functionality. Companies such as the marketing automation platform MailChimp and the online dating website OkCupid both use a freemium model to acquire and retain customers.

Types of Freemium Models

One of the most important aspects to operating a successful freemium model is carefully selecting which products to offer for free versus those that can be purchased for a fee. Freemium models can operate in a variety of ways, including: 

  • Giving one product version for free while charging a fee for the remaining versions. Software companies often use this freemium strategy by offering a free version that has a storage limit or a restriction on the number of users per account.
  • Giving one product for free while charging for complimentary products.
  • Offering a free trial for a limited time. Once the trial period is over, customers are given the option of paying a fee to continue using the product or service.

The Advantages of Going Freemium

For some companies, starting with or migrating to a freemium pricing strategy may seem too radical. While a traditional business model is certainly appropriate for brands that want to build a solid customer base, it’s worth considering some of the advantages of a freemium strategy:

  • Giving a quality product or service for free can be a strong driver of word-of-mouth advertising, customer referrals and free publicity.
  • Freemium models allow users and prospects to experiment with and test out your product. As potential customers become more engaged and familiar with your product, they’ll be more willing to upgrade for additional features or to join a monthly or annual subscription program.
  • Freemium products are not just for individual consumers; they’re for other businesses as well. Many small businesses use freemium resources since they have limited budgets. You can carve out a niche market comprised of small or mid-sized businesses while more traditional competitors target bigger companies with larger budgets. 

Although you always run the risk of giving away products and services for free without a return on investment (e.g. a user tries the product for a limited time, then leaves without making an actual purchase), you have the “Psychology of Free” on your side. Offering something for free helps minimize the mental barrier that makes consumers reluctant to prepay for a product or service or to become locked into a contract. Because people tend to ignore time as an investment (unlike cash or other monetary forms of payment), freemium models can serve as a huge driver of user adoption.

The Downside of Freemium Business Models

However, as with any business strategy, there are noticeable disadvantages to adopting a freemium model. The following are some of the drawbacks you should be aware of before investing in and launching a freemium business structure:

  • Be aware of the pitfalls that come with setting the number of free product features too high or too low for freemium products. If you set them too high, people may never convert to payer status. On the other hand, if you set them too low, users may become frustrated if they’re unable to use the product’s main functionality.
  • It may be more difficult to change the behavior of customers who are used to paying nothing, compared to transitioning customers who are already paying a small fee for premium access or subscriber status.
  • Freemium models are typically ill-suited for enterprise software or complex products that require extensive customization and maintenance. If your revenue is lower than the cost of servicing freemium customers, then you’ll see a negative return in profits.  

In addition to having a clear company vision over the short and long terms, know the size of your market and whether your freemium users will deliver cost savings to your company. Identifying what each free customer costs, as well as how many prospects existing customers can refer (think Skype or Dropbox), will help you decide if a freemium model is worth the investment.

Maximizing Your Success

Companies outside of the tech space have adopted and continue to adopt freemium business structures and have even formed business models that are hybrids of freemium and traditional strategies. One of the primary ingredients to freemium success is having a great product or service with high consumer demand and wide distribution to a critical mass of users. 

Before investing in a freemium business structure, ensure your production and distribution costs are lower than the dollar value your freemium customers bring to your business. Finally, the success of a freemium model depends on your company having a large reach; that is, marketing a product that generates enough momentum to capture the users willing to pay a premium. As the awareness and use of your free product increases, demand for your premium products is sure to follow.


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