Before we tell you how to make the freemium model work for your subscription company, let’s take a look at what the word freemium means. Freemium is a business model that combines a company’s free and premium offerings. A company’s core product or service is offered free of charge with the idea that a certain percentage of users will upgrade to the premium version of that product. Each company’s target and breakeven point will be different, of course, but the concept is the same.

As Freemium.org explains, this is NOT the same as a company that offers a free trial, allowing you to try before you buy. In other words, you get to “test” the service generally (but not always) for free- like Netflix or Spotify – for a specified period of time. At that point, to continue the service, you must subscribe.

Successful freemium companies

Pandora, a free personalized Internet radio service, is a good example of the freemium model. Users create their own personalized radio stations based on song ratings (thumbs up or thumbs down). The service is supported by advertising. To get an ad-free experience, users can subscribe to Pandora’s premium service – Pandora One – for $4.99 a month.

Evernote, a cloud-based note-taking and file-storage app, is another popular example of the freemium model. Free users get the basic Evernote tools and 60 MB of online storage at no cost. Users can upgrade to Evernote’s Plus plan with 1 GB of storage for $24.99 a year, or the Premium plan with unlimited storage for $49.99 per year.

Other freemium services include Skype, LinkedIn, NetZero, Flickr, Prezi, Hulu, MailChimp, SurveyMonkey, and Dropbox. Each offers a basic version of its service at no charge with upgrades available for a monthly or annual subscription.

Does freemium work?

Freemium.org says the freemium model works well for high quality digital products because the cost of digital production is low. It often costs just as much to offer a service like LinkedIn to 100 people as it does to 100,000 people. The model can also work for other types of companies, but its use across digital companies is the most prevalent.

A freemium product’s potential is determined by the reach of the free product and the possibility that complimentary products or upgrades can be sold, explains Freemium.org. Put simply, to get in front of potential buyers of the premium product, the free product must reach a large number of users.

Whether or not a product’s potential is sufficient depends on more than just the conversation rate. The number of users, cost per user, conversion rate, fixed and variable costs and revenue all contribute to the success or failure of a freemium-based product or service. 

Freemium model mistakes

In a June 2013 article in Forbes, Brett Nelson interviewed Brian DeChesare, the founder of Mergers & Inquisitions and Breaking into Wall Street who used the freemium model to grow his content-based businesses. DeChesare shared these four freemium model mistakes:

1. Choosing the wrong market. The target market must already have customers who are paying for a solution to a problem, and there must be a gap in the market. For example, customers in the market are underserved, the product or service isn’t adequate, or a distribution channel is being overlooked.
2. Not offering a compelling reason to upgrade. DeChesare said most freemium business models fail because they offer their customers either too much or too little value. DeChesare explained that finding the right mix is a balancing act. Freemium companies should provide sufficient value to all customers, paid or not, but paying customers should get exceptional service, so they are more likely to share their positive experience with others.
3. Tracking the wrong metrics. To make the freemium model succeed, organizations must track data such as total costs, how long free content will bring in new customers, how often content must be updated, what it costs to update that content, anticipated rate of return, etc. It’s a numbers game, and smart companies track metrics down to the tiniest detail to determine their breakeven point and to make smart decisions and tweaks to the freemium strategy.
4. Failing to guide prospects down the purchasing path. Simple calls to action are not sufficient, said DeChesare. He suggested this six-step approach:
   1. Start with a general purpose path that provides free products or services who are interested, but are not yet convinced they need the product or service to solve a problem.
   2. Once they’ve agreed to try the free version, ask them if they want more information and then explain to them what they’ll get from premium feature or upgrades. In other words, answer the question, “What’s in it for me?”
   3. When delivering free, only deliver a partial solution – not the entire solution – and give prospective customers multiple opportunities to upgrade.
   4. Once someone upgrades, continue to give them useful information including quick start guides, tutorials, etc. and offer exceptional customer service.
   5. Continue to provide tips, guides and other content after the purchase.
   6. For prospects who never sign up, stay “top of mind” by offering newsletters, content samples, tips for using the product or service, etc. to continue to entice them.

In a 2012 article in the Wall Street Journal, Vineet Kumar, a professor at Harvard Business School, said that start-ups are often attracted to the freemium model, because it is “deceptively simple.”

“The problem is it’s not always obvious what features should be free and which should be paid,” said Kumar.

Oftentimes, offering too many free features risks “cannibalizing your paid customers,” said Kumar.

David Cohen, founder and CEO of TechStars, told the Wall Street Journal the freemium approach doesn’t make sense for companies that can’t attract millions of users. Such large numbers are necessary, said Cohen, because only 1 to 2% of users will upgrade to the paid version.

In addition, the freemium model doesn’t work for companies whose products are limited in scope. Paid users expect superior versions of a free product or service to convince them to make the switch. To attract the right audience, the free version has to be attractive to the target market. Large corporations, for example, have bigger budgets than individuals or small to medium-sized companies, so they won’t necessarily be attracted to free products or services.

Freemium failure

Chargify, LLC, a billing-management software company, started out with a freemium model, but the strategy turned out to be costly with too many companies using the free version, according to the Wall Street Journal. When the company started, it gave its software away to merchants who billed fewer than 50 customers a month. Merchants billing more than 50 customers paid $49 a month for the service, but the majority of customers never became paying customers, leading the company to the brink of bankruptcy within a year of its 2009 launch.

To salvage itself, Chargify put up a paywall, starting at $65 a month. With more than 900 paying customers, the company finally became profitable in 2012.

“The decision to move away from freemium was the best business decision we ever made,” said Lance Walley, co-founder and CEO of Chargify.

Benefits of the freemium model

Though the freemium model doesn’t work for everyone, there are benefits to companies that do it right. Here are a few offered by Business Insider:

1. Customers: Free products make it easy to get customers – lots of them.
2. Cost: The marginal cost for each new free user is low.
3. Network effects: The more you use a product, the more valuable it becomes to you. Consider Dropbox. If you’ve ever shared a file or stored documents in the cloud, it would be hard to go back to the old days of emailing files or swapping thumb drives, wouldn’t it? The same is true of products like Flickr and Evernote. Once you’ve used them, it would be hard to go back to more manual services, and once you’re hooked, you are ripe for the picking!

Making it work for your subscription company

There are several key components needed to ensure the success of a particular freemium model. Here are 10 ways to make the freemium model work for your subscription company:

1. Identify the right market for a freemium-based product or service.
2. Offer a product or service that solves a problem and provides increasing value to customers over time.
3. Limit free offerings to avoid “cannibalizing your paid customers.”
4. Attract lots of customers to earn a reasonable ROI, and expect your free-to-paid conversion rate to be less than 5%.
5. Promote free and paid offerings and make it clear what users are getting for each and to highlight the benefits of the paid version.
6. Retain paying customers by continuing to provide value, especially as competitors hop on board the freemium train. Look at Pandora. Pandora must continually evolve and change to keep its share of current free and paid customers, because everyone is getting in the streaming music game – Tidal, Apple Music, YouTube Beta Key, Rdio, Spotify, and more.
7. Keep operating costs low to keep the marginal cost of each additional user low.
8. Track metrics data and customer usage habits to hone the freemium strategy.
9. Be patient. Because it can take a long time to convert free users to paid subscribers, profitability also takes time.
10. Come into the freemium model with cash or venture capital, because freemium does not mean free – to you.

Dana Neuts is a Reporter-Contributor for Subscription Insider.