Startups and The Challenges Of The Freemium Pricing Model

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Startups and The Challenges Of The Freemium Pricing Model

 

It has been a while since I wrote my last article on pricing models titled "Startup Pricing Models:  Free Forever, Freemium and Freedom To Pay".  This article ended up being reasonably popular (and continues to rank on the first page of Google for a search on "freemium").
 
I was reminded once again of freemium by a very interesting article from Don Dodge which notes that the average conversion rate of free to premium offerings for companies using the freemium model is about 3%.  I was actually quite surprised (in a pleasant way) by this level of conversion.  I've been considering the freemium model for one of the products currently being built at my startup, HubSpot.
 
The product under consideration, WebsiteGrader, is a website grading tool and recommendation engine that helps business people get a sense of how effective their website is from a marketing perspective, how it compares to competitor websites and makes recommendations for improving the site.  The tool is currently free.  Even in it's current beta state (very little PR and promotion), it has graded over 28,000 websites and gets over 500 visitors a day.
 
So, what are the challenges with releasing a product under the freemium model?
 
Here are the ones I've come up with (so far).  I'm sure the a few of you will have some of your own.  If so, please share.
 
Challenges Of The Freemium Model
 
1.  Deciding what to include in the free version and what to offer in the premium version is non-trivial.  The trick is to put enough in the free version to get traffic and usage -- but not so much that there's not enough incentive for a certain percentage of people to upgrade.
 
2.  Though hardware, bandwidth and infrastructure are cheap (and getting cheaper), they're still not free.  Supporting thousands of free customers costs money and unless there's enough money coming in from paying customers, there might not be enough cash coming in to subsidize the free folks.
 
3.  Support is a problem.  Though in theory you can take the position not to offer any support to the free users, in practice, it's hard to have the discipline and processes in place to actually do this.
 
4.  Pricing for the premium version is likely impacted by the fact that there's a free version.  For example, I don't think one could successfully offer a premium product for $250/month if there's a free version out there.  The premium version would have to be really good and an order of magnitude better than the free version.  This is probably why most freemium products are less than $50/month.
 
5.  It can get a bit tricky to use scaling pricing models for a freemium product.  For example, let's say you charge $20/month "per user" (per seat or per whatever).  For many customers, this creates an added barrier to upgrading.  If they have 10 users, there's even more incentive to just have all 10 users use the free version.  Or, they could just buy one paid license (for the key features they need) and keep the other 9 on the free version.
 
6.  Attrition rates can be unpredictable and potentially higher than traditionally priced products.  For example, if there's not enough "value" in the premium version, it's possible that even customers that upgraded will eventually revert back to the free version. 
 
Of course, there are lots of benefits to the freemium model too -the most important of which is efficient marketing.  It's a greaty way to get early users to use the product and have a pool of potential people to upgrade.
 
What are your thoughts?  Have you tried the freemium model?  If so, what has your experience been?  Are there other challenges that I missed?  Would loveto hear your ideas in the comments.

Posted by Dharmesh Shah on Wed, May 16, 2007

COMMENTS

A Web 2.0 called Mozy (online backup) uses the Freemium model, with the free service offering 2 GB of storage. Initially I thought I would never use that much, but after 6 months I'm almost at the limit. My point, and one thing you have mentioned in this article or the startup pricing models one, is that Freemium offers a great way to lock your free customers into your paid service. With Mozy, I've backed up almost 2 GB of documents, code and photos - if I'm going to pay someone for remote backups, it would be silly for me to switch providers.

posted on Wednesday, May 16, 2007 at 8:21 PM by RobJ


An idea: Start with the "mium" then do the "free". Prove people are actually willing to pay for the "mium" first. It doesn't have to be tons of people. Just a relevant handful so you can say, hey maybe I've got something here. Then do the "free" for marcomm. I know a company that is taking this approach.

posted on Wednesday, May 16, 2007 at 9:20 PM by Nivi


You raise some very good points about the freemium pricing model. However, compared to other pricing models, it is hard to beat in terms of both marketing and maintenance. From what I have seen, the best freemium models involve removal of caps and limits, as Mozy does. There, the value is clearly defined for the user, as they already have a "taste" of your full product. I've seen other services that simply offer "support" and other things which are intangible and useless to the ordinary consumer. As a follow up to this, you might want to come up with a guide to developing a freemium pricing model.... However, responding to Nivi's comment... I would argue that the most important thing is just to establish a user base and web traffic, mainly to see if this is a viable product in the first place, before taking on paying users.

posted on Wednesday, May 16, 2007 at 9:51 PM by Zvi Band


One issue I see with the freemium model is that in order to market your product you are relying on word of mouth....which is not necessarily under your control. It scales at it's own rate. Unless your well funded, you cannot take money from the premium users to fund these high cost programs to accelerate growth (You could if you didn't want to eat). Also, certain programs like affiliate programs or CPA marketing won't play well with the freemium model unless done very carefully with close attention paid to freemium-to-premium conversion rates.

posted on Wednesday, May 16, 2007 at 10:15 PM by ChandraB


I have used your website grader and it's very helpful. It provided quick due diligence on a domain/website a friend of mine was considering

I think lead generation could be a more profitable way to monetize the tool. You will get higher than 3% conversion on a free lead form "get expert help", the support costs are lower and you can resell the leads to multiple web/SEO vendors.

Website grader diagnoses the issues and sends people to the right doctor (who pays you a referral).

Dharmesh, M.D.

posted on Wednesday, May 16, 2007 at 11:30 PM by Mike


I agree that the mium is more important than its "freeness". the idea is to keep coming up with unique and innovative concepts that change the way we work in our everyday lives. I have been evaluating the free version of sugarsales and find it to be meeting most of my requirements. however, their premium models do have certain "must-haves" but thats the compromise any enduser would consider...there are many such models out there, waiting for breaking into the geometric progression growth in the premium offerings... just my two cents...

posted on Thursday, May 17, 2007 at 3:15 AM by pct


Another element to consider: I do sales consulting for early stage high-tech companies, and use a free version of Salesforce.com in my business. I've now recommended and implemented the fee version of Salesforce for a number of clients - another way the free version can pay its own way.

posted on Thursday, May 17, 2007 at 8:27 AM by Andy Blackstone


I have often seen an ad-supported free version. At least there is a chance of monetizing the free user base..

posted on Thursday, May 17, 2007 at 9:56 AM by Mike Buchanan


@Mike...If you are going to go the way using ads to monetize your site, try to get as much information about the user to build a profile during the registration. That way you can justify a higher CPM. A weekly email newsletter (with ads) is another way to monetize the base.

posted on Thursday, May 17, 2007 at 10:22 AM by ChandraB


One other way I've seen the "Freemium" employed is the product is free for home/NPO use, but businesses/corporations must pay to use it. This of course does away with issue #5, although something designed for business use, such as HubSpot, would not benefit from this.

posted on Thursday, May 17, 2007 at 11:10 AM by Jonathon


And sometimes free stays free not because it should but because it can.

posted on Thursday, May 17, 2007 at 6:42 PM by Mike


At Spongecell we employ a version of the freemium model in that we do offer a free social calendaring platform complete with embeddable widgets users can put in their myspace pages, web sites, blogs, etc to promote the events that they are attending. We don't focus on the upsell as the core way to monetize these users, as we have other fairly obvious mechanisms for doing this. Further, our business doesn't revolve around "upselling" these free users, which allows us to focus our sales, marketing and customer support efforts on our paying clients who want the publishing features of the free product plus all of the analytical and messaging functionality that just doesn't hold the same utility to our free users. We are fortunate in that there are two distinct use cases amongst each of the market segments we are targeting with our products. Thanks for the post - well written and keep them coming - always great to read what's in the minds of other startup entrepreneurs.

posted on Friday, May 18, 2007 at 11:49 AM by Ben Kartzman


Shareware "freemium" is a catchy, but Isn't this just the web application version of shareware, which is as old a concept as the software industry itself ? The implications for websites are slightly different in that there's on-going work to keep the free customers (bandwidth, servers), but it's the same idea.

posted on Saturday, May 19, 2007 at 11:13 AM by Drew V


Great read

posted on Saturday, May 19, 2007 at 3:11 PM by X Z


If you can make it so that you at least break even on the free accounts then you're golden with only a percentage upgrading to premium.

posted on Thursday, August 21, 2008 at 8:34 PM by Justin Chen


I have often seen an ad-supported free version. At least there is a chance of monetizing the free user base..

posted on Sunday, July 19, 2009 at 11:36 AM by yonja


Hi.. Your post got me thinking... What is more valuable for a software company (like facebook or flickr). 1,000 paying users or 100,000 non-paying users? What are your thoughts? View my blog post here: http://www.purlem.com/blog/?p=57

posted on Monday, August 10, 2009 at 10:40 AM by Martin Thomas


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