For hundreds of years, business models have been focused on the best way to make a profit. It was simple. A person would pay money in exchange for a product. With the age of the internet and the fast-paced startups, an increasing trend has begun called “Freemium.”
It is a business model based on exactly as it sounds. As it is a combination between “free” and “premium,” users are drawn to a product by getting free basic features, but enticed to pay money for higher functionalities.
From using Spotify to listen to music to sharing files on Dropbox, people have started to use Freemium models in their everyday lives. The model specifically focuses on the majority of the people using the product for free while a small minority pay for premium.
The key to a Freemium model is to have an Experience Good. A customer needs to have some experience using the product before realizing the value behind the product.
Once a company finds the proper product, the next thing to focus on it the conversion rate: how many consumers actually by the premium side of the product. A conversion rate of 1% is too low because it means the product offers too many features for free. On the other side, a high conversion rate of 50% is too high which shows that the product is being held back from it’s true potential.
There are two main reasons why a company would choose this business model.
The first reason is the ease of marketing. Having a free product allows companies to gain users easily. Free users, even if they don’t spend money, can invite other users to try the product as well. It reduces the need for a sales team as the user base grows organically.
The second reason is the network effects. Sometimes products become more valuable with the more users that are using the product. LinkedIn would be worth nothing if you couldn’t connect with any of your colleagues. The more users using the product the more potential there is for revenue.
There are many benefits to having a Freemium model, but there are also many drawbacks preventing companies from trying it.
The main drawback behind Freemium is that the business needs a huge user base in order to make revenue. These users also have to be returning users of the product.
With this drawback, the freemium model takes awhile for the company to turn profitable. The businesses often require many rounds of Venture Capital funding before they start seeing positive revenue.
We’ve got more where that came from, only on the Seamgen blog.
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