Freemium: How the Freemium Model Works

Freemium describes a business model in which companies provide a product or service with basic features for free and offer a premium option with advanced functionality at cost. The word “freemium” is a portmanteau of the terms “free” and “premium.” Startups and SaaS businesses (Software as a Service) use the freemium strategy to build a customer base quickly. This pricing strategy can be an effective way to convert free users into paying customers.

The freemium business model works by enticing potential customers with a product that is free to use. Users can continue to use the free product, but companies will encourage them to purchase the premium version via various stratagems. There is generally a significant leap between the free tier and the premium tier, as this is necessary to incentivize free users to become paying customers.

There are several advantages to the freemium strategy. This business model is becoming increasingly popular for software companies and mobile apps because it offers the following benefits:

1. 1. Acquisition: Freemium products and services do not require a credit card or a time-limited free trial for onboarding or activation, so there is a low barrier to entry for new users. And since this might push more users to try a product, this strategy offers the company a low customer acquisition cost.
2. 2. Growth: SaaS companies and startups often use freemium pricing models to gain a broad customer base reasonably quickly. Word-of-mouth marketing, referrals, and network effects for popular freemium products and services with a positive user experience can influence early growth.
3. 3. Retention: A user will become more reliant on a freemium product or service the longer they engage with it. This reliance encourages retention and serves as a backstop against the competition—users are less likely to jump platforms after using a product or service over time.
4. 4. Revenue: Freemium items are free, but many harvest user data and metrics and play ads for the free users. Display advertising can help incentive free users to purchase the ad-free option. These forms of monetization can prove valuable if companies reach the appropriate scale.
5. 5. Versatility: Many freemiums meet customer needs. Some free users, though, will convert to premium users relatively quickly. The free user base and new customers alike find this versatility attractive.

The freemium model does have some disadvantages. Consider the following drawbacks of this pricing strategy:

1. 1. Churn rate: Well-designed freemium products can engage users for an extended period, but many will tire of not being able to unlock the advanced features and functionalities of the premium version. Rather than upgrade, users often churn out, meaning they stop using the product altogether. A high churn rate can indicate that a company needs to improve its customer experience.
2. 2. Conversion: The customer lifecycle of freemium products and services can be short. Most freemium products have a disproportionate amount of free users, and converting these users to paying customers (known as upping the conversion rate) can be a challenge. Users can rely on free use for an unlimited time, so there is little urgency to switch from the free plan to the paid version.
3. 3. Desirability: Ideally, the freemium model perfectly balances the free services' usability and the premium features' desirability. This is hard to achieve in reality, as many potential users have diverse requirements and interests. Some will want the additional features, while others won’t.

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