Is the Freemium Business Model Right for Your SaaS?

The two prevailing schools of thought for the Freemium Business Model are either:

• Freemium is dead (ok…when was the funeral?)
• Freemium works depending on certain conditions (some say it might be best to use in the seed stage)

However, our State of SaaS Product Onboarding study we did in 2020 (2021 report coming soon!) found something interesting to add to this debate.

Of the 1000 companies we signed up for to study their onboarding, 73% of B2C companies offered a free or freemium product, and 86% of B2B brands offered a free trial instead of freemium.

In the Product-Led Era, your product is often the best driver of customer acquisition. And PQLs (product-qualified leads) are much easier to convert than MQLs. That, plus low CAC and inherent network effect = best conditions for using freemium to drive growth.

So Freemium isn’t dead. It just might not be the right business model for the vast majority of B2B SaaS companies.

This post will go over what exactly a freemium business model is and how it works. We will then explain the benefits of freemium for SaaS and why they work well for B2C companies and not so great for B2B. We will then go over the marketing strategies for a freemium product and finally a decision guide to see if a free trial is more appropriate for your business.

TL;DR

• Freemium is offering your most basic features and product experience for free. Users are then incentivized to upgrade through tiered paid subscription levels.
• The freemium business model is great for SaaS because it can help boost growth, build your brand, collect user data and test your product.
• The freemium business model works by having a small number of customers subsidize a product for the entire user base.
• These benefits almost exclusively apply to easy-to-use products with large markets, network effects, and self-service. B2C and SMB-B2B companies are more likely to develop products that meet those characteristics.
• B2B companies (especially upmarket and enterprise) struggle with freemium because they operate in highly competitive and narrow markets.
• A free trial is a more common alternative because it offers higher conversion rates.
• You can market both your freemium and free trial product through in-app experiences to convert users into customers.

What Is Freemium?

Remember the excitement you got trying free pizza samples in your local supermarket?

Now: show me one person who can stop eating pizza after taking one bite. Right, no one? They would have to have the willpower stronger than the biceps of a navy-seal.

The freemium business model works best when your product is like pizza: irresistible. Either because it’s so good at solving your users’ pain point they can’t imagine their life without it after trying it (hello Asana! StoryChief – I’m looking at you too!) or because it’s so good at forming habits in your users they simply can’t put it down (Facebook, Instagram, and all the other social media apps devouring your time).

Plenty of products have incorporated this model for hyper-growth. From Dropbox to LinkedIn, Spotify to Canva, these companies first hook you in, and then lure you to upgrade to a higher tier using several methods we’ll discuss below.

What Products Is Freemium Most Suitable For?

What did products like Hulu, Dropbox, MailChimp or Evernote have in common when they first launched?

There are some characteristics that your product needs to have (and that Hulu, Dropbox, MailChimp or Evernote did have) to enjoy the benefits of a freemium business model.

• Viral adoption ability– if you can employ your users to invite more users from day one, freemium will help you save tons on marketing. Take Dropbox – it encouraged its users to invite more users by offering them free space for each new user that accepted their invite. That way the freemium model drove massive user growth. Speaking of product adoption:
   
• Network effects-The more people that use the product, the better it gets. E.g. Marketplaces such as Ebay get better the more users they have. Same for social media networks like Facebook or Twitter – it wouldn’t make any sense for the user to hang out there if there weren’t any other users on the platforms already.
• Huge market potential -There is little to no competition, and the product solves a common problem. Take Evernote – everybody needs to take and organize notes.
• Self-service -There are low overhead costs for supporting free users. That’s why it’s a common practice not to offer in-person support for free plans.
• Easy to use/low barrier to entry– The product is intuitive, and users can discover the value independently. There’s no need for demos to figure out how to use the product, and no support needed to set it up – take social media schedulers. All you need to do is connect your social media accounts and you can start using the tools without any training.
• The value of the service increases the longer people use it-There is a certain stickiness. The more time users spend in it, the more they can’t leave. Take email automation tools. The more automation sequences you’ve build, the more difficult it will be for you to move – and the $20 subscription cost per month will not justify the hassle of moving to a different tool.
• The users will inevitably ‘graduate’ to a higher plan – take email marketing platforms like MailChimp. Since payment plans in MailChimp are based on the number of subscribers – you

Now let’s look at the benefits of developing a product with a freemium business model in mind.

The Benefits of Freemium for SaaS

Now you know if Freemium is actually suitable for your SaaS, what’s exactly in it for you? Here are a few benefits of using the Freemium model:

• A massive boost to growth-Since the product is free, there will be no shortage of users willing to try it out. As Patrick Campbell, the founder of Profitwell once famously said – ‘Freemium is not a business model. It’s an acquisition channel.’
• Brand building– if you can turn your free users into ‘walking billboards’ for your company – by e.g. attaching your company logo to the free graphics they are using via your platform (see: Imgur) or append a link to their messages/emails sent for free (like Hotmail in the good old days). If the product works, it is also much easier to establish user loyalty and as a differentiator in the market.
• Collecting user data-Now that the word is out and thousands of users are signing up, you can use that data to improve your product and engagement strategies. It also provides an extra asset to generate ad revenue.
• Businesses can learn a lot about their product-Offering freemium is a good test for product-market fit, who are your user personas, and developing a user journey.
• Increasing value for your users = boosting your retention rates. If your product relies on network effects – adding more free users will improve the user experience for all of your users. Take dating apps like Tinder. The premium members will benefit from having a larger pool of free members in the app.

Source: Spotify.com

How the Freemium Business Model Works

As with any entrepreneur, before you start a business, you need to figure out a problem you can solve for many people.

But what if you only needed a small number of those people to actually pay for your solution?

They would then subsidize the product, making it free for all, and still give you a hefty profit.

Freemium products essentially use this tactic to create value at scale.

However, this business model is extremely specific to how many users need to convert into customers.

• If your conversion rate is too high it means that you will eventually max out your growth potential, and people stop coming to try out your product (this also means the solution is too niche for freemium).
• If your conversion rate is too low it means that you will have to support a large user base with little to no revenue (Users can’t see the value in upgrading).

The perfect percentage of conversions actually lies in the 2%-5% range for larger markets and a bit higher for smaller ones.

So for the freemium model to work out, one specific core feature must already be in place. There can’t be any barriers to distribution or high maintenance (or fixed) costs. If the costs are kept as low as possible, additional free users will add up to pennies on the dollar.

Source: Google.com

Let’s look at how the freemium business model applies directly to consumer products (With some exceptions).

Why Does Freemium Make More Sense for B2C and SMB-B2B?

If you look for examples of successful freemium companies, you will notice that almost every example of a success story includes a B2C* company (or a B2B company targeting small businesses – which aren’t that much different from individuals).

Products in the B2C SaaS space are more poised to hit some, if not all, these levers based on the nature of direct-to-consumer interactions. The potential is higher:

• there are more B2C marketplaces/ companies relying on network effects
• B2C (or SMB B2B) products usually are cheaper, easier to use, and have shorter sales cycles

Of course, there are exceptions to this trend with products like Slack or Yammer. They can tap into large and small companies’ employee bases and create growth engines with their freemium offerings.

Source: Yammer.com

What is it about freemium that doesn’t fit B2B SaaS companies?

Well, it all goes back to the free sample example.

The Disadvantages of Freemium for B2B SaaS

You can’t give too much away.

If you are selling ice cream, you can’t offer the whole cone because most people will just eat them and not come back. You have already satisfied their hunger, and they see no value in purchasing your ice cream.

The same thing happens to many B2B SaaS companies when they are trying to acquire new users. They offer their full product for free to build up their user base but don’t have enough time to add more value to the product to convince their new users to upgrade. They can’t innovate.

As was the case with DocuSign when they first launched. With little incentive for their users to pay, they had to start offering free trial versions of their product through paid search marketing.

Source: Docusign.com

Most are already dealing with relatively narrow markets and then they still have to deal with all the overhead costs of servicing all of their new free users. This includes salaries, hardware, utilities, advertising, etc. None of this comes cheap, especially for businesses looking to generate revenue fast for V.C.s, and more often than not are bootstrapped.

In essence, to justify your product being free, you need to reach an absolute scale of users in an already crowded SaaS market.

It is a very high risk, high reward strategy that wouldn’t be worth doubling down on unless there truly was no competition out there (Think Slack). Or if you have the funds to test what works (Think LinkedIn).

Once many companies realize that freemium isn’t right for them, they scrap the free version and end up alienating their entire user base that refuses to pay for the product.

Why do 86% of B2B SaaS brands prefer free trial?

Well, it makes much more sense for their products.

Is Freemium Right for your SaaS? Alternatives to Freemium

Free Trial V.S. Freemium

As we have seen, there have to be certain market conditions and product characteristics for the freemium model to work for your business. Inherently these are more common among B2C companies than B2B companies.

If you decide to adopt a freemium strategy in the early stages of your company, you also have to be aware of the risks associated with it.

So what are the alternatives?

One option instead of freemium is using a free trial. This has many of the same benefits in attracting a user base and building a brand, but it cuts off all the freeloaders after a certain period.

Ok, that was a bit harsh. The real benefits are the conversion rates.

In a study by Openview Ventures, they found:

“The median activation rates for a freemium vs. free trial GTM approach are approximately 20% and 40%, respectively. The median free-to-paid conversion rate for free trial products is roughly twice that of freemium products (approximately 14% versus 7%).”

Of course, many factors come into play, but some are that the free trial demonstrates your entire value while also creating urgency for users to convert into customers.

You can easily do this through interactive checklists to show all of the features available in their free trial.

Source: Postfity.com- Double your activation rates with interactive productive experiences like these. No coding required.

Product-led growth

Although freemium can most certainly be included in a product-led growth strategy, the quality of your PQLs (Product Qualified leads) will depend on certain metrics – namely whether they:

• Engaged with your product
• Meet your activation criteria and have reached an “Aha!” moment
• Use your core features regularly.

The problem with limiting the functionality for free users is that there is a thin line between leaving your free users hungry for more and…rendering your product useless.

If you limit your free functionality too much, it may actually turn the PQLs off and make them spread bad word about your product.

So what’s the alternative when you can’t sensibly limit your core functionality?

A good alternative to freemium is offering a low-cost extended paid trial. You can reach out to personas or teams in medium-large sized organizations and pitch an entry-level version of your product, and get them to experience its value without a huge upfront investment.

Once the users are ‘hooked’ (they’ve e.g. built a few automation workflows, collected 500 email subscribers etc.) you can bump them to a normal paid plan.

How will your product marketing differ depending on whether you choose Freemium or Free-Trial? We’ll tackle that in the next section.

Product Marketing Tricks for Freemium and Free-Trial

If it’s a freemium product, the best way to market your product is to advertise what your users are missing by not upgrading.

Canva does a great job by including locks in the available designs for their free users.

Source: Canva.com

When you’re using Canva, you can browse thousands of available designs, elements, images and icons. While you can see them all, some of them are watermarked and available only for premium users. To remove the watermark and use your chosen design – you need to upgrade to the Pro Plan ($12.95 per month), or pay $0.99 for using the specific image. If you’re a heavy Canva user, it may soon make sense for you to pay for a subscription rather than making the one-off purchases all the time.

You can easily build such native tooltips code-free with Userpilot. Find out how with a quick chat with a product specialist.

For free-trial users, you can celebrate their progress in hitting your activation points (And exploring your product) through in-app achievements.

Source: Kontentino.com

You are motivating your users as they discover your product and encouraging them to engage more.

Free-trial users of all products have one thing in common: urgency.

But it’s not like only they are running against the clock: you are as well. You need to make most out of the time your triallists spend in your product to show off the value of it and convince them to buy.

Using interactive walkthroughs to show off the features that will solve their pain points and get their jobs done is the best way to do it:

Instead of dragging all triallists on the same boring product tour, you can personalize their journey and only show them what they need to do to get the job they came for done. That way, you can leverage the little time they have in your app to the fullest.

Of course, you can build fully interactive walkthroughs for your free trial users in Userpilot without coding. Let us show you how.

Wrapping Things Up

If you were a naughty kid at the market (like many among us), you would do laps and keep coming back for as many free samples as possible. Until finally, the wearied vendor would tell you “no.”

Companies should also be wary of the users who try to game the free version of their products. This might include creating accounts with multiple emails for free trial products. It can also manifest in users logging into the premium accounts of their friends or co-workers. Even worse, if you have a large user base of people not interested in ever paying for your product.

But if your product has certain characteristics like network effect or inherent virality – freemium can be your most powerful growth channel. Just make sure your unit economies add up and you’re off to strike gold.