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Freemium is a pricing model that allows customers to use a limited version of your product for free, in the hope that they will see value in upgrading in the future.

In theory, it’s a cheap way of acquiring customers. Offering something for free lowers the barrier for potential customers to start building a relationship with you. But even free customers take up resources. Every new customer you add means a higher processing load, more server power, and more time spent supporting them. If you aren’t getting a good enough conversion from free customers to make up for the strain they put on your company, freemium falls apart and your company implodes.

And in fact, that’s exactly what it did to us.

Freemium isn’t always the miracle lead machine that it’s been made out to be. In this lesson, we look at when offering a free plan makes sense – and when it doesn’t.

When does freemium work well?

It targets an individual

The most successful companies using a freemium plan start by targeting individuals, rather than companies. Think Dropbox or Evernote’s enormous free user base. An individual is able to quickly get started using the service, they have a good experience, and it spreads from there. Creating virality or a ton a referrals is one of the best ways to use a freemium plan.

There’s quick time to value

Customer are much less willing to put in time onboarding themselves with a free product. When things are given to us, we don’t tend to value them as much. Great freemium products provide value quickly so customers keep coming back to use the product. Think companies like Spotify. You understand what you’re getting the first time you hit play. The more you use it, the more likely you are to end up paying for an ad-free, mobile download pro accounts.

MailChimp saw enormous success in launching their freemium plan. A year later they reported a 150% increase in paying customers, and a 650% increase in profit (mostly due to a drastically lower cost of customer acquisition). Creating email campaigns in MailChimp is so easy, free users, limited to 1000 subscribers, saw the value right away and began to rely on the product as their business grew.

If your product requires a lot of set up to get to the Aha! Moment, you’re better off raising prices and using a more hands-on sales and onboarding approach.

Easy (and valuable) conversion to premium

The big idea behind freemium is to eventually convert those users into paid. So you better make it easy for free users to see the path towards premium. A common path is to convert individual users into a team account. I used Trello obsessively as an individual before I introduced it to my team at work. It was easy to see the value behind upgrading to a team account so we could all work together on projects.

Back to the success of MailChimp. As businesses grew their subscriber lists beyond the 1000 subscriber limit, it was much simpler to transition to the paid MailChimp account instead of moving to a different platform. Customers continued to receive value, and were happy to pay for it.

Make this path super clear, and keep reminding customers what they are missing out on. If you’re able to withhold features that power free users would love to have – it’s a great incentive for them to upgrade!

Customers bring value either through upgrading or acquiring more customers

Evernote CEO Phil Libin has said “The easiest way to get 1 million people paying is to get 1 billion people using.” If your customers aren’t upgrading, then they better be helping you acquire more customers who will upgrade.

It’s been hypothesized that offering a free plan (whether that’s a free museum pass, an individual SaaS account or a light version of your service) creates a ratio of 10 free users : 1 paid user. Your one paid user needs to be able to support those ten free customers (or they need to support themselves).

Freemium only works if you’re getting value from your free users. If they aren’t contributing anything to the relationship, the cost of supporting them outweighs the benefit.

When does freemium fail?

Available resources fall short

Resources are finite. As we discovered, “when your available resources, whether it be team size, performance caps or money, are tight, then “free” has a real possibility of causing more damage than providing any real benefit.” For many companies, the limited resource is the need to offer support to free users. Tickets and questions from paying users get drowned out by questions from free users, and service suffers.

For us, it was technical restraints on our server resources. Each free user created additional demand on our servers as we pulled their Stripe history and processed their dashboard. Too many free users signing up at the same time meant that paid accounts saw a decrease in performance. We simply couldn’t scale fast enough, and it starting affecting our churn rate.

There’s not enough value in upgrading

After trying out a freemium model Hubstaff realized that users of the free plan didn’t see enough value in the premium product to upgrade. The free plan offered a limitation of three users. For companies that needed more, instead of paying, they’d just use a different email address to get another three free users. Ouch.

If the free customers you’re acquiring don’t see a reason to pay money for your service, they won’t. It might be because your free plan is too generous, or there are too many companies that do the same thing for free. Regardless, why would anyone buy the cow if they can get the milk for free?

It’s an afterthought instead of a managed product

Creating a free plan isn’t just a set it and forget it pricing strategy. You need to be consistently working to improve conversion from free users to paid. Deciding who to market to, which features get added to each plan and how you’ll be supporting different tiers are all ongoing decisions. If you want to try freemium, you’ll need to commit to an entirely new way of doing business.

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