A freemium business model is where you give a limited version of your service away for free in an effort to rapidly acquire lots of users. You then subsuquently upsell value added services in an effort to monetize your base of free users. It's sort of like a virtual tupperware party – where anyone can come for free and eat the food – but, you've got to pay to take anything home.
Chris Anderson blogged some interesting thoughts on this same topic yesterday. In his post, he correctly points out that "freemium is the opposite of the traditional free sample: instead of giving away 1% of your product to sell 99%, you give away 99% of your product to sell 1%. The reason this makes sense is that for digital products, where the marginal cost is close to zero, the 99% cost you little and allow you to reach a huge market. So the 1% you convert, is 1% of a big number."
To be clear, an increasing number of web based software companies are using the model (inlcuding my own) but in order to make it work (with or without advertising) you must have a tightly defined conversion model and optimize your entire organization to achieve the proper balance between "free" and "paying" customers.
So what is the "proper balance"? Well, it depends on a lot of different variables – but mainly it is the cost of acquiring free customers; the percentage of those that convert to paying; the amount of recurring revenue; and the length of time those paying customers stay.
Anderson cites some fascinting research from MMPOW pertaining to the video game world:
-
Club Penguin: 25% monthly uniques pay, $5/mo per paying user
-
Habbo: 10% monthly players pay, $10.30/mo per paying user
-
Runescape: 16.6% monthly uniques pay, $5/mo per paying user
-
Puzzle Pirates: 22% monthly players pay, $7.95/mo per paying user
The numbers here are very impressive compared to the 5 to10% conversion typically targeted by Web 2.0 SaaS providers. The "penny gap" price point is also very interesting — and serves as a powerful reminder that the most difficult gap in the freemium model is the one between FREE and 1 cent.
In addition to upgrading free users into paid subscriptions — there is also the well tested freemium strategy of subsidizing services 100% with advertising revenue. My new favorite example is 1-800-FREE411. By offering free 411 calls, they have managed to capture a reported 5% of the overall 411 market. It's an amazing testament to the power of FREE — especially when you consider "cheaper" directory assistance services such as Easy411 have existed for years with very little, if any, market traction.
At the end of the day, Anderson's advice for Freemium revenue models is to target 5% as break-even, but balance the mix of free vs. paid features with the hopes of actually converting 10%. If you convert higher than 10%, you might be offering too little in your free version and thus not maximizing the reach of free. Less than 10%, and the costs of the freeloaders start to become a burden.
