freemium-business-model

The Freemium Business Model Complete Guide

The freemium – unless the whole organization is aligned around it – is a growth strategy rather than a business model. A free service is provided to a majority of users, while a small percentage of those users convert into paying customers through the sales funnel. Free users will help spread the brand through word of mouth.

Is a freemium a business model?

You create a product or software, you make it available for free on the web, thus (if the tool is good) it gains visibility quickly, and you call your company a freemium business model.

Looking at things from this perspective makes you confuse your business strategy with your marketing strategy. This can be extremely limiting. 

A marketing strategy will focus primarily on acquiring users, leads, or potential customers for the business. 

A business strategy looks at understanding the whole logic of your business to find a viable and potentially scalable business model

To understand this key difference let’s look at the whole story behind freemiums. 

The origin story

On March 2006, venture capitalist Fred Wilson wrote an article entitled “My Favorite Business Model” which said:

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 mentioned examples of this successful business model at Skype, Flickr, and a few others. 

According to Fred Wilson, the core advantage of a “Freemium business model” is fast customer acquisition. But he made clear that it had to be as frictionless as possible:

A customer is only a click away and if you can convert them without forcing them into a price/value decision you can build a customer base fairly rapidly and efficiently.  It is important that you require as little as possible in the initial customer acquisition process.  Asking for a credit card even though you won’t charge anything to it is not a good idea. Even forced registration is a bad idea.  You’ll want to do some of this sort of thing once you’ve acquired the customer but not in the initial interaction.

The main aim was to “eliminate all barriers to the initial customer acquisition.” He didn’t have yet a name for this kind of revenue model.

Giving it a name 

At the end of his article, Fred Wilson had clear in mind what the Freemium business model looked like. However, he didn’t have a name for it.

That is why he invited people to comment and to come up with a proper name for this business model. A commenter, Jarid Lukin suggested the name Freemium model.

Thus, service and product wholly free and frictionless, where most users don’t pay, and a small base of users pay for a product that has premium features.

Over the years Fred Wilson kept emphasizing the importance of free. Today the freemium business model has taken over also the gaming industry. But it has also become the most debated business model in the software industry.

On the power of free

Building a free product and making it available to anyone and then expecting to make money isn’t the right strategy.

Instead, the “free” within the freemium, if appropriately used, can be a lever for quick success.

As Fred Wilson pointed out in October 2008 “freemium is far from dead, in fact, it may be the business model de rigueur.

What did he mean? He recounted in a later article:

Facebook is a perfect example of freeconomics at work. A woman who works for a major media company was in my office recently. She quoted her CEO as saying “why doesn’t Facebook just charge a monthly subscription fee, they’d be making money hand over fist?”. Well I believe that if Facebook did that, they’d be vulnerable to other networks offering a free service. And certainly not every one of those 200mm+ users are going to cough up a monthly subscription. But by offering a friction free service, they have built a powerful and growing network that they are now starting to monetize in various ways and that they will monetize even further in additional ways. And they are super hard to compete with because they are free.

So that you know what key questions to ask that person to make sure the freemium is the right growth tool for your business. Some of those questions are:

  • Do we have the resources to sustain a free product? Many forget that a free product still requires a lot of maintenance, updates, support, or else. If you don’t have those things in place, your free product won’t be good, which will make it flop quickly.
  • Is the free product cannibalizing my premium offering? It might sound obvious to some people, but engineering a free product isn’t easy. Do you know how much of that free offering is enough to be valued? Do you know how to strike a balance between what you offer for free and what instead should be paid? Is the free product in line with your overall business strategy?
  • Is the freemium in line with my overall business model? For instance, if your organization is primarily structured on a sales team, which works with enterprise customers a freemium might make sense as it enables your brand to be known by more people. But will the fact that more people will know my brand to be a way to speed up the process of acquiring another potential enterprise customer? If not, is a freemium aligned with a business strategy where I want to get the lower end of the market?

Below is an example of what a freemium decision tree might look like:

freemium-model-decision-tree

Related Business Model Types

Platform Business Model

platform-business-models
A platform business model generates value by enabling interactions between people, groups, and users by leveraging network effects. Platform business models usually comprise two sides: supply and demand. Kicking off the interactions between those two sides is one of the crucial elements for a platform business model success.

Marketplace Business Model

marketplace-business-models
A marketplace is a platform where buyers and sellers interact and transact. The platform acts as a marketplace that will generate revenues in fees from one or all the parties involved in the transaction. Usually, marketplaces can be classified in several ways, like those selling services vs. products or those connecting buyers and sellers at B2B, B2C, or C2C level. And those marketplaces connecting two core players, or more.

Network Effects

network-effects
A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

Asymmetric Business Models

asymmetric-business-models
In an asymmetric business model, the organization doesn’t monetize the user directly, but it leverages the data users provide coupled with technology, thus have a key customer pay to sustain the core asset. For example, Google makes money by leveraging users’ data, combined with its algorithms sold to advertisers for visibility.

Attention Merchant Business Model

attention-business-models-compared
In an asymmetric business model, the organization doesn’t monetize the user directly, but it leverages the data users provide coupled with technology, thus having a key customer pay to sustain the core asset. For example, Google makes money by leveraging users’ data, combined with its algorithms sold to advertisers for visibility. This is how attention merchants make monetize their business models.

Wholesale Business Model

wholesale-business-model
The wholesale model is a selling model where wholesalers sell their products in bulk to a retailer at a discounted price. The retailer then on-sells the products to consumers at a higher price. In the wholesale model, a wholesaler sells products in bulk to retail outlets for onward sale. Occasionally, the wholesaler sells direct to the consumer, with supermarket giant Costco the most obvious example.

Retail Business Model

retail-business-model
A retail business model follows a direct-to-consumer approach, also called B2C, where the company sells directly to final customers a processed/finished product. This implies a business model that is mostly local-based, it carries higher margins, but also higher costs and distribution risks.

B2B2C

b2b2c-business-model
A B2B2C is a particular kind of business model where a company, rather than accessing the consumer market directly, it does that via another business. Yet the final consumers will recognize the brand or the service provided by the B2B2C. The company offering the service might gain direct access to consumers over time.

Crowdsourcing Business Model

crowdsourcing
The term “crowdsourcing” was first coined by Wired Magazine editor Jeff Howe in a 2006 article titled Rise of Crowdsourcing. Though the practice has existed in some form or another for centuries, it rose to prominence when eCommerce, social media, and smartphone culture began to emerge. Crowdsourcing is the act of obtaining knowledge, goods, services, or opinions from a group of people. These people submit information via social media, smartphone apps, or dedicated crowdsourcing platforms.

Open-Core Business Model

open-core
While the term has been coined by Andrew Lampitt, open-core is an evolution of open-source. Where a core part of the software/platform is offered for free, while on top of it are built premium features or add-ons, which get monetized by the corporation who developed the software/platform. An example of the GitLab open core model, where the hosted service is free and open, while the software is closed.

Open Source vs. Freemium

open-source-business-model
Open source is licensed and usually developed and maintained by a community of independent developers. While the freemium is developed in-house. Thus the freemium give the company that developed it, full control over its distribution. In an open-source model, the for-profit company has to distribute its premium version per its open-source licensing model.

Freemium Business Model

freemium-business-model
The freemium – unless the whole organization is aligned around it – is a growth strategy rather than a business model. A free service is provided to a majority of users, while a small percentage of those users convert into paying customers through the sales funnel. Free users will help spread the brand through word of mouth.

Freeterprise Business Model

freeterprise-business-model
A freeterprise is a combination of free and enterprise where free professional accounts are driven into the funnel through the free product. As the opportunity is identified the company assigns the free account to a salesperson within the organization (inside sales or fields sales) to convert that into a B2B/enterprise account.

Franchising Business Model

franchained-business-model
In a franchained business model (a short-term chain, long-term franchise) model, the company deliberately launched its operations by keeping tight ownership on the main assets, while those are established, thus choosing a chain model. Once operations are running and established, the company divests its ownership and opts instead for a franchising model.

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