Is the Freemium Business Model Right For You?

In 2006, venture capitalist Fred Wilson wrote a blog post describing his favourite business model: “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.” He ended his post by saying that he didn’t know what to call this model and asked his readers for suggestions. He got over 30 responses and e-commerce executive Jarid Lukin suggested the perfect name – freemium (an amalgamation of free and premium) – that’s still used to describe it.

Business characteristics

Skype, Dropbox and Evernote are among the many companies that have successfully used this model, but even small businesses and start-ups can use it successfully if their services have the right characteristics. First, you need a high-quality service that potential customers want and need. Second, you need the ability to duplicate and distribute your service digitally. Finally, your service needs the potential to reach a large audience, since only a limited number of customers will purchase something from you.

Factors to evaluate

If your product has these three characteristics, you then need to evaluate the following aspects of your business to determine if you should use a freemium business model.

  • The cost of providing the service. You need to evaluate the marginal cost of providing your service. Most likely, about 5% of your customers will buy something from you when you run a freemium business. Since the model is only successful if you can support your free users, your marginal cost for adding new free users must be low.
  • Your viral potential. Since your goal is to have a large customer base from which you can entice paying customers, you want to attract large numbers of people to use your service. You also want to keep your marketing costs relatively low while you do this, so your service should have the potential for your customers to use social media to tell others about the virtues of your service and attract additional customers for you.
  • The transition from free to paid service. Your success will depend on your ability to convert free customers to paid customers, so it is essential that you have a clear message that convinces them of the value to do so and makes it easy for them to upgrade.
  • The benefits of continued use. If you can show your customers the benefits they receive from using your service year after year, they are more likely to remain loyal to you and upgrade to your paid service. You must be able to make the case why your service is superior to your competition.
  • Your business infrastructure. Your goal is to attract a large customer base, so be sure your infrastructure can handle the traffic and that you can seamlessly scale up as your customer base grows. Consider using a website monitoring service to inform you if you are experiencing performance problems so you can take quick remedial action and keep your customer UX high.

Evaluate your business plan, and consider using the freemium business model if you think you can attract a large customer base and make them true believers.

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