Freemium: It's About Acquisition, Not Revenue

Updated On: October 24, 2019
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In this week’s episode, Hiten (co-founder of FYI and Product Habits) and I want to talk to you about something both of us have a lot of experience with: freemium product strategy. With more startups looking into this model every day, we think it’s important to discuss the inherent tradeoffs of using freemium for your business. While both Hiten and I are big proponents of freemium, it’s definitely not the easiest business model to work with if you don’t understand how to make it work.

 

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During our conversation, Hiten and I walk through how freemium acts as an acquisition strategy as opposed to a revenue driver, how product teams need to think about things differently, and why it’s important to understand customer psychology when building your own freemium product to make everything work together. And if you want to learn more about the history of freemium and how it impacts the economics of your business, check out The Freemium Manifesto.

The Tradeoffs

  • Building a freemium product requires a lot of forethought to keep your infrastructure costs low since you’re not deriving revenue from customers until they upgrade.
  • Product teams managing a freemium product need to do more targeted customer research than other product teams. Understanding the product value for customers isn’t enough—you need to understand their usage intent as well.
  • Offering a freemium product means dedicating your time to focus on conversion. There needs to be a clear and easy upgrade path for every customer that’s consistently reevaluated and iterated on.

Freemium is an acquisition model, not a revenue model

“You want to get as many customers as you can as fast as possible. And there’s no other model that will get you those customers faster than freemium.” Hiten Shah

Lots of people think freemium is a revenue model, but they’re wrong. As Hiten said, freemium is one of the best tools you have for acquiring customers quickly. With that in mind, there are some customer acquisition cost (CAC) implications that also make freemium appealing.

Even with the steadily increasing CAC over the past five or six years, freemium products are still a much more cost-effective way to acquire customers than those with no free offer.

For companies without a freemium offer, average CAC has risen from approximately $100 to $160. Average CAC for freemium companies has still gone up but only from $100 to about $135. This lower CAC is what Hiten saw with CrazyEgg as well. Even though costs are rising across the board, freemium companies aren’t encountering the same high costs as everyone else; they’re acquiring customers faster, too.

But if you’re not careful, the perception of your brand could suffer from preconceived notions about the quality of free products. Your customers must understand and believe your core value proposition from the start.

This is why product marketing is crucial for freemium products. Take ProfitWell, for example—we had to reposition our product in the market after going freemium. And it’s been difficult because the perceived value of analytics does not scale as companies grow. To put a finer point on it, people don’t want to pay for analytics.

When we started ProfitWell back in 2012, freemium wasn’t our first choice. We had this awesome paid product we knew could help companies calculate their metrics better, but as soon as we started gaining users, new competitors came in fast. All of a sudden, we had 35 or 40 different companies offering a similar product. That’s when we decided to spend time doing more research and found out that people didn’t really want to pay for analytics.

Only then did we decided to launch a freemium offer.

“There’s an argument to be made that we went free too early mainly because we didn’t know enough about our customer before we launched, which caused resource constraints, product roadmap constraints, and other issues. But ultimately, what it allowed us to do was train the market and own our own leads over time.”

That’s why we call freemium an acquisition model instead of a revenue model. Simply put, free products can’t drive revenue. What they can do is give you access to a cohort of leads that are easier to upsell and upgrade into a paid platform, as long as you understand the best way to get them there.

Freemium products positively impact retention and customer satisfaction

The ultimate goal of any freemium product is to get users to become paying customers. When users are happy with your product, they’ll engage with it more often, which makes it easier for you to retain them long-term. This regular usage also gives you plenty of opportunities to nudge users along the upgrade path towards the conversion goal of an eventual purchase.

Which is why you need more customer research before you consider launching a freemium offer. Your product needs to showcase continual value and grow in usability alongside the customer. Hiten has a great way of breaking this down.

"You need to learn to ship, not ship to learn." Hiten Shah, Founder of FYI

This can be a different kind of mindset for lots of product people. On the surface, freemium might look like a great opportunity to test and validate a new idea. But, if you’re not 100% sure there’s a need in the market, or that your product nails its core value proposition and solves a specific problem, freemium won’t work.

But getting customers to pay isn't the only benefit of freemium acquisition. It also has the potential to boost retention and NPS scores.

Customers who converted from a freemium product typically have 10% to 15% higher net retention. That’s more than double what companies that only offer a free trial have and close to triple what companies that have no free offer whatsoever have.

Freemium factors into NPS scores as well. Companies that offer freemium have significantly higher scores than those that offer a free trial or no free offers.

When you look at this data, you can see how this is changing as well. Five years ago, freemium wasn’t as much of a factor in NPS scores, but now it is. Especially in the SaaS market, users are starting to expect some sort of free offer to let them try out the product before considering a purchase.

This all works together to support the idea that showcasing continual value is one of the key drivers for a successful freemium product. The longer you retain users, the more time you have to nurture them towards an eventual purchase. The best way to do that is understanding what your customers need at the exact point they’re ready to upgrade.

Understanding intent is key when designing your conversion path

“You need to think about your cohorts from both a retention and an acquisition perspective. Someone might come in this month and not convert until next year!”

Freemium products make it easy for users to decide when they want to upgrade to a paid feature or product. Knowing when and why these users convert all comes down to their intent with the product. Customers who come in on a freemium product are happier with this conversion path as well. They’re upgrading on their own terms.

Just remember that this might not happen right away. Unlike a free trial, which has a hard end date, there’s no one period of time in which your freemium users will convert.

This is why companies with a freemium offer need a team of people focused on the inflection point between free and paid. Product, user experience, marketing, and even sales should all be a part of this conversation.

We’ve already talked about how important product marketing and customer research are—this is where you bring it all together. With strong product positioning in market needs as well as how customers intend to use your product as they grow, you can target the right personas who are primed for an upgrade.

Think about a daily usage product. While you may be able to get people to sign up with great marketing, conversion potential is going to drop significantly if users don’t interact with the product every day—whether that’s due to a lack of knowledge, a skewed value proposition, or a bad user experience.

Knowing which features keep users engaged, which features they’re willing to pay for, and how those features are better than the competition are key. If you offer too many features or a feature that people aren’t willing to pay for, then your upgrade path won’t be optimized to customer needs.

Good freemium products balance short-term tradeoffs with long-term goals

All the tradeoffs we’ve talked about today play into the idea that freemium isn’t worth it. But we hope you understand that freemium is a long-term strategy—all the work required happens upfront before your product has a chance to grow.

If you’re turned off by the wait, just remember that by adopting a freemium model now, you’re building a strong and engaged customer base for years to come. These users are cheaper to acquire and easier to retain with freemium, which is why the pricing model is so valuable in the long run.

What do you think? Have you used freemium in the past? Are there questions you still have before getting started? Let us know in the comments, and we’ll take it from there!

Tags: tradeoffs

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