What is a freemium business model and is it right for your business?

11 min read
Derek Miller

The internet has changed how companies do business. Just within the past 10 years, freemium business models, subscription services and influencer promotions have changed how you reach your customers and how you create your organizational structure.

Within digital services and applications, the freemium business model reigns supreme.

In fact, more than 77% of the top sellers in the Apple App Store use the freemium model.

Is the freemium model actually profitable for businesses, and what kinds of businesses is it right for?

Keep reading to learn about this incredibly popular startup business model and whether or not it is a good choice for your business.

What is a freemium business model?

The freemium business model splits customers into two categories: those who pay and those who use the service for free.

The free accounts have limited access to your services, which creates an incentive for users to upgrade for full features and benefits.

In this way, your free service actually serves as a marketing tool—generating top-of-the-funnel leads that you can work to convert into paying customers.

With a freemium business model, you need to use your product and its features to sell users on the value of upgrading.

Your product has to be essential to them as a free service, but even more valuable as a paid option. Otherwise, you are doomed to lose customers on your free service before you have time to upsell them.

Freemium services are found across the web but are especially common within B2B software tools and B2C phone apps.

On the B2C side, for example, MyFitnessPal by Under Armour lets customers track their calories and exercise. This is a free service with many valuable features.

However, when users want to add custom recipes with nutritional information or gain deeper insights into their health needs, they need to upgrade.

In most freemium business models, the services can be used for free, but paying to use them creates even better experiences.

A freemium business model is a valuable lead generation tool, but that doesn’t mean it is right for every business.

Keep reading to learn more about evaluating this option and implementing it for your brand.

Reasons to use the freemium business model

The freemium business model wouldn’t have grown to its current level of popularity if it didn’t work. Freemium has proved to be a popular option for both businesses and users.

For businesses, freemium creates a path to profit through premium conversions, while users get access to a product for free unless they really need the extra features.

There are a few additional benefits of the freemium model to consider. These include:

You can use free services to market your business

Sales and marketing are all about lowering barriers to entry.

If something seems low-risk, more people will be likely to try it.

Your freemium business model removes any risk to customers who don’t want to pay for your services. This turns a “no” into a “yes,” already moving your customers deeper into the sales funnel.

From there, you can focus on upgrading your existing loyal customers instead of asking new customers to convert.

You can quickly attract attention and grow your user base

Hummingbird Stretching Illustrating Attracting Attention

Dozens of apps and services have gone viral because of their value to customers.

This is a great way to build a following through word-of-mouth marketing, customer reviews, and testimonials.

The more people that use your product means more potential brand advocates.

Building a freemium business model is a great way to get users to try your service

Whereas a customer might not try your service before, they can at least test it out with your freemium model.

For some customers, this is a preferred alternative to a free trial, where they will get charged at the end of a promotional period.

A freemium service will always be free until the customer decides to upgrade to the paid option.

You can build your business quickly to prove that there is demand for your product that interests customers

A freemium model can be used to prove to investors that customers need your services.

This can allow you to lobby for more funding to grow your business or show your investment team that your business will soon turn a profit as more free customers convert into paying users.

As you can see, some companies place free users within their sales and marketing funnel. They use their free service to develop a pool of users and then work to upgrade them to paid plans.

Related: How to give away free stuff to boost online store sales

Reasons to avoid the freemium business model

While the freemium business model certainly has its benefits, there are also drawbacks that might make some companies rethink offering this option.

For example:

Freemium brands need a lot of users in order to convert customers

Even companies that are considered successful freemium brands have surprisingly low conversion rates.

For example, Dropbox has about 500 million users, but only about 175,000 are paying customers.

This means that only four out of 10,000 users upgrade.

Most freemium companies expect a conversion rate of two to four percent, proving that the vast majority of users will stick to your free option.

The low conversion rate to your premium model shows how much time and energy will go into maintaining a free user base

This investment is why many companies only offer dedicated customer support to their paying customers.

You might have thousands of users that rely on your service but never pay you a dime. While these users help you market to potentially paying customers, a large portion of your staff’s time and energy will go to maintaining services that don’t bring in any direct money.

Building up a large free-user base to create a pool of customers who will pay takes time

As a result, freemium providers take longer to be profitable. This is why some brands prefer the free trial option over the freemium model: they would rather have free users drop off within a few weeks so the majority of their customer base pays for their services.

However, if you have the time to develop your free base and paying customers, the freemium option might be better for you.

Business is all about weighing the risk versus the reward.

While your freemium model might pay off with significant dividends in the short run, there are certainly risks to your profits and business operations in the short run.

How to determine if a freemium model will fit your business

Group Working Session At Coffee Shop

There are a few key questions that you can ask when developing your business to determine if the freemium model is right for you.

These questions are meant to provoke more discussion and research so you can better understand the challenges of launching a freemium service.

Does your product have the potential to grow quickly?

Many freemium companies rely on their ability to go viral in order to grow their business.

These brands need to reach thousands of people and get them to try their products if they have any hope of building a strong customer base. This means that you need to invest in marketing as well as development for your service.

You need to send a message that resonates with people and gets them to download or sign up for your product.

Is there a large customer base at your disposal?

Before you can even decide whether or not your business can grow quickly, you need to see whether you have a large customer base at your disposal.

This is where the “freemium vs. free trial” debate often gets heated.

Companies with niche markets often don’t have large audience bases. They can only reach a few thousand people, or they are competing with existing products or services in the market.

Without that large audience, they turn to free trials in order to lock customers in.

However, if you do know that you can reach a large customer base and drum up excitement for the services you offer, you might have the size and marketing ability to try a freemium model.

Do you offer something that users would pay to upgrade?

User Paying On Laptop With Credit Card

Considering that less than 5% of free users upgrade to a paid service on average, it is essential that your business offers something that keeps customers engaged and actively makes them want to upgrade. This is the delicate balance that freemium business owners need to walk.

If you offer too few free options, then your customers will test your service and then leave. However, if you offer too many free options, then no one will want to upgrade.

As you develop your products, consider which items would be considered standard for your business and which ones would be optional add-ons.

Instead of gatekeeping entire features, you can also set a limit on the number of uses for that feature.

For example, the Harvard Business Review only allows guests to read three free articles per month, which bumps to five free articles for free subscribers.

If you want access to more content, you need a paid subscription.

This is where customer research and testing come in.

Something that you think is an essential feature might not be for users, lowering your conversion rate and limiting the success of your business model.

Can you still monetize your free users?

Many companies offer paid services as their main source of income but also monetize their free users in order to offset the costs of their operations.

For example, Pandora and Spotify are freemium streaming services based on the idea that paid users don’t have to listen to ads.

While the companies make money from subscriptions, they also profit from ad sales to brands that want to advertise to this captive audience.

As you work to monetize your free customers, make sure you follow the data privacy laws in your area.

It might be tempting to share your customer data with advertisers or other companies in the short term, but you could lose the trust of your customers in the long run.

Plus, these strategies might be illegal depending on what data you share and with whom you share it.

Can your company support a large number of users?

Researching the size and interest of your customer base is the forward-facing aspect of your business model — however, there is also an internal aspect to consider.

Your company will need to offer customer support and care for hundreds of non-paying customers.

Your servers will need to handle thousands of hits to your website and you will need to keep your products running at their best no matter how many users you add. Can your company support this? Is it financially viable?

It’s not uncommon for freemium services to grow their staff sizes within the first few months of their product launch. They need to keep up with the demand of free users signing up.

However, over time, these paid employees end up costing the company more than the business brings in.

Consider the amount of manpower that it will cost to support a large user base and whether or not you can support it.

Know the risks and opportunities of choosing freemium

There is no guarantee that a freemium business model will be right for your business. It comes with its own challenges and drawbacks like any other plan.

However, if you are aware of these risks (like the low conversion rates and need to keep up with a large user base) then you might be able to mitigate them and manage your business successfully.

More customers are opting for the freemium model so they can get access to services, so it’s up to you to create something so valuable that your free customers want to pay.

Editor’s note: Microsoft Office 365 from GoDaddy can help make your freemium business run better and more efficient. For instance, with Online Essentials and Business Premium you can also create a domain-based email address to share calendars and contacts with people inside and outside of your company and you can manage your customer relationships right within Outlook.