A Look at the Impact of Freemium Pricing on SaaS Products

Brent Chudoba by

To be free, or not to be free. That is the question. 

I have a love/dislike (hate felt too strong) relationship with “free”. I love that anyone can give a free product a test drive, but dislike the lack of commitment that accompanies free. On the one hand, you want as many people trying your product as possible, on the other hand you work your butt off building something that people can take a bite of, discard and forget like a sample at Costco because it was, well, free.

We’ll start to unravel how to think about “free” in this post with the following topic areas:

  • Defining “Free”
  • Why use free?
  • Picking the right form of free
  • The “cost” of free
  • Perception, Expectations & Virality.

Defining “Free”

“Free” includes a few variants that we’ll all bundle under the “Free” umbrella:

Indirectly Monetized Free

The product is free and monetized through things like advertising or data. For example:

  • Facebook is free for consumers, but monetized through advertising.
  • Firefox and Google Chrome offer free software. They monetize by using search revenue shares and leveraging the data they capture from browsing to enable other business initiatives.
  • Credit card companies aggregate data which becomes a sellable product to businesses.

Freemium

There is a free version of the product with limitations (“paywalls”) and there are one or more paid versions of the product. Typically, the free version of the product is limited (e.g., SurveyMonkey, Evernote, Dropbox) and the paid version(s) include more features. A customer can typically derive value from the product (e.g., edit a picture and download it, create and send a survey and analyze data) but the more valuable features sit behind a paywall which requires a user to upgrade to access.

Free trial

A product has a free trial period where it collects some information from a customer (e.g., name, username, email, demographics, credit card information) in exchange for a limited time access to a product that is typically only available to paying customers. For example:

  • Salesforce uses it’s free trial to allow users to understand the interface and functionality but also as a key lead generation tool
  • PicMonkey uses a free trial to give potential customers access to its full range of features and storage so they can evaluate whether a paid subscription is a fit
  • Gotomeeting and nearly all conferencing solutions use free trials to let users try out the product before they purchase
  • In exchange for some information (e.g., email address) a customer is granted access to a version of a product. The complexity here is that that “version” could be a limited version, full version, a certain SKU/package. A trial by nature has a time limit, most are 7 days or 30 days, but should be mapped to the duration a customer can actually “try” the product.

Why use Free?

Free (inclusive of all the derivations described above) is most often a way to reduce friction and get customers to give your product or service a try. Free is a marketing tactic. And Free is an incredible way to open up the top of your funnel (increase the number of users who give your product a try). So Free is most effective when a) the customer expectation is that there is some Free way to evaluate a product b) when getting new users at a very low cost is critical (e.g., startups often leverage free to minimize sales/marketing costs) and c) you are trying to steal share from dominant providers or convincing customers to change behavior or do something very new.

Picking the right form of Free

If you’ve decided that Free makes sense for your business, there are two categories of decisions:

  • Level 1 (Business Model): These are picking the right form of Free (Indirectly Monetized, Freemium, Free Trial)
  • Level 2 (Optimization): These include things like the duration of a free trial, which features sit behind a paywall (freemium speak for which features are paid only) or whether to collect a credit card to allow customers to enter your free trial.

Level 1 decisions are a pain in the *ss to change because they impact so many things (UX, messaging, marketing, existing customers, billing systems…). But Level 1 decisions can and should change over time when it makes sense.

Level 2 decisions should be simpler to change, and can really help optimize a business. As with any decision that will impact lots of customers and teams, it’s best to be really thoughtful and try to get it as right as you can first and then optimize.

Level 1 Decisions

Start with the customer and work backward. How does your target customer expect to use your offering? Are there incumbents who have set standards that you can leverage in terms of purchasing model, or innovate on if the purchasing model is a customer problem?

Case Study – Dropbox: For a business like Dropbox, does Free Trial or Freemium make sense? The consumer value proposition is a long term one (e.g., your “magic moment” with Dropbox may come when you don’t expect it and can access a file from your phone when you really need it). And that may be hard to recognize in a 7 or even 30 day period, so Freemium feels like an appropriate model where you gate the storage amount and maybe some of the advanced features. The business model is also very sticky, so once you can get someone to upload enough files to go beyond a paywall, you may have a customer for life.

But, a Free Trial may make a lot more sense for teams who want to understand functionality before committing to a new storage solution, and a 30 day or even longer trial may be required to give a group time to try out the product.

Case Study – Spotify: In a highly competitive field where Apple, Google, Amazon, Pandora and others play, Spotify has to be excellent at what it does and be aggressive on the top of the funnel to keep users and continue to find/steal new ones. Spotify was an early mover in how it let users consume music which helped it gain user scale and funding to keep iterating. But users expect a lot for Free. So offering Indirectly Monetized Free & Freemium makes sense to get users engaged, and because other companies (e.g., Pandora and even terrestrial radio) helped set/manage user expectations. Using freemium paywalls like devices interoperability and local storage are smart paywalls and leveraging a trial is great way to get users a full taste of the value of the paid product. Importantly, the free trial period (whether 7 or 30 days) doesn’t let a user take all the value. Music listening, like file storage, or conference calling, is for the majority of people an ongoing need.

As you can see in the above examples, some businesses decide to employ multiple Free models. It’s about mapping the experience to target customer expectations, and considering when you want to reduce or introduce friction to open your funnel or drive better qualification.

Level 2 Decisions

When you land on a set of Level 1 business model decisions that will map to a Customer Journey that you feel will get and convert enough users through your funnel (unless you are purely looking to Indirectly Monetize Free), it’s time to optimize. What decisions are optimization focused?

If you’re using Freemium

Which features sit behind a paywall? You should iterate on these. They are hard to test. So running “A” tests, as a comparison to “A/B” tests is an interesting strategy. It basically means just move some features for a period of time and see what happens. There will be some backlash from existing users, but if you come up with a methodology on your approach, and something you can justify and be transparent about you should feel confident. When more customers pay you, it not only increases your chance of staying in business, but increases the amount of resources you can put into making your product even better for customers. Moving features or versions from free to paid can seem tricky, but don’t be afraid to use your support, marketing and social teams to handle backlash with customer friendly policies.

Creating smart “trojan horse” features. The smartest freemium apps help get you deep into the experience and derive value before they hook you. I remember at SurveyMonkey when we tweaked a feature and let free users collect more than 100 responses, but we had a 100 response limit on viewing. So what did that 101st respondent say? Want to know? Upgrade… Is this “evil” – I don’t think so at all. In the SurveyMonkey case, someone has already gotten tremendous value out of the product and is a great candidate to derive even more value.

If you’re using Free Trial

7 day, 30 day, 1 day? I’ve never seen 1 day, but the length of a trial is key. How long does it take a customer to really “trial” your product? If you are operating a project management (e.g., Basecamp, Asana) or CRM product (e.g., Salesforce), getting multiple folks onboard and finding time to play with the tool takes a bit of time, so 30 days feels right. But what if you are Netflix, Hulu, Spotify, PicMonkey? A shorter trial can make more sense since getting to a successful outcome (e.g., watch a movie, listen to a song offline, create a great design) shouldn’t take 30 days. The trial is your gift to the user – helping them gain confidence that the product is worth the price. The trial duration and all of your assorted engagement and onboarding marketing efforts are to make sure the customer takes advantage of their trial in a timely fashion.

Credit card upfront, or later? Put more simply, do you block your trial with a credit card requirement? If you have hard costs in offering your service (e.g., Netflix, Dollar Shave Club), capturing a credit card up front (or charging for shipping costs) may be important at certain stages of your business to reduce risk. There is a fine balance of optimizing for sheer volume of users and quality (paying) customers. The shift toward mobile consumption and federated logins (e.g., Google and Facebook) can be helpful in reducing the likelihood of fake/ghost accounts. At the end of the day, it’s always about continuously learning about your target customer and how to explain/demonstrate your value and then asking for payment at the right time/place in their journey. And what makes most sense for the customer can be vastly different based on the existing expectations, industry, product, value proposition, business model, etc.

The “Cost” of Free

Free comes with real costs which typically come in a few different forms.

Hard costs (e.g., bandwidth, compute, storage, customer support): the operating costs you incur to support those users who may never pay you directly. These costs can really add up if you are not disciplined about your model. If there isn’t strategic reason to provide a public service, or if you aren’t Indirectly Monetizing, at some point the freeloading customers can be a huge cost drag on your business.

Time/distraction costs. Free opens up your funnel which makes it harder to qualify leads. When you have a paid-only product offering, the inbound leads are a lot more qualified on average. Which would you rather have?

  • 100 sales qualified leads
  • 1,000 marketing qualified leads
  • 10,000 registered free users

It all depends on your conversion rates, your price point, your funnel, your sales process and business model…

Another consideration is that if you plan to go upmarket over time, your organization will have to be comfortable “outgrowing” your free or lower value users over time which isn’t always easy to navigate.

Perception, Expectations & Virality.

The “free monster” can set customer pricing expectations at zero which can be hard to overcome. The “free monster” is something I heard from our investors at PicMonkey and was meant to encompass the competition our paid product faces from both our own free product and every other offering out there that is using Free to acquire users. Whenever you have a free offering or you start out with a low price point, that can anchor customers. It can be very hard to upsell something that costs $5k/year when a customer is used to paying $5/month, and even harder when your brand is associated with being a “free” offering. It’s not great when users wonder how you even make money…

Many businesses can justify a low price tier or Free because their customers are doing the marketing for them by sharing their product. This is especially true for products like Facebook and Freemium tools like SurveyMonkey. One area to keep an eye on is that when customers become part of your marketing engine, the quality of their work reflects on your brand. So if your Free customers are using a limited version of your product, potentially producing lower quality output, they may be spreading the wrong message by not showcasing how great your product really is.

Hopefully this primer on the variations of Free was helpful. Please don’t hesitate to comment or reach out and keep the dialogue going, there is much much more to talk about when it comes to leveraging the power of Free.

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  • There are two more aspects to this. In some businesses, let’s call them network business models, having a large number of users benefits all other users. So it is worth growing the user base to grow value for all users. LinkedIn and Facebook are examples but there are many others. In this case it makes sense to have a large group of free users and to find other ways to monetize (it does not have to be ads). The second case is two-sided markets where one has decided to monetize only one side of the market. Google Search and Adwords are an example of this. The underlying thought is that you have to model value and understand the interactions of how value is created for different groups of user before you think about pricing strategy.