Approaches to Freemium Business Models

This is a guest post by Dorrian Porter, president of Northern Imagination and speaker at Ynext™ Incubator boot camp. Feel free to view his business model presentation here.

Credit for the “freemium” business model is probably owed to the inventor of Coca-Cola®, Dr. John S. Pemberton, who wandered the streets of Atlanta encouraging people to try his new drink. Asa Candler, an aggressive marketer who took over the company in the 1890s, took the concept further and had his employees hand out "complimentary tickets" for Coca-Cola, which was then sold only at soda fountains. As described on Coca-Cola’s website, “Candler was confident his refreshing concoction would find an appreciative repeat following-if folks would try it just once!” A free sample or free trial period is a common ingredient to “freemium”, but a true freemium business model likely depends on a deeper commitment to free than a simple trial. If you are a startup selling to the enterprise, the free trial may not be something you need to promote at all.   Here’s a summary of freemium business strategies that developed over the last ten years: “Land and expand” was a strategy mastered in the enterprise by Salesforce®.

They figured out that to compete against big competitors like Siebel they needed only to improve the life of an individual salesperson (or small team of salespeople) instead of selling a large enterprise deal from the get go. I still have access to the totally free “Personal Edition” of Salesforce, which was used to entice individuals to try the product and become internal champions. It didn’t take long for teams of salespeople to get themselves up and running, love the product and make the switch. From there Salesforce identified how to grow the size and revenue of accounts.

A company like Box could be said to have a similar land and expand strategy. “Trojan horse” was a model aggressively pursued by Yammer®, the enterprise Twitter-follower which exited with a billion dollar sale to Microsoft a few years ago. In its model any set of users and any number could sign up for the service totally for free within the enterprise, and then Yammer identified a set of features it would ask the enterprise to pay for to enhance functionality for whoever was using the app.

Slack is a similar model today: “Slack is free to use for as long as you want, and with an unlimited number of people.” If the enterprise happens to want things like guaranteed uptime and compliance exports of message history, that costs money. “Premium” is a widely understood freemium model and it means that free users will bump into some kind of operating limit, or have limited or no access to appealing features. I’ll distinguish it from Trojan Horse on the basis that not all users in an enterprise need to upgrade to get the value offered for a fee - most users choose to stay free. Simpler models that involve premium strategies can focus on things like file size or storage limits (e.g. Dropbox®, but note Dropbox itself has to add other strategies like Trojan Horse to grow).

Most startups experimenting with a premium model often have trouble identifying the key premium features that really make a difference for scaling to a large number of paying users. There’s a delicate balance between giving enough value in the free product and identifying those features that are worthy of payment and it’s certain that many startups have gone out of business by getting it wrong.

To be successful it’s important to establish a base of customers for the product and then vigorously test the feature limits, enhanced features and price points that could allow the business to scale successfully through upgrades or usage limits. Zendesk has an excellent model for how it graduates customers from (virtually) free to large scale accounts. The sampling model pioneered by Dr. Pemberton forms the basis of the free trial today but if you are selling to enterprises it may not be the most appropriate model to focus on.

Are you running with or thinking about a freemium business model? Are you looking for expert guidance, access to financial data APIs, or technical resources to grow your startup? Click here to learn how Ynext Incubator supports financial innovation.