The Freemium Business Model: Don’t Walk Away, Run
If you're trying to get your SaaS company off the ground, you're probably thinking about implementing the freemium business model. It's a great way to get your foot in the door - offer your software for free, get a lot of people to use it, and eventually convert them into paying customers. Before you know it, you've gone from being the newcomer to the best on the market. And since you're now generating revenue left and right, you can sit back and relax.
Sounds too good to be true? That's because it is. From creating unrealistic expectations to downright ruining your chances for success, the drawbacks of the freemium model far outweigh the benefits.
What we'll cover
- What freemium is and how it works
- The downsides of using a freemium model
- Better alternatives to a freemium model
What is the freemium model and how does it work?
Coined from the words "free" and "premium", freemium is a business model typically used in a tiered pricing strategy. In SaaS, it involves offering a basic, free version of your product and charging for advanced (i.e., premium) features. Ultimately, the goal is to create a large customer base quickly and converting them into paying users over time.
In theory, the freemium model allows you to gain traction on the market and collect valuable data to improve the product further. As a result, you would then be able to attract paid users at lower customer acquisition costs. In practice, however, freemium models often turn out to be silent revenue killers that bring more trouble than they're worth.
Why freemium isn't a good business model
Every decent business model results in two things: profitability and positive ROI. In order to achieve these, your business model needs to be based on the following key elements:
- Strong value proposition that separates you from the competitors
- Deep understanding of the target market
- Cost structure that ensures the revenue generated exceeds the costs incurred
- Potential to scale and grow the business
Taking this into account, it's easy to see why freemium isn't a good business model. For one, a free product doesn't bring in revenue. Yes, a user could upgrade to a paid plan a few months down the line, but that means months of incurred costs for your company.
What's more, a freemium model puts you at risk of reducing your value proposition to nothing more than your product being free. While this does mean you'll bring in more leads, eventually your target market turns into the entire market. As a result, the data you collect becomes virtually useless. You lose track of your ideal customer to cater to everyone, making it impossible to scale your business.
At the end of the day, using a freemium model means trading long-term sustainability for short-term, unreliable results. If you're still not convinced, here are all the ways freemium can backfire.
1. Freemium attracts the wrong type of customer
The biggest problem with the freemium model is that it attracts everyone. Think about it - how many people you know don't like getting free stuff? It's like going to a store and getting a free perfume sample. Sure, you'll take it home. You might even end up using it because it's there and it was free. But the chances of you going out of your way to buy it instead of the one you always use are pretty slim.
The same principle applies to freemium software. People don't need a lot of convincing to use something for free, but you'll want them to break out their wallets sooner or later. Otherwise, you won't be able to generate revenue and grow your business.
However, since freemium attracts such a wide user base, a large portion of your potential customers won't be willing to pay for the premium version. That's because you'll also attract the people who:
- Just want a freebie and don't care about the limitations of the free version
- Think of your product as nice to have, but can't justify paying for it
- Signed up out of curiosity, but never bothered to get to know the product
2. Freemium devalues your product
Perception plays a huge role in how much value your potential customers see in your product. Offering it for free makes it seem like you don't think of it as useful enough to ask people to pay for it. And if you don't value your own product, why would your potential customers? If you do something well, don't do it for free.
3. Freemium has a negative impact on your revenue
When you build a business on the freemium model, free users make up the most of your customer base. This means that you either need to have enough paid users to sustain the overhead costs or you need to get yourself some funding.
No matter how much money you have in the bank, a large base of free users will result in it drying up quickly. At the end of the day, the goal is to build a sustainable business - and that means bringing in more money than you're spending.
4. Freemium is a burden on support
Seeing that free users aren't paying customers, spending support resources on them costs money that you aren't getting back. Now, you could limit support availability or not offer it at all, but it's a double-edged sword.
On one hand, you'd be saving the resources for your premium users and enhancing their experience. On the other, not providing support to free users can result in them getting frustrated and dissatisfied to the point of not being interested in your product anymore.
And while it's true that you don't have to keep every customer to run a profitable business, the problem with freemium is that it relies on eventually converting those free users into paid ones. In the end, you're backed into a corner where you can neither afford to support a huge base of potential customers, but also can't risk losing all of them.
5. Freemium results in high churn rates
Since free users aren't technically customers (remember, they aren't paying you), you could argue that they shouldn't count towards your churn rate. And while that may be fair in any other business model, freemium is different. Since attracting free users is the very basis of the freemium model, you can't afford to overlook them while calculating your churn rate.
As counterintuitive as it may sound, every free user lost is a lost customer when you're going with the freemium model. This is because freemium focuses on potential, rather than reality. And since you're relying on the potential of eventually convincing free users to upgrade, you can't ignore losing that potential.
While this is great news for your non-paying customers, it puts you at the disadvantage of being the only party who is financially invested. You can't afford to lose them, but they can easily find another free alternative to your software.
6. Freemium makes converting users into paying customers difficult
There's no arguing that going freemium is a great way to bring in leads. However, it often comes down to quantity over quality. Since freemium models are all about casting a wide net, lead conversion is more challenging as opposed to other tactics for several reasons:
- Free version satisfaction. Some leads will decide that the free version of your product meets their basic needs. For this reason, they won't see the point in upgrading to a paid version.
- Perceived value. Since freemium isn't time limited, some users will get used to the free version and perceive its value based on the free features. This leads to hesitation to upgrade because they either don't understand or don't appreciate the added value of premium features.
- Limited budget. Freemium often attracts users with limited budgets. This isn't great for business because, even if they see the benefits of the premium version, they can't upgrade due to budget constraints.
7. Freemium puts extra pressure on your paid plans
In order to make people use the free version of your product, it has to bring some kind of value. This puts you in an uncomfortable position because you can't completely strip down your free plan. You still need to pack it with features that are good enough to lure users in. At the same time, you have to leave something for your premium plans, otherwise there's no incentive to upgrade.
This is where it gets tricky to find the right balance. On one hand, offering only the most basic features might result in people not signing up. However, offering too many features on the free plan doesn't leave you with much to work with when it comes to the paid version.
Sure, you could develop additional premium features to include in your paid plans so that the free version still looks enticing. That said, you'll essentially be spending more resources to keep drawing in more free users who may or may not convert one day.
8. Freemium skews your value proposition perspective
Knowing exactly what value your product brings to your target customers doesn't only help you position yourself on the market. It also lets you analyze data effectively so you can improve based on user feedback.
That said, going with a freemium model puts you at risk of losing track of the actual value of your product. Since your user base is a mix of free and premium users, you need to keep in mind that not all the data you collect is reliable.
Yes, your premium users are a good reference for further product development. But relying on a freemium model means that the majority of your data comes from users on a free account.
Ideally, you'd get every free user to upgrade. So, if they aren't, it's easy to get caught up in trying to cater to them more in order to get them to commit. Over time, this can lead to shifting your value proposition to the point where you don't even know what it is you're bringing to the table anymore.
Selling only works when you know who you're talking to, what their motivation is, and what value your product brings. With freemium, there are just too many variables to keep track of.
9. Freemium gives you the illusion of growth
The reason why going freemium looks like a good strategy is because it lets you gain access to a lot of people in a short period of time. The more new users you have, the easier it is to get your name out there. So what if you have to give out freebies at first? It's an investment in the future and you'll get it all back once the users upgrade.
Besides, at least you're not struggling with customer acquisition. New users are piling in and your popularity is growing every day, so it's only a matter of time before you start getting some of your money back. Right?
While it is true you need to spend money to make money, the problem with freemium is that you'll be spending a lot more than you're making. Especially in the beginning. At some point, your servers won't be able to sustain the number of users you have, so you'll need to upgrade. Eventually, your support team will be swamped with various questions, so you'll have to hire more people.
In the beginning, this can all look like positive growth. After all, people are noticing you, your product is more popular than you thought it would be, and hiring more people is never a bad thing. This is exactly the reason why freemium models are dangerous. At the end of the day, someone has to pay for the bill. And if it isn't your users, it's you.
10. Freemium opens you up for customer backlash
If you start using the freemium model and realize it's hurting your business down the line, you'll naturally want to change it. Whether it's moving away from freemium towards a free trial, cutting down on features or limiting support, expect pushback from your free users. Once you've set the expectation of offering a free product, going back on it will inevitably cause negative reactions.
To avoid this, you could also go the route of increasing the prices of your paid subscriptions. However, if you do this without offering existing customers additional features, you risk losing them as well.
What to do instead of using the freemium model
There are much better alternatives than trying to make the freemium model work for your business. Here's what you can do instead to get your product out there and bring in more quality leads at the same time.
1. Offer free trials
Instead of offering your product for free forever, you can go the free trial route. That way, you give users the chance to try your product before they buy it. What's more, having to sign up for a free trial will automatically filter out everyone who isn't ready to commit to a paid plan sometime down the line.
When thinking about the length of the free trial you'll offer, make sure it's enough time for users to get familiar with your product. In addition to that, think about whether or not you're going to ask for payment information upfront as this could deter users who tend to forget to cancel subscriptions.
For example, at Better Proposals we offer a 14-day free trial, which is enough time for users to get to know the system and send their first proposal. We also opted for not asking for any card information before the start of the free trial.
2. Give product demos
Usually, SaaS companies offer both free trials and product demos to cater to customer preferences. While some people might be more comfortable with getting to know the product themselves, others find product demos more convenient.
A product demo can be less time-consuming for potential users and puts less pressure on them than a free trial. This is because they get a dedicated expert guiding them through all the software features, ensuring nothing is left out on accident.
3. Make the most out of video
Using video to showcase the value of your product is an effective strategy for bringing in potential customers. Besides demonstrating key features, video lets your prospects get a sense of how your product works.
4. Host webinars
Think of webinars as specialized product demos. Hosting webinars that show potential customers how your product solves their problems in practical terms is one of the best ways to bring in quality leads.
In conclusion
While using a freemium business model can help you reach wider audiences fast, it also has the potential of silently killing your business before it's even off the ground. At the end of the day, customers should be paying you for using your product, not the other way around.
Profitability and sustainability are the key factors to any successful business. And if you look at it from this perspective, it's not hard to see that free is just a bad pricing strategy.
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