Why the Freemium Business Model Is So Successful

A freemium business model helps engage new customers and can eventually upgrade them to paid customers. These companies are great examples of this model.

Daniel Ternyak
February 8, 2023

It’s tough to get someone to hand over their cash for a product or service they’ve never tried before.

That’s why free trials are a popular way to introduce someone to your service. There’s a better way to welcome new customers though that’s even more attractive to them — the freemium business model.

In this guide, we’ll get to know the basics of the freemium business model and why it’s so great. We’ll also take a look at some of the measures of success and explore successful SaaS companies to take inspiration from the way they operate their freemium plans. 

What Is a Freemium Business Model?

“Freemium” is a term that was coined in the early 2000s to describe a particular way of doing business. The word is a mix of “free” and “premium”, which points at the two tiers that make up this business model. 

With most successful freemium business models, there’s a clear distinction between the two offers. With the free plan, you have access to the basic functionality of the tool or service, plus maybe an extra feature or two to encourage you to explore further.

With a premium plan, you have access to more features plus bonuses like better customer support, a referral or loyalty scheme, or branded swag. 

The freemium business model is especially popular in the world of startups and SaaS companies. With most companies in this space, competition is fierce — that means that you want to win over as many potential customers as possible. A competitive pricing strategy helps, but a free plan means there’s no hurdle for people to jump over to try you out. 

Freemium vs. Free Trials

There’s a lot of freedom, flexibility, and time offered with a freemium business model. People can explore your product and see if it works for them at no cost, and with no time limits. A free trial, on the other hand, often gives users the full product or service suite for free, but it’s time limited. 

Free trials can present a barrier to users that isn’t present with a freemium model — giving away your credit card details. Often, you’ll need to hand over your card details to the company in order to activate the free product or service trial, with your card being charged for the premium version if you don’t cancel in time.

For organized people, this is no problem. But for some people, it creates an atmosphere of pressure. If you can structure your business around it, a freemium model is a great way to get people through the door. 

What Are the Benefits of a Freemium Business Model?

freemium business model: group of people happily discussing something

Adding a freemium product to your business model can bring you plenty of benefits. Here are some of the main positives of switching to a freemium business model, or introducing a free tier to your existing line up. 

Faster User Acquisition

People don’t like going through multiple steps to get something they want. By removing the need for someone to give you their payment details upfront, you simplify the process and shorten the customer journey. That means they can enjoy your product faster. 

Not only does this speed up the process for people who’ve made the decision to become customers, but it makes it easier for them to spread the word about you too.

With no barriers in the way of signing up to your free service, it’s easier for people to refer potential customers by word of mouth. These referrals mean you can grow your user base even faster, which is great news if you have targets to hit to satisfy your board or potential investors.

Built-in Upsell Opportunities

Once someone’s part of your world, it’s easier to convince them they need the additional features in your paid version. Your free users are just as valuable as your paying customers, because they’re easier to convert than cold leads — plus you have plenty of opportunities to upsell to them. 

Don’t be afraid to show your free plan users what they’re missing. Offer them the chance to see where a premium feature could improve their experience with helpful tips and hints in your user interface, or showcase a new premium feature within your weekly email newsletter.

Celebrate your free plan users, but always be mindful that they’re only a thoughtful suggestion or enticing offer away from becoming a premium tier user. 

Easier Beta Testing

With a freemium business model, it’s easier to build up a strong user base compared to focusing solely on paid plans. With more users, it’s easier to find people that are willing to sign up as beta testers for new features or improvements. 

Seek customers who are interested in becoming a tester for you, and offer an incentive or reward as a thank you for their time — like a free upgrade to your paid plan for a number of months or early access to new features.

They benefit from experiencing something they might buy into later, and you have an excited group of people ready to test and rate your new premium features. 

Further Monetization Opportunities

Just because someone’s on your free plan doesn’t mean they can’t earn you any money. Before they jump aboard as a premium plan customer, there are still ways you can monetize their presence and use the funds to grow your business. 

A great way to monetize your user base is through advertising. You can display ads to your free plan users and offer an ad free version to your paid plan users.

This means you benefit both from the ad revenue from free plan customers and the revenue from those that would rather avoid ads and become a subscriber.

Plus, a higher number of active users per month means you can charge more for your ad spots and attract bigger commissions from sponsored content deals on your blog or newsletter.

Freemium Business Model Metrics to Track Success

freemium business model: person pointing to graphs on a tablet

The freemium approach doesn’t work for every business. Like any business model, you need the right culture, product, and team to make it happen. 

If you’re ready to give it a go, here are some of the key SaaS metrics you’ll want to track to see if it’s a success or not. 

Customer Acquisition Cost

Your customer acquisition cost looks at how much it costs to convert someone into a customer. It covers any sales and marketing costs throughout the process — from that initial social media ad to the cost of onboarding them as a new customer. 

To calculate your customer acquisition cost, you divide the number of new users gained over a period of time by the length of that period.

There’s no set figure this should be, but as you move to a freemium business model this cost should ideally drop. You no longer have to reach out to as many cold prospects as before — which are harder to convert. Instead, you have a warm audience of potential paid customers already in your ecosystem. 

Number of Active Users

With a freemium model, there’s no need for someone to add a new monthly expense to their list. They don’t need to pay every month to use your service or cancel if they can’t find the funds or don’t get approval from management. Instead, your customer base can make your product part of their regular routine. This should be reflected in a healthy number of active users. 

To work out how many active users you have, you first need to define what active means to you. For most businesses, this is simply recorded when someone accesses the tool or product — or does so for a defined amount of time.

Next, decide how long you want to measure this data point over — a month is a popular time frame. Compare how many active users you have before and after switching business models, and for a few months either side, to understand if it’s having a positive effect on user numbers or not. 

Conversions from Free to Paid Plans

The ultimate way to determine whether your free version is successful or not is to look at how many people upgrade to your premium tier. This might be a simple stat to record and monitor, but it’s a powerful one as it’s a direct and defined action as a result of your free tier existing. 

It’s easy to monitor your conversions — simply reflect back on the previous month’s data to see how many users upgraded their plan during that time period.

Compare your results with months where you only had paid plans available, and see what effect this has had on revenue. If the freemium model is working for you, your conversion rate should be healthy and you’ll see a positive reflection in your revenue figures. 

5 SaaS Companies With an Effective Freemium Business Model

The freemium approach is popular with SaaS companies, as it’s an easy way to bring new customers through the door, which in turn makes your service look like an attractive prospect for investors, partners, and other potential users. Here’s a collection of SaaS companies with a successful freemium strategy that you can take inspiration from. 

1. Slack

Slack is one of the most popular messaging tools around for businesses, and its free plan is one of the reasons why. You can set up a workspace on Slack and have everyone chatting together in moments, without getting approval for a new paid tool or going through a lengthy process. 

This popular messaging tool has a free tier and three premium tiers above it. The free plan has all the basic features, but you’re limited in how many previous messages you can access. This is a clever way to encourage people to upgrade — once they hit that 10,000 message limit they’re not going to suddenly want to miss out on previous conversations. So, they’re likely to upgrade to a paid plan. 

2. Spotify

Spotify is one of the biggest music streaming services out there, and a large reason for that is its huge library of free music. You can get access to over 50 million songs without paying a dollar. So why do so many people subscribe? For a must-have premium feature — ad free music. 

There’s nothing worse than having your playlist interrupted with an ad, and Spotify knows it. Spotify Premium features other benefits too — like higher music quality, being able to play any track on mobile within a playlist, and downloading music for offline play. Beyond the solo plan, Spotify also offers plans centered around relationships and family life, bringing the cost down for couples or families and introducing useful features like shared mixes. 

3. Mailchimp

Mailchimp started out as an email marketing tool that simplified things for small business owners and solo entrepreneurs but has grown into a fully featured marketing automation suite. Throughout that time, they’ve offered customers an easy introduction to it all through a free plan. 

Like most email marketing tools, Mailchimp’s pricing scales with the number of subscribers you have. The free plan is only available to customers with up to 2,000 contacts — meaning they have to take out a paid plan in the future to stay with them, or move to another system. It’s a smart way to encourage people that’ve already got used to your system to stay and upgrade. 

4. WordPress

WordPress makes it easy for people to bring their voice online, with a free plan that lets anyone set up a simple website in moments. To unlock better features and improve their experience though, they’ll need to subscribe to a paid plan. 

Tapping into the understanding of how frustrating adverts can be, users can remove WordPress.com ads by taking out a premium tier plan. Not only that, but they get a free domain for a year — a must-have for any serious professional. Beyond the first paid tier, the plans scale based on features and need.

An interesting feature is that they’ve highlighted the signup button for the Premium plan in a different color and given it a “popular” tag, making it a more attractive option than the other plans. 

5. ServiceBell 

You don’t need to be a huge SaaS company to see success with the freemium business model. Here at ServiceBell, our innovative live video chat tool is accessible to anyone with our free plan. This gives people the chance to experience the benefits of live video calls with customers as they browse your website, before they commit to a paid plan. 

Our free plan gives customers everything they need to get the best from our service, with the next tier above offering added extras like unlimited takeovers and additional team members.

Our plans scale up to cater for the needs of different business sizes and styles, with premium tiers offering multiple domains, priority support, and discounted extra calls. Our strategy also combines freemium with free trials. Users can trial a premium plan for free — giving them the ultimate choice to see which is best for them. 

Is a Freemium Business Model Right For You?

Not every business model is right for every business. But if you’re a SaaS company or run a tiered membership scheme, it can be a powerful way to bring new customers into your ecosystem without putting barriers in the way. 

If you want to take a look at a freemium business model in action, take a look at our pricing page. While you’re there, take our product for a spin and see what adding live video chat to your website can do for your customer engagement, acquisition, and retention.