Three flavors of freemium

You wouldn’t think there’d be much of a difference between natural vanilla and vanilla bean ice cream, but for some reason, parties are more exciting when the host rips out the Haagen-Dazs with the little black specks.  Freemium models are like vanilla ice cream, most of the time we lump them together and consider them equal, but a further exploration reveals subtle differences that make some types more appealing than others.

First, there’s the “capacity-based freemium” model.  This is the strongest known freemium model.  If you offer capacity-based freemium, your customer can immediately get her foot in the door and start using your fully-featured product or service for free.  Your customer only incurs costs when her need scales beyond a quantitative threshold for capacity, usage, or number of users.  Simple examples include Dropbox (at least 2 GB) and HipChat (first 5 users).

Alternatively, there’s the “feature-based freemium” model.  Even though it’s weaker than capacity-based freemium, it’s easier to build into products and more widespread.  With this model, your customer can immediately use some version of your product or service completely free.  However, he or she must pay to use additional features or functionality.  Classic examples include LogMeIn (free remote access, pay for file transfer capability) and Skype (free VOIP calling, pay to dial out).

With both of these models, upgrade price tiers are often (but not always) correlated with cost.  Large deployments in the “capacity-based freemium” may be more costly to the provider.  Similarly, premium features may require additional infrastructure and incur higher OpEx.  However, your customer is oblivious to nearly all of this.  Here are three reasons “capacity-based freemium” is superior as far as your customer is concerned:

  • With “capacity-based freemium” you only need to solve ONE customer pain point, but with “feature-based freemium” you must solve at least TWO customer pain points – one drives free adoption and the other upgrades.  Oftentimes the customer doesn’t fully understand or recognize the second pain point until later.  (If the second pain point isn’t acute, the company suffers from low upgrade rates.)
  • With “capacity-based freemium” it’s easy to alter the pricing model.  The threshold is typically defined by a number (e.g. 5 users, 50 GB, 10 groups) that can slide up or down with minimal coding and messaging.  The impact of this sliding scale is easy to model out based on data previously collected.  On the other hand, “feature-based freemium” requires flipping a switch on or off.  Suddenly choosing to start or stop charging for a particular feature may result in drastic economic consequences.
  • With “capacity-based freemium” it’s more natural to incentivize referrals.  If customers Boring Barry and Average Anne realize they can get “more of the same” without whipping out a credit card, then why not nudge a friend or two?  They anticipate using more capacity and appreciate it.  However, they might care less about new features that they don’t understand.

Observe that these freemium models aren’t mutually exclusive.  Some companies may slap a “capacity-based freemium” model on the primary use case and “feature-based freemium” models across an array of features that appeal to a subset of the core audience.  Some premium features are popular, inexpensive, and have high conversion rates.  Others are elite and priced to a high-end, yet dedicated customer segment (with a low conversion rate).  Unfortunately, it’s the low-price and low-conversion features that exhaust resources and kill companies.

At last, the French vanilla of the freemium world is the “use case freemium.”  This overlooked and underused freemium model refers to products or services which are either free or paid based upon how the product is used.  The product functionality may be identical across use cases.  Examples include:

  • free for non-commercial use (often with a label indicating “this is licensed for non-commercial use” so as to embarrass out-of-compliance companies)
  • free for schools (perhaps a dot edu email is required)
  • free for certain distribution channels, and
  • free for non-profits.

Fortunately, these models are straightforward to test and implement.  On the other hand, customers can cheat these systems fairly easily.  Cheating is only a problem if your product or service is expensive to deliver; after all, cheaters may be evangelists and future customers.

Follow Steven Dupree on Twitter @MarketFound

10 thoughts on “Three flavors of freemium

  1. March 29, 2013 at 10:19 am

    Not sure if it is covered by your three, but there’s the freemium flavor that let’e users pay to remove ads.

    1. Steven Dupree
      March 29, 2013 at 10:26 am

      Thanks Christopher, good point. I think of this as a “use case freemium” since the product isn’t fundamentally changing but one could legitimately argue that it’s another category.

  2. March 30, 2013 at 2:24 am

    Thank you for a great article! However there are some businesses that can’t use the capacity based freemium model such as reviews websites which are all based on premium features – examples are freeindex and tripadvisor

    1. Steven Dupree
      March 30, 2013 at 9:13 am

      That’s right – part of the reason feature-based freemium is more popular is that it applies to more models and industries.

  3. April 2, 2013 at 11:44 pm

    Thank you for listing the different models. I agree that removing ads is a use case based model. The issue with the feature based model is that people Trend to use the free stuff only, Skype beging an excellent example.

  4. Craig Cohen
    April 11, 2013 at 5:12 pm

    This was a nice clean piece – worthy of a forward!. Any thoughts on freemium models – where the capacity-basis is reversed. e.g. where its free/cheap for the company to provide the service to a large number of users – but not cost effective to provide it free/cheap to a small user? e.g. A service that brings an ice cream cart to your office for free – where the cart vendor hopes to sell enough ice creams to make it worth the trip. This model works well – when there are 100 people in the office – but poorly when the office only has 10 people.

  5. Steven Dupree
    April 15, 2013 at 5:42 pm

    Craig, great example! What I wrote was most relevant for software and technology-enabled services where fixed cost of delivery is close to zero. In your scenario, it would indeed be prudent to invert the capacity threshold. This is because the unit fixed cost (fixed cost / # customers) tends to be greater than the unit variable cost and thus the unit average cost (equals sum of unit variable cost and unit fixed cost) decreases with volume.

  6. Steven Dupree
    April 15, 2013 at 5:46 pm

    Let me correct myself: it’s not that the unit fixed cost is greater than the unit variable cost – it’s that the unit fixed cost decreases faster than the unit variable cost increases. For your example: from 10 to 100 ice cream cones, the cost of a truck rental / 10 is MUCH higher than the cost of a truck rental / 100. But the cost of producing 100 ice cream cones is SLIGHTLY higher than the cost of producing 10. That’s why average cost decreases with volume and hence you could have a minimum threshold to justify sending the truck.

  7. May 24, 2013 at 9:54 am

    Good article Steven, thanks for sharing your thoughts.

    As for our business experience, I must say a combination of both freemium models is working quite well for us at in essence, a simple, yet strong, innovative method to establish proof that the content of a particular email has been delivered to a third party at a verifiable time.

    We use a combination of the two models: free licenses are for single users, when flat-rate premium licenses can be shared by as many users you like; premium licenses include perpetual backup of all emails and certification files, when free licenses do not include backup features. With a reasonably good free value offering, our +13% conversion rate shows we must be doing something well.

    For what I can tell, the profile of your free users is key. Although addressed to individuals and companies alike, 89% of our free users going premium share their licenses with co-workers. No question this is the kind of free users we were looking to get.

  8. Alex Burgess
    November 17, 2013 at 11:02 pm

    Thank you for all your blog posts Steven. Please could you help me with this one. I’m interested in hearing your thoughts on how the principles of freemium can be applied to Crowdfunded projects. I am researching the potential behind using a Crowdfunding platform, along with major exhibitions and offline activity, for the launch of a furniture collection by a small start-up manufacturer.

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