Your guide to freemium business models

Freemium business models can be a great way to attract new customers to your business and showcase the value your brand offers.

In this article, we’ll guide you through everything you need to know about freemium business models, as well as offer some tips for converting free users to paid users.

What is freemium?

A combination of the words “free” and “premium”, freemium is a business model which offers users free access to basic features and limited functionality, but charges a premium for additional features and full access.

The freemium model works well for web-based businesses. It attracts users to your service by offering them something for free, and, once the user decides they get value from it, they are more likely to opt to pay for the premium version.

Freemium works by building trust with a customer. First, by convincing the customer of the merits of using a certain service, and then charging them. The tactic is often used by new software companies to attract new users before taking payment from them or — if the service is B2B — the organisations those users work for.

Pros and cons of freemium

Pros

Freemium business models offer the advantage of attracting users who can contribute subscription revenue in the future. Users are often happy to try out a product as long as there is no financial obligation on their part. This gives you, as a business, time to get onboard them and eventually convert them to paying users. Spotify, for example, has achieved an impressive 46% conversion rate from free-to-paid, helping to make the brand the premiere audio streaming service on the market.

According to Harvard Business Review, the freemium-to-paid conversion rate tends to hover around 2-5%.

Cons

One of the drawbacks is that it can be easy to end up with many free users but minimal paying subscribers. This can be avoided by assessing how many features are on offer on the free version. However, you should be aware users can be put off by seeing their access suddenly change and decide to leave the platform altogether.

Moreover, some users can grow tired of the free version but don’t see enough incentive to start paying for the premium version. This compares unfavourably with other business models, like free trials with payment details taken up front, which GoToMeeting used to achieve a conversion rate of around 45% (vs. 3% in cases where payment details were not taken up front).

There are, however, a number of hugely popular platforms that have had success using the freemium business model. These include:

Spotify

Spotify is one of the most famous freemium subscription model platforms. The free version of the service allows listeners to stream music, however, users are forced to listen to unskippable ads every couple of songs. With the premium version, users can stream unlimited songs with no ads.

In 2020, Business of Apps reported 365 million people use Spotify once a month, while 165 million are subscribers. While Spotify’s success is primarily because it has an expansive and highly desirable catalogue of music, its ability to convert free users to monthly subscribers is what has allowed it to reach profitability.

Trello

Trello is a workflow management platform that has a unique approach to the freemium model. Whereas other similar services often limit the number of users on the platform in the free version, Trello limits the number of platforms it is possible to integrate the service with.

This means that free users can profit from near-total access and even experience the benefit of an entire department or business using the service. Users are then incentivised to upgrade to the premium version as they become more reliant on it and decide they need greater integration options.

Dropbox

Dropbox was one of the first services to offer a freemium model. With the free version, users have up to 2GB of storage space. Once users become accustomed to the service and add more and more files, they’re likely to upgrade to a premium model to acquire more storage space to accommodate all their needs, plus other features aimed at power users.

How to make freemium work

Freemium can be a great model for attracting customers, encouraging word-of-mouth marketing, and growing your company. However, in order for it to work, there are a number of things to consider.

What should be free and why?

One of the main purposes of the freemium model is to get users onto the service, paying or not. If, as a business, you see that this is not happening, it’s probably because your free service is just not attractive enough to users. In that case, you should consider offering slightly more access on the free version to get people using the service.

On the other hand, if you have a lot of users but hardly anyone is upgrading to the premium version, then you have the opposite problem: users are satisfied with the free service and aren’t incentivised to purchase the premium subscription. A popular example of this is the New York Times website, which saw very few subscribers when they allowed total access to readers. To encourage regular readers to subscribe, The New York Times ultimately decided to limit users to ten free articles a month (and since then down to just five).

Decide on a conversion rate target

In this context, the conversion rate refers to what percentage of users switch from the free version to the premium version and become paid subscribers. What you want your conversion rate to be will depend on the stage of growth your business is at and how you collect revenue. As mentioned above, a conversion rate of 2-5% is the typical range.

For example, new businesses may accept a 2% conversion rate to maximise the growth of all users, whereas an established business may want 5% to increase revenues.

If you rely solely on subscription revenue alone, then you want your rate to be as high as possible. If you obtain some revenue through advertisements, as a site like LinkedIn does, then you can afford to sacrifice conversion to an extent.

How to convert users to premium

In order to convert free users onto the premium version of your service, you will need to employ an effective upgrade strategy.

The most crucial step is to ensure free users have a satisfactory experience using the service but can clearly see the advantages of upgrading. With Spotify, for example, users can still access all the music they desire, but are impeded by frequent ad breaks. Knowing that they will be able to listen to their favourite songs without these intervals makes upgrading an attractive option.

You can also try these tactics for persuading users to convert to premium:

1. Explain the benefits of paid features: make sure free users know what they’re missing out on. You can tell them about all the extra features via email or through automatic pop-ups on the app or platform

2. Share positive feedback from premium users: adding in testimonials of a satisfied premium user can help convert a free user to a paid user

3. Allow access to paid features for a limited time: letting users access paid features for a short time means they can see for themselves what the benefits of upgrading are

4. Offer deals on premium: a great way to convert free users to paid users is to offer them a percentage off the typical premium price

5. Add a sense of urgency: offering a discount for a short time only can encourage customers to upgrade to your paid service to avoid missing out

How can a better payment experience improve your freemium model?

When you’ve shown a free user enough value for them to warrant upgrading, make sure you don’t fall at the final hurdle – collecting a payment. Card payments have high failure rates, while manual bank transfers force users to navigate away from your site to complete a payment.

Offer customers a seamless online payment experience using TrueLayer's payments product, which is powered by open banking technology, and achieve payment success rates of up to 96.6%. Find out more about how open banking payments can help your business.