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October 10, 2019

Why (most) Startups Should Ditch the Freemium Model



How many free trials have you signed up to this week? One? Two? Ten? It seems like whenever there is a new technology tool on the market, it gets pushed out primarily with the use of the term “free” - which we all love so much. Who doesn’t like a free anything? When we’re talking about a piece of software that can help your business, or your personal life, you’re likely to give away your precious email address for a trial run at something that could really change the way you do things.



Of course the downfall of the free trial is when those 7, 14, or 30 days are up. You’ve invested time and energy into this application you’re using, and now it’s turned to stone. Like the end of the ball for Cinderella, your resources are turning into pumpkins. This doesn’t help the user, nor the company that seeks to create a paying customer base. That seemed to have been the impetus for startups that decide to offer the ever popular “freemium” model. It seems to be the best of both worlds. Customers can continue to use the free features they’ve become dependant on, while companies can keep them around and convert them into paying for certain “premium” features.

It sounds perfect on paper, but in reality there are some serious flaws for this model. Before your startup decides to take the freemium road, you should consider some of the disadvantages. Here’s a look at some of the biggest problems you could face, that may very well prompt you to drop the idea entirely.

Monopoly Money Resources

One of the first obstacles you’ll face when offering free products or services is the resources you’ll need to expend. Remember, you’ll need to give these “free” customers a great experience so that they pay for premium options. That means you can’t skimp on giving them the full experience. They need customer service, product fixes, and anything else a paying customer would get. It’s just that you are fitting the bill for this while they pay nothing.

It’s easy to see this as simply an investment in your future returns. It’s not that this isn’t true, but be aware that it might make you treat your resources as monopoly money. They aren’t! Even if you have funding, your resources will run out if you don’t plan correctly. Sometimes resources are scalable, like creating a knowledgebase that can serve 5 customers or 5 million. Other times, they aren’t, like server space. File storage companies like Dropbox offer freemium, as do website building platforms like IMCreator, and they need to pay for server space for each and every user - paying or not. How do they do it? Well, it all comes down to converting enough freemium users into paying ones.

The Conversion Conundrum

This may be your biggest blindspot. You believe in your product and are sure that the more people use it, the more they will want to pay for it. Don’t fall into this trap of throwing around your resources because you have rose-colored glasses on when it comes to your conversions. Sure some brands convert incredibly well and yours could be one of them, but the fact is that the average conversion rate for freemium users to paid is in the 2% to 5% range.

Your CFO will need to run a tight ship so that you can be profitable with such conversion numbers. This might be possible for your specific vertical, but don’t assume as much. Perhaps you’re okay with taking a loss now and cutting into your funding. Just as with investing in the stock market, the more you leverage your dwindling resources, the bigger the chance that it will all come crashing down on you. This isn’t meant to scare you, but inflated projections are often the downfall of companies. The recent resignation of WeWork’s CEO is directly tied to their pie in the sky valuation, that some aptly termed as the most ridiculous IPO of 2019.

Under Viral Pressure

There is one way to guard against low conversions, and that would be high volume. If you’ve priced your product correctly then you should be able to carry the costs of your freemium freeloaders as long as there is enough money coming in on a whole. What you do have is a smaller margin for error, so you won’t have the luxury of a proper marketing budget. You can’t afford to incur the costs of freemium and pay a decent CPA (cost per acquisition) for your paying customers. That means you’re going to rely greatly on organic marketing techniques.

“But my product is awesome and people will tell all their friends!” you say. That may be correct, but in a world where the competition for eyeballs is fierce, you’re going to need to really stand out. It isn’t enough to have some word of mouth going for you. No, what you really need is a viral hit. Unfortunately, it is just about impossible to predict what will go viral and what won’t. There are some general guidelines on how to make your product go viral, but beyond that you are at the whim of the public and fate. Which will naturally leave you under an intense amount of viral pressure if you don’t have any resources left to spend on marketing.

The Big Caveat

If this sounds like a bunch of doom and gloom, well... you have a point. Not every startup will be susceptible to the type of risks that a freemium business model brings. In fact, if your product has a low footprint in terms of resources, then freemium may still be your best option. That’s why we say “most” startups should choose a different model. Freemium isn’t a scourge to be defeated, it just shouldn’t be the go-to option. Think long and hard about your product pipeline, revenue model, and industry vertical before you decide that taking on a lot of free customers will ensure your startup’s success.

In the end, you want profitability, not huge scale. Make sure not to lose track of what you’re working for and the bottom line, and your startup will be just fine no matter which business model you decide on.

About the Author:

David is a freelance writer and startup enthusiast. He often writes about new tools and how the business world is being turned upside by technology. He's been online since people called it "the net", pairing his love of words with technical know-how. He's excited that nowadays, due to technology, everyone can create an impact, both online and offline.



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