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Freemium or premium, that is the question many entrepreneurs and startup enthusiast are asking every day. As a pricing model, freemium has many benefits and a lot of people like to use it. In this article, you will learn about three reasons why this might not be the right pricing model for you. In addition, I will also offer some potential solution you can use to avoid at least some of the issues. Without further ado, let’s take a look at the three reasons why free is a wrong price.
Freemium attracts wrong customers
The first and biggest problem with freemium is that it attracts wrong type of customers. When you offer something, whatever it is, for free you will attract people interested in that. In other words, offer something for free and you will find people who want free stuff. The problem is that even freemium need some source of money. You have to have some way to make profit to create sustainable business. This is where freemium model start to make problems.
When you build your business on freemium model, it is possible that you create a large base of users. Unfortunately, these users are using your product because it is free. The question is, how many of these users can you convince to pay for premium. And, before you say some ridiculous number, think about this. Even the well-established companies have problems with convincing free users to pay. Around 7% of people using Evernote for a year become premium users.
If we would take a look at people using Evernote for two years, we could reach 11%. Let me repeat it. It takes Evernote two years to convert 11% of their free users to premium. Remember, we are talking about billion dollar company, not some lemonade stand. Although, lemonade stand could have higher conversion rate, especially in the summer. Dropbox is the same story. Its conversion rate is somewhere around 4-5%. By the way, do you use Evernote or Dropbox?
Freemium allowed these companies to expand their user base in a short time. Again, the problem is that the majority of these users will probably never become premium users. It is similar to offering people testers in shops. It is one thing to convince people to use something for free. Convince them to pay for it is something completely different.
Freemium, VCs and sustainable business
Some people may argue that you can raise money to avoid this. Or, that you can at least postpone it. Well, if we are talking about building sustainable business, this is not true. Sustainable means building a company that can make money, make ends meets. And, this doesn’t mean going and pitching investors every time your funds dry up. It means that your company must make money without outside help. Otherwise, your business is simply not sustainable.
Sure, one may argue that startups that are bootstrapped and startups with venture funding are different cases. I don’t think so. It doesn’t matter how much money you have in the bank. Sooner or later, you have to find some source of revenue. Otherwise, your company will become just a number in statistics of failed startups. Okay, there is one difference between those two. Bootstrapped startups usually have less time to become profitable.
The question is, whether this is a disadvantage or advantage. I believe it is the later. We discussed this in 6 Reasons Why Fundraising Is Bad for Your Startup. When you don’t have abundance of money, you have to focus and move fast. You don’t have to time to look around and wait for things to happen. This doesn’t mean that venture-backed startups do this. These startups have to move fast too. However, money can make them a bit more comfortable. You know, the roof is not on fire.
Another mistake is believing the illusion that there will be always someone willing to invest. Investors are patient, not stupid. Investors know that company may need time to get momentum. And, that this during time it might not be profitable. However, with time, it will get harder for you to get more money. Why? It is simple. Investors will lose their patience. It is one thing to need money to survive for a short time. Asking for funds again and again is a sign that it doesn’t work.
First potential solution
We could spend hours talking about problems. However, that would useless without giving you some ideas on how to solve these problems. First, limit the free version of your product and make the paid version irresistible. You have to give your free users some reason to pay for premium. Let me give you a number of examples. We talked about Evernote and Dropbox. Evernote makes premium more interesting by offering more space, offline access to notes, better support, etc.
When you decide to pay for Dropbox premium, you will get much more space, better security, etc. Mailchimp will allow you to send unlimited amount of emails and use advanced tools for email marketing management. Hootsuite will allow you to use more social profiles, analytics, suggestions etc. Buffer uses similar approach. Finally, Spotify will remove ads and let you listen whatever music you want in highest quality and even offline. The key here is to make premium plan interesting.
It is not enough just cut the freemium in half and let people pay for the other half. Premium version of your product must be worth every penny. If the free version is good, the premium version must be excellent. Free version should a starting point for people to try your product. It should get people’s attention and show some of the possibilities of the premium version. So, again, limit the free version and make the paid version of your products irresistible. Hopefully, this will help you increase the conversion rate.
Second potential solution
Second option is to have additional source of revenue. This will usually mean some form of advertising and paid promotion. Users will probably not like ads, but you have to pay the bills. So, let it be. Free app Duolingo is using this approach. At the end of every training session, small ad will pop up. If you decide for this option, remember this. For some users, these ads will be annoying and the will potentially pay for premium.
There will be also users who will not like this “commercialization” and leave. That’s okay. These users don’t make you any money anyway. You are actually spending money on them. If they leave, you will save some money you can invest in making premium version even better. And, lastly, there will be users who will be pissed off by the presence ads, but they will stay. These users will take the ads as necessary evil. I should note that this will probably happen with first option as well.
Some user will like the options of premium version so much they will be willing to pay for it. Other users will like them, but they will not want to pay for premium. And, they will not like the limitations of free version. Result? These users will leave. Finally, some users will like the features of premium, but don’t want to pay for it. However, they will be satisfied with features in the free version. So, they will stay. Good for bragging about your user base, bad for your bank account.
Third potential solution
Ditch freemium in the favor of free trial. I know that this is not exactly solution for freemium model. It is rather about modifying it. However, it works very well so it is worth mentioning it. Instead of offering free version of your product forever, offer it only for limited time. This will mean that some people will not even try your product because they would have to pay for it soon. I think this is a potential upside. You will filter out people who would not pay for your product anyway.
The downside is that some of these people could potentially become paid users after some time. Some users of Evernote used the app for years before they became paid users. This will not be an option of you implement free trial. Well, at least not if the trial is in range of years. However, I would not call such a thing a trial anymore. So, you have to decide. Sacrifice the chance that some percentage of your users will become paying users. Or, find a way to make money elsewhere.
Freemium is expensive
Many startups use freemium to acquire new users and get traction in the beginning. With this comes another problem. Not only that the majority of users will not help you make money. In addition, you will have to spend money to let these users use your product. Although we are living in a great era where starting a company is easier than ever before, nothing is completely for free. Yes, there is plethora of tools and resources you can use for free.
For example, you can use servers to deploy your product. However, even these servers usually come with some limitation. When your daily or monthly usage exceeds certain threshold, you have to decide. Either you will pay for allowing more users use your product or your provider will restrict how many users can use product. In other words, even if you don’t make money from your users, you have to spend money on them. Somebody has to pay for the party.
And, we are talking only about smaller expenses such as servers. Chances are that you need to pay some staff. If you are in tech, you probably have smaller o bigger team of developers you have to pay. Even if you are currently outsourcing this, you have to pay for it. Luckily, when it comes to other expenses such as customer service, you can handle it for period of time. However, as your user base grow, you will need to hire people to help you.
This is where freemium gets expensive. And, this is also why many so startups that use freemium model decide to raise money from venture investors. They know that they will need to somehow get money to survive this stage. And, they also know that freemium is just temporary solution. They know that, sooner or later, they will have to find a way to become profitable.
Potential solution
Well, I’m not sure there are any solutions for this problem other than those we discussed in the previous section. You can filter out users not willing to pay for premium and “accept” only those willing to pay. This means using something like free trials. Or, you can find another to make profit. Available options are advertising and paid promotion. Both of these options can help you cover the expenses and make your business sustainable and profitable. Finally, you can also raise money.
Still, you should remember that raising money is only temporary fix. It will not help you solve the problem in the long run. Maybe you postpone the necessity of making a profit for a couple of months, or even a year. However, this task will be still here. You had better make a plan for it before it is too late. As Gary Kasparov once said: “It is better to have a bad plan than no plan.”
Freemium provides only questionable validation
This is probably the last problem I see in freemium. When you get an idea for new product, you need to test it somehow. You need to know that it is worth your time and energy. Is my product solving some serious problem? And, are people willing to pay for my solution. You may also ask, is my product vitamin or painkiller? Vitamins are “nice to have”. You might feel better if you use them and there are some benefits. However, you don’t need them. Painkillers are different.
Painkillers solve some serious problem you want to solve. What’s more, you are willing to pay in order to get rid of that pain. If you have a migraine, you don’t need to think for a long time about buying painkillers. You just do it because the benefits of painkiller outweigh the costs. Price is what usually help you distinguish painkillers from vitamins. This is the problem with freemium. There is no price you can use as an indicator to validate your product.
Offer your product for free and the majority of people will try it. This is true even in case of harmful products such as tobacco and some drugs. Although, these products are actually not for free, at least not that often. This makes product validation almost impossible! I should say that we are talking about viable product. In other words, you can build a business on it and make money. And, no. We are not talking about charity or startup that is just chasing investors.
Potential solution
So, how can you solve this problem? How can you validate your idea even if it is based on freemium model? Other than asking for money first and offering the solution for free later? I have no idea. Seriously. People’s wallets or credit cards are probably the best way to validate your idea. If there is nobody willing to pay for it, your idea is not a painkiller. It might be “nice to have”, but people will not miss it if it ceases to exist. Now you know why there are so many unused free apps.
Okay, there is one metric you can use, but it requires that you have at least MVP. So, you can’t use this metric to test idea that is still only inside your head. Still, if you do have a physical product (atoms or bits), this metric can be handy. It is daily or weekly usage of your product. This is not a bulletproof way to validate your idea. However, it can help you find out if you have painkiller or vitamin. The theory is that people are more wiling to pay for things they use often.
If you use some product multiple times a week, or even a day, chances are you may decide to pay for it. Well, at least one day. Do you remember Evernote example? Some people use this app for years before they start paying for it. During this time, the app basically becomes part of their live. They use it so long they can’t imagine living without it. And, they start to think about what more the app can offer for some small cost.
And, what about those millions of free users using Evernote for more than two years? First, I have to admit that I am one of them. I had Evernote account for years and I’m not even thinking about upgrading. The reason? I don’t use Evernote every day, two or three times a week at max. Here we are again, daily or weekly usage. It is no wonder that Evernote didn’t become “a must have”. It is not part of my life. As a result, it is easier to replace it. In a fact, I’m playing with Simplenote.
So, here is one possible answer. These people are not using Evernote so often. For them, and me as well, it is a vitamin, not a painkiller. Take a look at your product and your user base. What daily or weekly usage says about them?
Closing thoughts on freemium
So, am I against freemium? No. I think that freemium works very well as a strategy for acquiring users. However, I don’t think it is wise to rely solely on it. Freemium is good for hacking growth. If you decide to try freemium, you need to have some plan to make money. Thinking that you will get as many users as possible for free and then convert all of them is nonsense. Many well-established companies already demonstrated that this just doesn’t work.
As a marketing strategy in the short-term, freemium is good. If you want something that will work in the long-term, you need a better plan. In the long-term, you need something that will help you build sustainable business. Freemium might not be the best tool for this. Although, there are always some exception to every rule. And, rules are made to be broken. Are you willing to take the risk and break those rules? In the end, this is what entrepreneurship and innovation is about.
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