“Everything is free now,” folk music artist Gillian Welch sang in 2001. “Everything I ever done, gonna give it away.”
The song, “Everything Is Free,” was written as a lament of the rise of Napster and its free-mp3-file-sharing ilk that shook up the record industry by normalizing the digitization of media. Looking back, Welch’s lyrics also functioned as a prescient foreshadowing of the freemium business model that dominates today’s music industry — as well as plenty of others, especially in the B2B software space.
What Is Freemium?
Businesses of all kinds — ranging from Grammarly to Calendly, Notion to Fortnite — use freemium as part of their pricing strategies. Their free-to-use products reel in lots of users, turning some of them into paying customers by offering bells and whistles in exchange for a fee.
There’s no denying freemium’s popularity. But it’s worth asking: Is the business model for everyone?
What Is Freemium?
Should companies give away their products for free? It used to seem like a trick question to Mark Brenner, who co-founded Wiss & Company subsidiary WEST Growth.
“You had a product or service, you got people to pay for it, and that’s how business was done,” he told Built In in 2020.
But in the 21st century, that conventional wisdom got turned on its head. It started with Facebook and Google. Best-known for their free products, they went from objects of skepticism — what was the business plan, anyway? — to swaggering tech behemoths.
Along the way, Chris Anderson published a book called Free. The year was 2009, five years after Google went public at a valuation of $23 billion, and Anderson, then the editor-in-chief of Wired, was making a business case for giving products away. In the internet age, he argued, a select few paying customers could subsidize a product that was free for all.
Anderson also touched on an intriguing alternative model, Virginia Postrel wrote in her New York Times review of Free:
Less familiar [than the ad-supported strategy] is the “freemium” strategy, in which a site like Flickr offers one package of services free but charges for an ad-free package with more features, allowing a small fraction of users to subsidize the rest.
In the more than a decade since her review, “freemium” — syntactically, a mash-up of “free” and “premium” — has become much more familiar.
Freemium Model Examples
If you’re reading this, you’ve almost certainly used a freemium product before. Maybe your office job relies on the freemium version of some collaboration software, or maybe you make video calls to family with a free Zoom account, or maybe you test your patience by listening to the ad-supported version of Spotify.
These services, and others, helped make freemium a mainstream business model.
Freemium Model Examples
- Slack
- Dropbox
- Spotify
- Zoom
- Canva
Launched in 2014, Slack’s chat app amassed more than 500,000 active daily users within its first year and more than tripled that in its second. The key was — and remains — its free tier, which lets prospects try out basic functionality indefinitely. It comes with certain built-in inconveniences, though — for instance, it only lets free users access the most recent 10,000 messages in their archives — that only a paid subscription can solve.
Slack’s free tier, like all free tiers, fueled a product-led growth strategy, helping the app amass a user base through word of mouth and network effects. Unlike many startups of its era, Slack didn’t rely on marketing professionals or sales reps, even when it came to enterprise accounts — instead, it landed them through grassroots adoption. Employees tried Slack out and shared it with their colleagues, until the lack of a company account became an inconvenience.
Dropbox, the pioneering cloud storage provider, rose to prominence on its freemium pricing model. The company offers new users two gigabytes of free storage when they sign up, and, once they reach their limit, it’s easier to pay for more space than to switch platforms.
This fundamental convenience factor has pushed about four percent of Dropbox users from free to paid accounts — a low conversion rate compared to Spotify, but robust for the tech industry as a whole. According to Harvard Business Review, a roughly five percent conversion rate from free to premium is optimal: it means the free tier strikes a balance between growing the overall user base and bringing in revenue.
Dropbox is living proof of that: Since its 2007 launch, the company has amassed more than 700 million users, and its IPO valuation was $10 billion.
Spotify has a free, ad-supported tier of its music streaming app and a variety of ad-free paid subscriptions. Classic freemium. Back in 2015, in fact, the company garnered criticism for overreliance on its free tier. Could it ever be profitable?
The company defended its business model, though, saying in a statement:
Our Premium and Ad-Supported Services live independently, but thrive together. We believe this business model has allowed us to achieve scale with attractive unit economics and is a critical part of our success.
The past several years have borne out this argument: Spotify has grown faster than competing streaming services. In 2019, it was the first to reach 100 million paying users worldwide.
The company has honed its conversion strategy too. Today, it has a high ratio of paid to unpaid users: More than one-third of its subscribers pay.
Zoom went from a collaboration tool known only by some office workers to a fixture in the everyday person’s vocabulary during the early months of the pandemic, when the desire for free video conferencing became ubiquitous.
Zoom reported year-over-year revenue growth of 326 percent between March 2020 and March 2021, even though it costs nothing for someone to create a Zoom account and set up meetings — even meetings with up to 100 people.
But the meetings on the free plan only work up to 40 minutes. To unlock longer meetings — and meetings that can host more participants — users need to sign up for paid plans, which start at nearly $150 a year.
Canva rode its freemium business model all the way to a $40 billion valuation. The software, positioned as a consumer-oriented alternative to Adobe Photoshop, lets non-professionals create graphics with simple design tools on their web browsers — and it’s free.
To unlock additional features — like advanced design tools, premium templates and access to a vast stock-image library — users are asked to fork over $13 a month for a Pro plan. And businesses that want to take full advantage of Canva’s features can pay $30 a month, per person, for the Enterprise plan.
Freemium Advantages and Disadvantages
Rob Walling, a serial entrepreneur, once said that “freemium is like a Samurai sword: unless you’re a master at using it, you can cut your arm off.”
On one edge of the sword is a whole bunch of benefits. Freemium models excel at:
- Quickly scaling up a massive user base.
- Tapping into virality and word of mouth.
- Keeping sales and marketing costs low.
At the same time, freemium is not for everyone. Some possible downsides of using the model for your business include:
- Having lots of users who are non-paying customers.
- Struggling with low free-to-paid conversion rates.
- Confusing users (if the product is complex).
Indeed, the constellation of freemium stars all have one thing in common: scale. All of them have “bet on the idea that they can get ... mass adoption,” Brenner explained. And they won.
“Once you do have mass adoption,” he said, “there’s a variety of ways to generate business value and market value.”
A massive audience becomes a product in its own right. Companies can sell all that aggregated attention to advertisers, or convert enough users to paying customers to stay afloat. Some companies — like YouTube, with its 2.6 billion users — do a little of both.
A freemium product with a smaller audience, though, is not long for this world. Only a small slice — some say 2 to 5 percent — of free users convert to the paid tier in freemium models, so covering even fixed costs with freemium pricing requires a huge user base.
Most digital publishers, for instance, have struggled to reach freemium’s requisite scale. Many had been offering less and less free content before the pandemic; its arrival triggered a precipitous drop in ad revenues, and hastened the industry shift to paid subscriptions.
Way back in 2009, even optimistic Anderson acknowledged that freemium posed a risk to smaller companies. “Everybody can use a Free business model,” he wrote in Free, “but all too typically only the No. 1 company can get really rich with it.”
In hindsight, freemium may have gotten famous on an inversion of cause and effect. It can’t turn any old company into a Slack-style household name. It’s more that any company using freemium pricing has to become a household name — or it will tank.
It’s a “high-risk, high-reward strategy,” as Brenner put it.
But if freemium pricing only works for an elite minority of ultra-scalable tech companies, does that mean the end of the trend?
Not necessarily. While freemium isn’t dead, Brenner believes it’s evolving from a common long-term business model to a common phase in a startup’s lifecycle.
For instance, Brenner recommends that client companies offer their core product entirely free in the seed stage, to assess basic demand and product-market fit. It’s a way of “de-risking their business,” by finding out answers to basic questions before asking for investors’ money.
At first, wide-ranging feedback and proof of demand is worth more than money, and “pricing is a huge barrier to getting the product into the market,” Brenner said.
But that initial free offering is just a “first step” for most companies, he said — the beginning of a conversation with their audience about pricing. What features are users willing to pay for, and how much will they pay for them?
Based on this information, startups begin finding ways to combine product-led growth with revenue. That may mean experimenting with freemium pricing, or month-long free trials and demos that lead to paid subscriptions.
Ultimately, though, free and freemium pricing models rarely last. They can lead to venture funding and early growth, but it’s only financially sustainable in the long-term for a lucky, famous few.
Freemium Vs. Free Trials
Freemium is different from — but bears slight resemblance to — its cousin, the free trial.
A freemium approach offers a stripped-down product with a limited number of features. A free trial, on the other hand, gives users the full product experience, but it only lets them use the product for a limited amount of time (or take a limited number of actions with it).
Free trials are often preferred by companies that want to show off everything their products can do. They give users a more-accurate sense of what the paid experience of the product looks like. And that makes it an especially useful strategy for companies whose products are more complex or specialized.
Free trials also make for faster sales cycles. At the end of the trial period, the user either churns or converts to a paid plan, so there aren’t many free users hanging around.
Even so, free trials don’t always give users enough time to “fall in love with the product,” Jessica Meher, co-founder and CEO of Wonderment, previously told Built In. “If you’re going to have a free trial, experiment with trial lengths.”
For companies with simple products that are trying to grow the largest user bases possible, the freemium approach is often the better bet.
