Freemium: is it good for your business?

A freemium pricing illustration: designed by Freepik

Time and time again, topics about freemium draw heated and opinionated debates among marketers, executives and entrepreneurs.

On the one hand, this simple ‘free + premium’ idea carries an enticing possibility of bringing in a huge customer base efficiently, which has been fueling amazing growths of Spotify, Fortnite, Zoom, etc.

On the other hand, it’s been the culprit of struggles and even bankruptcies for other companies. Many SaaS companies suffered painful losses due to freemium. Some went bankrupt, and others eventually ditched it to become profitable. GetResponse (email marketing), Chargify (B2B billing and revenue management) and Qualaroo (survey tools) are some of the victims. Even DropBox, a once hardcore player in the freemium club, decided to hide their free tier in the website to draw attentions to pay options.

What makes freemium a hero for growth? What makes it a villain for struggle? We’ll dig into both success and failure stories, to demystify the productive and destructive powers of this controversial model.

Let’s start with the story of MailChimp, a successful freemium practitioner. Founded in 2001, the modern marketing platform currently occupies 62% share in email marketing. In 2019/20, it enabled 12M+ active customers to reach a 4B audience, and achieved $700M revenue.

Freemium has been considered as a key driver for MailChimp’s rocket growth in the past 10 years.

Freemium fueled MailChimp’s hockey-stick userbase growth

When asked about what enabled MailChimp to break out from its intense competition, the company’s co-founder and CEO, Ben Chestnut, replied: “It has to be freemium… When we launched our freemium plan, everything took off… We went from tens of thousands of users to a million in the first year. And then it doubled and doubled and doubled after that. It’s been a crazy rocket ride from there.”

In fact, MailChimp’s userbase grew from 85K to 450K, or 429% Y/Y in the first year (2009) they introduced freemium. To Chestnut’s description, it doubled and doubled after that.

It also created huge unintended consequences

Along with MailChimp’s 429% userbase growth in their first year of freemium, emails sent soared from 200 million to 450 million per month. That’s when the abuse started. Spammers flocked to the free service, pushing abuse-related issues up by 354%. Just within the first seven months of freemium, the company sent 35,539 warnings, suspended 4,233 accounts, and shut down 1,193 users.

The abuse problem cost MailChimp a lot. Its workforce to deal with abuse grew 200%, and legal costs grew 245%. While the company only had 38 people on staff, its CEO had to decide whether to hire 30 new employees just for customer support. Not being able to find an effective detecting solution in market, they also had to develop an algorithm in-house to detect spam, which crushed their own servers. Then they bought supercomputers, and eventually shipped the heavy computing to Amazon’s EC2 server cloud, in order to sift through 61 trillion samples.

Eventually it’s about helping customers outgrow its free tier fast

Although the free version caused MailChimp significant cost and effort, they managed to get through it. In addition to the 429% overall userbase growth, they also increased paid customer base by over 150% in their first year of freemium, and realized 650% growth in profit.

MailChimp does not make money from its free version. All of their revenue comes from paid tiers. Converting from free to paid is the critical path.

MailChimp chose a customer-friendly route to make money — to help users grow beyond the scale of its free version. The company rolled out a comprehensive set of initiatives to proactively help customers grow. They created learning pages, set up expert directory and shared research articles based on their own data of millions of businesses. They also developed new features to help customers make money and save time, such as the capability of easily building Facebook and Instagram ads directly inside the MailChimp platform.

With MailChimp’s help, many customers were quickly onboarded to the platform, got better at marketing their business, and grew faster their email list beyond the free limit. According to the Company’s CEO, the conversion from free to paid “was less like a forcing mechanism, but more like a celebratory rite of passage.” Customers tend to feel proud that they are “finally a paying customer”.

MailChimp’s story showcases freemium’s huge potential in expanding a product’s userbase. It also uncovers freemium’s damaging consequences which may lead to serious business failures.

Chargify’s struggle with freemium

Chargify is a SMB billing management software provider. The company used freemium when it started out in 2009. They gave away their software to merchants that billed fewer than 50 customers a month, and charged $49 a month to those who billed 50+ customers. However, most users never grew their billing and accounting needs beyond the free version. As a result, few Chargify users ever became paying customers. Within a year, the company was on the path to bankruptcy. Chargify eventually put up a paywall for all users, and became profitable a few years later. “The decision to move away from freemium was the best business decision we ever made,” said Lance Walley, co-founder and chief executive officer.

MailChimp’s success and Chargify’s struggle reveal the two criteria of a successful freemium:

  1. Getting an abundance of free userbase (free-user obtainability)
  2. Converting sizable free users to paid customers (free-to-paid upgradability)

Building a 2X2 matrix with these two aspects, we may evaluate whether freemium fits a product or not, and understand why some choose to stay out of it.

The ideal freemium candidates

The ideal candidates for freemium locate in upper right quadrant of the grid. These products appeal to a sizable userbase, and are simple enough to demonstrate value in free. They also have intuitive triggers to support natural and reasonable free-to-paid upgrades, as products’ value to users broaden and/or deepen. Examples in this group includes MailChimp, Zoom, Spotify, Fortnite, etc.

Premium/niche products with proper upgrade mechanism

Candidates in the upper left quadrant may adopt freemium in a more careful and targeted manner. These products possess proper mechanics to convert relevant users from free to paid. However, because of their premium/niche nature (e.g., luxury goods, high-end restaurants or specialized tools) or inherent technical complexities (e.g., technical products), it’s not realistic or economic for them to obtain and maintain a large free userbase. For this type of products, offering freemium exclusively to selected users may yield the best return. It showcases product value to targeted customers via free (samples, seeded capacities, etc.), and at the same time limit the burden of supporting too many free users unnecessarily.

Enterprise focused and/or high-ticket products

Products in the lower left quadrant lack both free-user obtainability and free-to-paid upgradability for net new users. Many enterprise-focused (ERP systems, servers, etc.) and high-ticket products (diamonds, cars, etc.) fall into this category. They usually require dedicated and complex decision-making cycles, as well as high upfront commitment and investment. In this case, freemium neither helps attract target users, nor does it drive any free-to-paid conversion organically. Instead of freemium, vendors are better off investing in a capable sales force and good customer support.

Products with broad appeal but low upgrade intent

Last but not least, products in the lower right quadrant should resist the temptation to adopt freemium. For this type of products, having a free version brings in a large userbase, for they are simple to adopt and quick to demonstrate value in free. However, they lack effective triggers to convert free users to paid ones. Without good upgradability, freemium can be destructive.

Chargify falls in this quadrant. Their problem is to identify meaningful delineations between free and paid versions. Due to lack of effective conversion paths, vendors like Chargify struggle to convince users to upgrade above the free tier. According to a study from Harvard Business Review, most freemium companies have free-to-paid conversation rates ranging from 2% to 5%. It is not uncommon for freemium practitioners to be suffocated by a heavy load of moochers.

Many ‘billion-user products’ also fall into this quadrant, such as Facebook and Google search. For these products, revenue hinges on a gigantic active userbase. Having a paid version on top of free not only complicates the ‘free-for-all’ message, but also runs the risk of stalling user adoption and engagement. In this case, freemium acts as a speed bump, rather than an accelerator for user and revenue growth. A simple ‘free’ model better serves the purpose.

Takeaway

Freemium, like many other business models, need to be carefully matched with the nature of a product and business.

I recommend three questions below to anyone eager to hop onto the freemium bandwagon:

  1. Is your product capable of attracting and serving an abundance of free users?
  2. Does your product have effective mechanics in place to incentivize natural conversion from free to paid versions?
  3. Could you afford serving 95%+ of your userbase for free, and managing possible abuses?

If your answer is ‘no’ to any of these questions, think twice.

Sr. Business Planner at Microsoft