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Freemium Model For SaaS Companies: Risks And Strategies

Updated on October 14th, 2020 at 7:29 am

Freemium Model For SaaS Companies: Risks And Strategies

Who doesn’t like free stuff?

Be it free Wi-Fi at coffee shops, free parking, free practice sheets for a test, free ebooks, free upgrades, or free software, you hear the word “free”, even if you don’t necessarily need it or use it, free stuff pulls you like a magnet.

Although Freemium models are very popular amongst the customers, they fail to find similar love from the company owners, for obvious reasons of not generating sufficient revenue. Despite facing lots of criticism, freemium models prove to be the best choice for SaaS startups as it provides a direct path towards a massive customer base and unleashes opportunities for substantial revenue.

However, there’s only one problem with the Freemium models, companies don’t know how to use it properly.

What is the Freemium Model?

Freemium is a business model that offers both free and paid versions of its product with limits set to the free version. The free version can have a preset limit on usage time, features, or users. Platforms usually have several tiers with prices increasing upon the addition of a new set of features. The common examples here are LinkedIn, Slack, Dropbox, etc.

Pros:

  • The freemium model makes it easy for customers to get started and understand your product.

Cons:

  • It’s a revenue killer because obviously, you won’t be generating any revenue from the free users.
  • It also means that you need to generate enough revenue from your paid users to support the cost of serving both your paid and your free users.
  • It can easily devalue your core service. Even if your product solves a painful problem, your users may resent having to eventually pay for the service.

While some experts claim that the freemium is extremely harmful to the company’s ROI and increases customer acquisition cost (CAC). Others are of the opinion that it’s an attractive method to generate users and nurture them into paying customers.

We say it’s not that simple.

That’s why even with the freemium pricing model, some SaaS businesses manage to become industry leaders, while others struggle to generate revenue and face heavy losses.

Rob Walling of HitTail can’t be more accurate when he said in a Wall Street Journal article, “Freemium is like a Samurai sword: unless you’re a master at using it, you can cut your arm off”.

How the Freemium Model works

To revive your faith in the freemium model, let’s consider the example of one most successful Freemium model, a game that was declared to be the “Game of the Year” in 2013 just a year after it’s release and that also received 2.73B downloads in just 5 years.

Candy Crush.

Although I never really liked the game personally, it’s business model appealed to me.

The idea behind it is pretty simple. You begin with 5 lives and lose 1 when you fail a level. Once you lose all your 5 lives, you can either send requests to your Facebook friends for more lives, wait for 30 minutes to replenish themselves, or purchase them for 99 cents. A lot of people cave in saying it’s just 99 cents and well who won’t especially when they are on the brink of finishing a level, right?

Well, that’s the trap.

King successfully implemented the freemium model and earned money from this addictive game in the form of in-app purchases.

So, it’s not just the lives you’ve to pay for, but also when you are in desperate need of a lollipop hammer, color bomb, a sticky hand, or any other add-ons or even for some extra moves when you’re on the verge of making it past a level. Everything comes with a price.

It was with these microtransactions the King managed to generate a whopping revenue of $1.5B in 2018 across iOS and Android.

That’s the power of a freemium model.

Risks in the Freemium Model

Don’t offer too much or too little”. That’s the first thing you need to understand while developing a Freemium model for SaaS business.

Also remember, if your product is designed for a tiny niche and only a very small percentage of people will be willing to signup even for the free version, you should most likely ignore the freemium model.

You might be spending too much

Freemium model is very risky and if applied in the wrong situation, it can act like a tornado and blew up your business completely. So initially, to justify a freemium model the formula is simple:

If the Customer Lifetime Value (CLV) to Customer Acquisition Cost (CAC) ratio (LTV: CAC) is +ve, freemium is viable. If not, consider alternative pricing strategies.

Undervaluing your product

When you’re offering something for free, your customers have pretty high expectations from the premium version and if they don’t see much difference between the tiers, they might not upgrade at all.

Customer Satisfaction – but not completely

When you’re offering a product for free, it’s important that your customers should be, although not completely satisfied but happy to an extent that you will be able to upsell. If they didn’t like the free version, they’re less likely to pay for a paid one. On the other hand, if they’re completely satisfied with the free one they might not find it viable to upgrade.

Too much for nothing

You’ve invested your time, efforts, and money in your product. Value it. If you’re giving away everything for free, your customers might feel you don’t value your resources and hence, in turn, they won’t see the value in your product either.

Late profits

You won’t be generating immediate profit like in case of premium or subscription models.

But remember, “All good things to those who wait”.

Creating A Freemium Model That Works

“The more, the merrier”

This old saying fits right in the freemium model as the more number of potential users your product has, the better it is because only 2% – 5% will end up paying you. So your goal should be to attract as many customers as possible.

In 2014, Slack’s free-to-paid conversion rate rose to 30%. Because, Slack’s basic plan allowed you to create unlimited channels, share files, and even send messages. On the other hand, with the upgraded version you could get the customer support, full message archive, and much more. 

Nurture customers

Not everyone spends money spontaneously. To convert your freemium users to paid ones, you need to nurture them and convince them over time to upgrade. Show them the advantages of upgrading, maybe with webinars, free trials for some days, demo sessions, customer reviews, or anything else.

Separate them properly

Make an obvious and clear distinction between free and premium features within the product. If a missing feature is genuinely appealing to the customers, they’re more likely to convert.

Like Spotify. Although both paying and free users get to enjoy the music, the free users won’t be able to skip a bad song or play their favorite track on mobile. On the other hand, premium users enjoy unlimited skips, downloadable songs, listen to their favorite track on the go. So there you’ve it. The advantages of being a premium Spotify member are clear and worth to anyone who enjoys music.

Word of mouth

Although on average, only 2-5% of the freemium users convert, you still can use your free customers to create your own army of product advocates. This will only be the case when your service had provided them enough value in the free model.

Freemium is one of the most powerful pricing strategies if businesses use it for the correct purpose with a balance between value and incentive. With customer experience, becoming increasingly important, freemium companies will attain the top spots only when they give customers something they will be excited to buy — not something they will feel they were tricked into paying for.

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