Freemium Pricing: Customer Acquisition Hero or Revenue Killer?
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For free or not for free...If you're reading this article, I guess you've been ruminating on this dilemma for a while and still haven't come to a decision. It's no wonder. Since the early 2000s freemium pricing model, which turned to be successful for some famous freemium practitioners, including Evernote, Dropbox, Spotify, and other billion dollars companies, has been gaining traction and giving hope for stellar success to many SaaS startups.
But is freemium pricing a magic pill for a SaaS company to ensure its dramatic growth (spoiler - no)? Unfortunately, you can't just google the answer or follow the advice your best friend, a successful SaaS founder, gives you. Just because what worked for him will not necessarily work for you.
Actually, in the headline, I put the rhetoric question. Yet, I hope you'll get a bit of insight if the freemium pricing may work for your business by the end of this article.
What does freemium mean?
Freemium, being a combination of the words "free" and "premium", is a business pricing model that offers customers both free and paid versions of a company's product. The free option typically has fewer features than the paid one. Free users have limited access to product functionality or lack of customer support unit they upgrade to the paid account.
The freemium pricing model's core objective is to get the users hooked to the free product, encouraging them to subscribe to the paid plan later.
Whereas the conventional customer acquisition strategy requires significant marketing expenses to move leads through the SaaS sales funnel, freemium pricing can reduce costs, saving on advertising and engagement. The users self-educate themselves through the actual product usage, so your main goal is to make their user experience as great as possible, improving your product's "stickiness".
As a go-to-market strategy, the freemium pricing model can be justified by the quick customer base growth. However, this approach has some pitfalls I'll uncover in the next paragraphs.
Just a few examples of freemium pricing in action.
It can be:
- A service with limited features on a free plan and additional functionality on the paid ones (MailChimp)
- An online magazine that sets a monthly free articles limit and requires customers to upgrade to get unlimited access to the publications (Harvard Business Review)
- A free app with advertisements, which users can get rid of by paying for the premium plan (well, I'm sure you have at least one such app on your phone)
In the ideal world, after the users fall in love with your product, they reach the limits of the free account and decide to upgrade to experience the best value your product can ever provide. However, in reality, only around 2%-5% of free customers convert into the paid ones.
Before we dive deeper into the freemium pricing peculiarities, I'd like to stop for a minute to emphasize the difference between freemium and free trial models (as they're close, but not the same).
Freemium vs. free trial
Like freemium, free trials help lower the customer acquisition cost by letting the product and onboarding do the main job of converting leads into customers. Yet, these two pricing models have significant differences:
Freemium products are forever-free, whereas free trials grant access to the product only for a limited period.
Free trials provide users complete access to all (or most) product's features; freemium customers enjoy only basic functionality and can unlock additional features by going premium.
The most obvious free trial benefit is that you don't need to support users who never generate any profit for your business. Once their free period expires, they have to either sign up for the service or churn.
As a pricing model, a free trial is generally more effective at converting leads into paying customers.
The first reason, during the free trial, the users experience the full product functionality and are aware of what they need to pay for. Another thing, in most cases, requiring the credit card to sign up for the free trial, you may account for more qualified (read - ready to pay) though fewer leads.
As for the freemium pricing benefits, this pricing model is definitely easier for the customers as it doesn't make pressure up-front, requiring the credit card to sign up. And, for the SaaS business, there is a possibility to eventually convert the free users when (if) their needs will evolve. This scenario depends much on successful product integration into the users' workflow. At the end of the day, it'll be much more painful for them to switch to something else than change from freemium to premium within your app.
Getting a bit clear whether you should go with freemium pricing or not?
I guess, no, as I haven't told you yet...
What is wrong with freemium pricing?
"Freemium is like a Samurai sword: unless you’re a master at using it, you can cut your arm off." - Rob Walling, Founder, Drip.
Personally, I'm not against freemium pricing, say more, as a user of dozens of free apps, I love zero price! However, if I were a SaaS business owner, I'd think twice before going into this gamble.
Let's look at freemium from another angle.
Problem 1 - Freemium attracts freeloaders
The biggest problem with freemium pricing that it attracts the wrong customers. Offer something for free, and you will attract people who like the free stuff. As a business, you need to make money to ensure sustainable growth, and here is where the problem roots. You may get a huge customer base, but the question is how many users you'll persuade to pay for the product or service they used to have for free.
Just note, around 7% only of Evernote users switch to premium. We'll come back to Evernote later to see their freemium story, though.
By the way, do you use Evernote? If yes, do you pay for it?
Freemium pricing allows to quickly expand the user base, but the fact is the majority of the customers will never go premium.
How to overcome
Firstly, you can limit the free version and make the paid version truly valuable. More cloud space (as Dropbox did), unlimited marketing emails (as Mailchimp), ad-free music, playing offline (as Spotify).
Then, don't hesitate to add advertising and paid promotions to your free product. Some people will be freakingly annoyed with the ads, and they will leave. So what? They don't pay you anyway. Some of them will take the ads as a necessary evil and stay. And some customers will opt for the premium.
Problem 2 - Freemium cost is high
While most users will not help you make a profit, you will have to spend money to let them use your product. Along with your user base growth, you may face capacities limitation.
For example, you will need to pay for the servers to host your product or invest in the development team who will maintain it. Sooner or later, you'll have to expend your customer service, put more money in the product updates, and whatever else may happen as a business is a living creature. That's why many freemium pricing startups try to raise money from investors - they know they will need money to survive.
How to Overcome
One "unpopular" solution may be to learn users' behavior and sell the intelligence to other industry players. And again, the advertising and paid promotions will help. At the beginning stage of your SaaS, you can put aside the idea of getting immediate profit. However, one day you'll have to tackle this task, so better to prepare the plan.
Problem 3 - Freemium makes validation questionable
This problem is not that obvious, but I consider it critical for the early-staged companies. When you have a new product idea, you need to test it and get market feedback. It's crucial to define if the idea is worth your efforts and determine whether people are ready to pay for the solution you offer.
The point here, offering the product for free, you'll definitely find people who are eager to try. But there will be no confidence they would have paid for it as for something valuable and irreplaceable.
How to Overcome
To validate your idea (of course, when you have an MVP ready), you may track daily and weekly product usage. The statistics will give you an understanding of whether people enjoy your product or just downloaded it and keep it on the last home screen page of their phones. The more the customers interact with your product, the higher the chances they won't leave it easily.
Despite all the problems you may face with freemium, it is still a very effective short-term customer acquisition strategy. And to understand more if freemium pricing will work for your business, let's turn the kaleidoscope to see another picture.
How to decide if freemium pricing is your "good-to-go"
Running a SaaS business is an exciting journey and, minding this journey is not a one-day trip, it's crucial to have a road map and prepare for the adventure.
Before putting everything on the table and going freemium, assume what strategy will lead you to success.
Choose your market entry strategy
If you are serious about business, you know that the right go-to-market strategy is at the core of success. Tony Ulwick, in his job-to-be-done growth matrix, distinguishes the five most common growth strategies that will work for your SaaS business if you want to grow fast. I'll highlight here the three of them - the differentiated, disruptive, and dominant strategies - so you can think over what may be the best strategy for you.
Dominant, differentiated, or disruptive?
The dominant growth strategy works great if you perform better and charge less than the rest of your niche market players.
Uber, Netflix, Shopify - these companies employed dominant strategy and didn't mistake. This strategy can help you seize a big market share with one important condition - the market should be big. Jason Benkins, the SaaStr founder, claims that you need 50 million users to make the freemium pricing model work.
Well, maybe, not 50 million, but it wouldn't hurt to think whether your market is big enough, the product is significantly better, and the audience is price sensitive and needs a lower price.
If you have a narrow-niche product, the dominant strategy may not be the right choice.
The differentiated strategy works well with the underserved market segment in a particular niche. If there is no strong competition and you do a job much better than competitors, you can charge more. However, due to the specifics and small market size, the freemium most likely will not work in this environment.
And for the disruptive strategy, the freemium pricing may work.
Don't be confused, looking at the graph above, that disruptors really do their job bad so that they charge less. No, they just may create simpler and accessible by many people products on the overserved market.
For example, Canva is a simple custom graphic tool and can't compete with Photoshop by its functionality. But, due to the product's simplicity, Canva gained huge popularity with those who need to quickly create social media graphics.
With an understanding of whether your market is big and you have enough resources to support free product usage, you can go ahead making freemium work.
Work out your tactical plan
To make a long story short, just try answering the following questions before deciding to use the freemium pricing.
Why do I want to offer the product for free? If you have any doubts you'll get customers, then, is there really a market?
What benefits will you get by offering freemium? Are you going to improve your customer acquisition? Increase your market share? Any other reason?
Do you have a plan for how to shift customers from a free to a paid version? Unless the premium features have irresistible value, the customers may not have the right incentive to upgrade to a paid account.
How are you going to monetize the users if they do not convert? Placing the advertising inside of your free product? Selling customer's behavior insights to other industry players?
Before I leave you with these questions, let's see two different freemium pricing success stories. I promised to come back to Evernote's business model, so here we go.
Notable cases to learn from
Besides Evernote, the second hero we'll talk about is Mailchimp. I found the stories of these two skyrocketed companies in "The Freemium Manifesto" ProfitWell's e-book, so I will briefly cover the essence.
Evernote, the struggling giant
When Evernote was launched as the first cloud-based notes app in 2008, they didn’t raise much venture capital. In 2011, the CEO Phil Libin said, “The easiest way to get a million people to pay for non scarcity product may be to make 100 million people fall in love with it.” And this was done.
Having relied on word of mouth referrals, the App Store, and freemium pricing, Evernote rapidly grew to 75 million users and a $1 billion valuation by 2013. In 2014, they hit 100 million customers. However, the conversion rate was around 1% only - millions of people just didn't see any point in upgrading. Instead of improving its core note app, Evernote released a bunch of new products and focused on partnerships with Post-it Notes and Moleskine. The main product became secondary.
With 150 million users, Evernote laid off 18% of the workforce and closed ten offices to save costs. In fact, Evernote's strategy to upsell other products along with the core one was great. They just failed to do two things:
- Continue offering the app's high value to loyal users
- Understand their customers and what really makes them use Evernote
To give more value to the note app, they could use, for example, machine learning to predict what users might want to write. In a nutshell, Evernote might not have struggled with revenue, providing a more valuable product to the customers.
MailChimp, the product perfectionist
MailChimp's business model also used freemium pricing, but their approach differed from that of Evernote. MailChimp had been working for years with customer data to ensure they built the product everyone needed.
When they implemented freemium pricing in 2009, the core email product was affordable and profitable. They had saved server costs by switching to the cloud.
A year after launching their free plan "Forever Free", MailChimp grew from 85,000 users in 2009 to 450,000 users in 2010. The "Forever Free" still is a perfect match for startups, non-profit organizations, and small businesses if you’re not sending a large volume of emails.
During 2009-2010, MailChimp's profit grew by 650% (!), and CAC (customer acquisition cost) decreased by 8% (this was the main reason for the company's profit growth).
MailChimp not only created more value for more people but also increased their profit.
The freemium pricing is rather an effective marketing strategy aimed to boost growth through quick customer acquisition and user base growth than a revenue model. Before going freemium, it's crucial to work out the right go-to-market strategy and choose appropriate monetization options. However, you have all chances for success if you make sure your product has a huge market, delivers irresistible value, and can become an indispensable part of customers' lives. And to learn how to stop guessing and start growing, read SaaS pricing strategies article.
Well, we at Eleken can't decide instead of you what pricing strategy will be effective for your SaaS, but we can work with you on designing a great SaaS product that provides the value your customers are looking for.