The Secret to Freemium Pricing

Tuesday, July 21, 2015

I'm sure you've heard the expression there's no such thing as a free lunch. While true in most cases, many software companies offer significant value to consumers under freemium pricing.

But while free pricing tiers can represent a boon for consumers, they can cause great injury to software producers' bottom lines. Sure, a single free user is unlikely to cost much, but in aggregate they can eat up significant bandwidth, increase support costs, and divert attention from more profitable endeavors.

So why bother with free? There are two main reasons:

• Viral marketing
• The chance that "free" users will upgrade to paid plans

The marketing potential of free is obvious. As the number of free users grows, more and more people will tell their friends about the wonderful product that they are using. Unfortunately, I suspect that the benefits of this type of whisper campaign are overhyped. After all, free users are most likely to recruit those like themselves (other free users). "Oh, this product is great and it's free too!" Do you know what you call free users who do not recruit paying customers? Expenses.

Much better is to focus on the potential to convert free users into paying customers. Companies should optimize their product tiers to ensure that free users have an incentive to upgrade. That means that firms should think about how they want to limit their bottom tier plans to ensure that users will choose to become paying customers.

Here are a few common strategies:

• User count limitations - Some products, like Harvest, offer free plans for one-person teams. As a user's team grows, he will have to be forced to upgrade to a more expensive plan.
• Calendar limitations - Many companies will only allow use of their products for a limited time. Although Circuit City found nothing but failure with its DIVX rental strategy, shareware companies have been using this model for decades. Many successful companies like Basecamp offer free limited-time trials to get customers hooked.
• Functionality limitations - Microsoft didn't have much luck with its MS Office Starter Edition, but many companies like Wolfram Alpha have found great profits in releasing limited functionality tiers for free.

The proper approach will be highly dependent upon the nature of the product being offered. For instance, GitHub has a free tier, but all stored data is visible to the world, unless users upgrade to a more expensive plan. The key item to remember is that a free plan (if you choose to offer it) should be limited in some fashion so as to reduce customer value. Otherwise, why would anyone ever choose to pay money for a higher-priced plan?

Rethinking your pricing? Don't know where to start? Why not contact me for a free consultation, or take a look at my amazing book on how to price software systems.