Freemium pricing is a business strategy where a company offers their basic products or services to users at no cost and then charges a premium for supplemental or advanced features. The term “freemium” was coined in 2006 and came from a combination of the words “free” and “premium.” Yet, the business model has been in use by software and SaaS companies since the 1980s.
In particular, the video game industry has capitalized on this pricing model through variations like free-to-play (F2P or FtP) games that allow players to access a significant portion of the content without paying, as well as providing entirely costless freeware games. Additionally, social media has become woven into the fabric of global culture through its freeness and extreme ease of use. In 2020, the international video game industry was valued at $175+ billion, and the worldwide social media market was valued at just under $200 billion. Both industries are predicted to continue to grow exponentially through 2025.
A freemium strategy is uniquely positioned to combine well with almost any other pricing model and can be used to build innovative, customer-centric approaches to billing. Many freemium software products utilize in-app purchases, ecommerce plug-ins, and targeted ad space to supplement earnings made from premium tiers. Some modern companies are even moving away from offering additional tiers altogether and are instead focusing on collecting user data to perfect personalized ads.
Not every business is suited to using a freemium model. Still, by exploring the wide variety of ways it’s applied to other industries, you can discover new methods and inspiration for your pricing model.
Want to explore a specific aspect of freemium pricing? Skip ahead by clicking on the topic.
- Unpack the pros
- Unpack the cons
- 5 freemium pricing strategies
- Understand revenue recognition and deferred revenue
- Implement and manage the complexity
Understand the benefits and challenges of freemium pricing
Unpack the pros of freemium pricing
- Low barrier to entry since the user can access the products or services for free, making it easier for customers to engage with your offering.
- Exponential growth is possible with excellent strategy execution as the model can handle a massive volume of customers. As you build an extensive pool of active leads, you will have access to people already signed up for your services to upsell more advanced features and packages.
- Customer acquisition costs are lower as it’s easier to upsell your premium tiers to customers that already use the free model and scale with them as they develop brand loyalty.
- Expand brand awareness as more and more customers interact with your products or services. Like a pricing penetration strategy, a freemium model will allow you to cut through market saturation to effectively capture and upsell your audience.
- Save on marketing expenses, especially if you’re tapping into a newer market to source your customers. Freemium users are a great asset for word-of-mouth promotion.
- The freemium model creates multiple revenue streams from elements like ads and in-app purchases to support the earnings from your main products and services.
- Collect user data and utilize free beta testing to gain feedback that will help fine-tune your pricing tiers and marketing to attract the right buyer personas.
Unpack the cons of freemium pricing
- Operational costs are higher to support offering a premium product for free. You will need to budget appropriately to maintain quality through an influx of not-yet-paying customers.
- Return on investment (ROI) requires enormous volume. Freemium models rely on an astronomical number of active users to generate revenue.
- The conversion rate of those willing to pay is usually lower as customers of all kinds are attracted to trying out the free version but will not necessarily upgrade. A substantial portion of your users may not fit your buyer personas and can end up costing your company over time.
- Customers might undervalue your offering because you may unintentionally educate the market that it’s worth a lower price by marketing it as free. This phenomenon is known as the anchoring effect, to learn more about how it works, read our blog on pricing psychology.
- Lower conversion rates often necessitate lower-priced premium tiers. Appropriate pricing is essential to upselling customers who are used to the free version. You also don’t want to be combatting sticker shock.
- Churn rates can be inflated. Potential customers might be turned off if your offering isn’t extremely easy to use, and even customers who’ve decided to use your product or service might abandon your free version if they become bored with it. Casting a wide net will bring you more customers but will not guarantee stickiness. Confusing or complex elements are best kept for paid tiers where customers are already invested in learning.
5 freemium pricing strategies with examples
There are several different ways to create a freemium pricing model, so this list is to help you determine which approach might work best for you. Below quickly summarizes the various strategies, and you can click the pricing strategy of your choice to jump ahead:
1. Traditional freemium pricing | Explanation and example
Traditional freemium pricing consists of an introductory free tier and a few paid tiers. Unlike trial-runs or demos, the free tier is available to the customer, at no cost, forever. Many companies will limit the functionality of the free tier to conserve their resources and direct their customers towards the premium tiers.
Dropbox is a file hosting service that offers cloud storage, file synchronization, personal cloud, and client software. They provide a basic free tier and then two upgraded plans that include more storage and users. Since their freemium model is not offered as a tier, it’s strategically positioned to entice customers who may balk at the price while minimizing any anchoring effect.
2. Freeware | Explanation and example
Freeware refers to the practice of offering a fully functional product for free forever. The term comes from combining the words “free” and “software.” This pricing strategy has led some companies to tremendous success in the video game industry. Free online mobile games are often ad-supported, and many developers incorporate in-app purchases into their games for players to customize their characters or gain better in-game equipment.
League of Legends, often shortened to “League,” is a multiplayer online battle arena (MOBA) video game developed and published by Riot Games. The game is exceedingly popular with 150+ million registered players and about 120 million active daily users. In 2020, League generated $1.75 billion in revenue.
Riot Games employs an array of tactics to generate multiple revenue streams. They sell League-themed product lines for loyal fans that want to purchase merchandise and have begun developing in-game banners to display advertiser branding for real-life companies during official League esports broadcasts.
One of their more lucrative strategies involves players purchasing Riot Points (RP), which work like in-game currency to buy specific “champions”, items to enhance their gameplay, or changes to the appearance of their character known as “skins”. Although many of these elements can be earned through completing challenges and milestones in-game, many players treat them like collectibles and would rather speed up the process by spending RP.
3. Land and expand | Explanation and example
The land and expand strategy is a staple of the SaaS market, where a product or service is offered for free with account sign-up. When the customer reaches a specific threshold limit, the company then monetizes the product/service. Unlike other freemium models, the free offering is usually a teaser for other goods and services.
Yammer was an enterprise social networking service used for private communication within organizations and a historic example of a land and expand strategy. Yammer Basic was a free, smaller version of Yammer Enterprise for individual use. In 2017, Microsoft began to phase out Yammer Enterprise and re-integrate the network into Office365. At the height of its popularity, Yammer’s conversion rate reported 15-20%.
4. Ecosystem | Explanation and example
Ecosystem pricing is when a company offers their base product or service for free forever and relies on revenue made through deals with third-party developers. Ecosystem models often work when your offering is the missing link connecting buyers with sellers and facilitating partnerships.
Capterra is a free online marketplace vendor that serves as an intermediary between buyers and technology companies within the software industry. They help customers select software by providing them with user reviews and research. Vendors pay Capterra whenever they receive web traffic and sales opportunities earned through the ecosystem, allowing buyers to use the service for free.
5. Network effect | Explanation and example
The network effect is a type of pricing strategy where a company monetizes customer traffic and behavioural data. This can be done either through directly selling user data to third-parties or selling ad space for personalized ads—marketing that’s tailored to a specific buyer persona constructed from user data.
Meta, previously known as Facebook, is a technology conglomerate and parent organization for social network subsidiaries Facebook, Instagram, and WhatsApp. Users gain free access to these products, but upon sign-up, also agree to permissions allowing Meta to share their user data with third parties and to receive personalized ads.
Meta for Business allows vendors to purchase advertisements to be displayed across one or more of Meta’s daughter companies. When creating an ad, you can choose the objective, target audience, platforms, budget, and format. Meta’s algorithm will then analyze user data and exhibit your ad in accordance with your selected goals. You can also manually track performance and edit your campaign in Ads Manager to ensure optimal outcomes.
Revenue recognition for freemium pricing
Freemium pricing strategies generate multiple revenue streams, so it’s important that you can correctly attribute earnings during revenue recognition. Errors in revenue allocation data can have wide-reaching consequences on your ability to make strategic, data-driven business decisions.
You could be left unsure of how much each revenue stream is generating and lost on how to handle third-party advertisements or in-app purchases. Not to mention without a robust recurring billing solution in place, it’s much harder to maintain compliance with accounting standards like ASC 606 and IFRS 15.
Managing the complexity of freemium pricing
Avoid subpar management of your freemium pricing strategy by familiarizing yourself with these three critical elements of the pricing model that will aid your growth journey.
The 3 critical elements of your freemium pricing strategy
1. Appeal to mass markets
To achieve a successful freemium model, you will need considerable volume, so your business must attract as many customers as possible. Freeness is often not enough. Your offering needs to be extremely easy to use and create increased customer stickiness. Invest in excellent quality assurance and user experience.
2. Balance resources and budget
Even at peak performance, the freemium pricing strategy demands higher operational costs to provide premium-level quality to not-yet-paying customers. That’s why you must balance your resources and budget to forge a sustainable business model that can weather market fluctuations and higher churn rates.
3. Manage multiple revenue streams
A powerful recurring billing solution can automate revenue allocation while simultaneously helping you remain compliant with accounting standards like ASC 606 and IFRS 15. Tracking which earnings are being generated by what revenue stream doesn’t have to be complex. The right system will also streamline any additions to your pricing model or updates to your customers’ invoices, so tweaking y providing you with optimal agility to adapt to changes in the market.
Are you interested in other advanced subscription pricing models? Check out our guides below.
- The definitive guide to per-user pricing
- The definitive guide to tiered pricing
- The definitive guide to flat-rate pricing
- The definitive guide to usage-based pricing
- The definitive guide to bundle pricing
- The definitive guide to feature-based pricing
- The definitive guide to hybrid pricing