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What’s the best way to demonstrate the value of a new product or service? Give it away for free and let your customers see for themselves. 

That pricing strategy may be unrealistic for some businesses—such as most consumer products brands—but for software companies, the freemium model has been a cash cow going all the way back to the 1980s. 

For software-as-a-service businesses, “freemium” is a particularly convenient and promising business model. That’s one reason why 75% of all companies pursuing product-led growth choose either a free trial or freemium model to build their brand and expand their customer base.

But a freemium business model isn’t foolproof. If you don’t strike the right balance between offering valuable free services and incentivizing consumers to upgrade to paid services or invest in upsell offers, your business could end up bleeding cash without bringing in any revenue—and your finances could quickly unravel. 

Before you commit to a freemium approach, educate yourself on the best practices that will set your SaaS business up for success.

Freemium 101: How this Model Works

The “freemium” business model is simple: To attract users and demonstrate the value of a product or service, businesses will make that product or service available to users for free.

This free access typically comes with one of two restrictions. In some cases, free access to a product is available on a trial basis, after which the customer must pay to continue using the solution. In other cases, a freemium model offers a limited version of its product or service available for free while keeping its full range of features and capabilities gated behind a paid subscription service.

By offering a free, no-risk option for test-driving these solutions, businesses are banking on enough users finding value in the solution that they decide to become paid users. For the businesses rolling out products and services, this low barrier to entry can make it easier to onboard new users. 

Ideally, the freemium strategy leads to high customer satisfaction and increased brand loyalty which—when combined with a paid subscription—can lead to high customer lifetime values, and at a low customer acquisition cost.

Value vs. Money: The Consumer Psychology Behind Freemium Models

Whether you’re dealing with individual consumers or corporate buyers, every SaaS business must understand how its target customers calculate the difference between the cost of a solution and the value it offers.

The value of your company’s solution is always relative to its cost. If your startup’s software solution offers only minor value at a high cost, many of your prospects will conclude that the expense can’t be justified with its return on investment.

On the other hand, high value at a low cost is an obvious opportunity for customers to drive strong ROI. The freemium business model gets its foot in the door by eliminating the barrier of cost while giving prospective customers a chance to experience the value of a solution for themselves before your monetization strategy kicks in.

Free trials and free basic services offer limited risk for customers, but the potential upside is great. As a SaaS business, you’re taking on the risk in this proposition by delivering services that may never lead to revenue with a particular customer or user. In fact, most businesses employing a freemium model only see a small percentage of those users convert to paying customers.

Yes, there’s always value in growing your user base, building your brand’s reputation, and inspiring brand evangelists among your freemium users… but you still need to make money. The goal of this business model is to prove the value of your solution and convince free users that the value of upgrading will far exceed the price of a subscription.

Keep in mind that this value can take many different forms. Along with financial value and performance-based value, consider how SaaS solutions can offer logistical value through enabled efficiencies, as well as emotional value by offering users peace of mind. This value proposition must be clearly defined and demonstrated through your freemium offer.

Creating Your Freemium Offer: What Should You Offer for Free?

Planning a freemium offer isn’t always as straightforward as it seems. Deciding to offer some of your services for free is easy—but choosing where and how to draw the line is far more difficult.

Create too limited a freemium offer and you’ll lose your users upfront. Give away too much and potential customers may decide the free version of your solution offers everything they need. 

Here are some steps to help you design an effective freemium offer:

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1. Know Your Core Value 

You should be able to clearly and succinctly determine the one thing your product or service is solving, above all the rest.

This core service and the value it offers should be accessible, in some capacity, through your freemium offer. If not, you won’t be able to demonstrate your platform’s central value proposition.

2. Need to Have & Nice to Have

While users should be able to test-drive your solution and experience enough value to convince them of its worth through your freemium plan, paid tiers must also offer valuable functionality and/or permissions that make it enticing to become a premium user. 

Evaluate the freemium offer, and your paid tiers, from the perspective of all of your buyer personas. Will the freemium offer be useful to them? Do the paid tiers offer an increase in value proportionate to the increased cost? Are you giving them what they need upfront but holding a few things they really want behind a fee?

3. Decide Your Limitation Philosophy

Some SaaS solutions offer a specific volume of platform usage for free but require a paid subscription to increase that volume. Others offer more basic tools for free and charge a subscription fee for access to additional features and more robust workflows. Figure out if you want to divide up your product by usage or features.

Many SaaS businesses combine these strategies to further incentivize the upsell. Basic features may be available for a limited volume of activity, but users can pay to upgrade and increase their usage as well as their access to premium features.

4. Track Freemium User Activity

Engagement is often reflective of value, so the features that get the most engagement from your users are likely the elements of your solution that offer the highest perceived value for your clientele. 

As users accept your freemium offer and use your platform, you may uncover important trends that can be used to tweak your freemium offer. Incredibly high usage for one feature, for example, might convince your company to put a cap on usage levels at the free level in hopes of persuading more users to convert to paid accounts.

Creating a Conversion Plan

A conversion plan is your roadmap for turning free users into paying customers. Your free product offer should be designed as a customer path leading to purchase, creating various moments for customers where a conversion opportunity is presented and encouraged, without annoying your customers so much they churn.

By this point, some elements of this conversion plan may already be baked into your offer. Usage caps, for example, can be paired with a pop-up prompting an upgrade to a premium version. Your business may even want to consider a one-time promotional offer to sweeten the deal. Still, consider different strategies to drive conversions over the course of a customer relationship. A 30-day check-in email with a promotional offer, for example, could be one strategy for gathering feedback while also pushing for a paid conversion.

Ultimately, this conversion plan should be designed with a target conversion rate in mind, primarily because your business needs a roadmap to revenue generation—and without conversions, you’ll end up bleeding the company of funds before you get your SaaS solution off of the ground. 

Your target conversion rate will be based on many different factors, including your target audience and the entry cost to upgrade to a paid subscription. Average customer lifetime value (LTV) also matters here, since a low conversion rate can be more feasible when LTV is high. The same goes for your customer acquisition cost: how much you spend on converting a new client may matter more than your conversion rate, especially where your company’s cash flow is concerned. 

Put Your Customers to Work

Freemium business models are often used by small brands trying to spread the word about their products. As a result, they often pair well with campaigns and other strategies that harness word-of-mouth referrals from existing users, turning them into evangelists for your brand.

Referral codes can be a simple way to grow your user base while rewarding users with free credits toward a paid subscription—and those credits can actually help turn some free users into paid customers, too. You can also attempt to build a community around your SaaS solution through community-based Slack groups, Discords, and other digital channels for social engagement—especially if these communities can offer expert insights and other resources that will benefit your customers.

Social campaigns indicating customer engagement can also be effective. Asking B2B customers to share a testimonial of their experience on LinkedIn can be a great way to build low-cost exposure and acquire new customers on the cheap. This strategy also strengthens ties with your existing customers, bolstering the stability of your user base.

Examples of the Freemium Model in Action

There are thousands of examples of businesses using the freemium model to build success at every stage of growth. Here are a handful of examples that every business should know about. 

Grammarly

This digital writing and grammar-editing tool is a lifesaver for anyone who struggles with spelling, punctuation, and other grammar issues. 

The company’s software service blew up in 2015 after switching to a freemium model: thanks to a free browser extension, as well as free access to basic grammar and editing services, the company’s daily active user base grew from 1 million to 30 million in a five-year span. It now offers a paid version with more advanced services and support for businesses, but its core capabilities are free for anyone to use.

Dropbox

Dropbox was offering cloud-based storage and file sharing before it was cool. More importantly, though, Dropbox offered a select amount of storage space free for anyone to use.

This free plan was a great way to add users and get them invested in a specific storage and sharing platform. Then the company built up its revenue stream by offering huge value for paid users: while its free version offers 2 GB of storage to users, the cheapest Dropbox paid tier provides a massive 2 TB of cloud-based storage. That’s a 1,000-fold increase in storage just for switching to a paid account.

Zoom

Everyone is familiar with the almost overnight explosion of Zoom’s userbase at the start of the pandemic. In addition to having the infrastructure to support this rapid growth, Zoom expanded quickly because its video conferencing solution was available for free.

There were certain restrictions, though, such as a 40-minute time limit and other limited features that were particularly valuable to business clients. Even while some users were content to stick with Zoom’s 40-minute meeting limit, many organizations opted for a paid Zoom service that would enhance the remote work experience for everyone.

Spotify

Part of Spotify’s approach to their freemium product was making the free plan ad-supported to generate revenue. 

But going ad-free isn’t the only reason Spotify users opt for a paid account: While you can listen and shuffle as much as you want for free—in exchange for the occasional ad break—Spotify also reserved certain features for its paid accounts, including unlimited skipping, offline listening and superior audio quality. When you pay for Spotify, you get a much more enjoyable and flexible listening experience.

From Freemium Users to High Customer Lifetime Value

If a freemium model makes sense with your margins and growth plan, proceed… with a plan!

The most important thing you need to do is create an offer and conversion plan that are designed to generate revenue and offset the early costs you’ll incur when giving away your solution for free.

As the above brands have demonstrated, a well-designed freemium offer can lead to exponential growth and massive market share. Just make sure you have enough runway to support this strategy, or else your next round of funding might be needed sooner than you thought.

Comment below to share your personal advice when planning a premium offer! Looking for more insights and resources empowering today’s tech CFO leaders? Subscribe to The CFO Club newsletter today.

By Simon Litt

Simon Litt is the Editor of The CFO Club, where he shares his passion for all things money-related. Performing research, talking to experts, and calling on his own professional background, he'll be working hard to ensure that The CFO Club is an indispensable resource for anyone seeking to stay informed on the latest financial trends and topics in the world of tech.

Prior to editing this publication, Simon spent years working in, and running his own, investor relations agency, servicing public companies that wanted to reach and connect deeper with their shareholder base. Simon's experience includes constructing comprehensive budgets for IR activities, consulting CEOs & executive teams on best practices for the public markets, and facilitating compliant communications training.