Startups & The Challenges Of The Freemium Pricing Model

2007-05-17 by Dharmesh Shah



It has been a while since I wrote my last article on pricing models titled "Startup Pricing Models: Free Forever, Freemium and Freedom To Pay".

This article ended up being reasonably popular (and continues to rank on the first page of Google for a search on "freemium").

I was reminded once again of freemium by a very interesting article from Don Dodge which notes that the average conversion rate of free to premium offerings for companies using the freemium model is about 3%. I was actually quite surprised (in a pleasant way) by this level of conversion. I've been considering the freemium model for one of the products currently being built at my startup, HubSpot.

The product under consideration, WebsiteGrader, is a website grading tool and recommendation engine that helps business people get a sense of how effective their website is from a marketing perspective, how it compares to competitor websites and makes recommendations for improving the site. The tool is currently free. Even in it's current beta state (very little PR and promotion), it has graded over 28,000 websites and gets over 500 visitors a day.

So, what are the challenges with releasing a product under the freemium model?

Here are the ones I've come up with (so far). I'm sure the a few of you will have some of your own. If so, please share.

Challenges Of The Freemium Model

1. Deciding what to include in the free version and what to offer in the premium version is non-trivial. The trick is to put enough in the free version to get traffic and usage -- but not so much that there's not enough incentive for a certain percentage of people to upgrade.

2. Though hardware, bandwidth and infrastructure are cheap (and getting cheaper), they're still not free. Supporting thousands of free customers costs money and unless there's enough money coming in from paying customers, there might not be enough cash coming in to subsidize the free folks.

3. Support is a problem. Though in theory you can take the position not to offer any support to the free users, in practice, it's hard to have the discipline and processes in place to actually do this.

4. Pricing for the premium version is likely impacted by the fact that there's a free version. For example, I don't think one could successfully offer a premium product for $250/month if there's a free version out there. The premium version would have to be really good and an order of magnitude better than the free version. This is probably why most freemium products are less than $50/month.

5. It can get a bit tricky to use scaling pricing models for a freemium product. For example, let's say you charge $20/month "per user" (per seat or per whatever). For many customers, this creates an added barrier to upgrading. If they have 10 users, there's even more incentive to just have all 10 users use the free version. Or, they could just buy one paid license (for the key features they need) and keep the other 9 on the free version.

6. Attrition rates can be unpredictable and potentially higher than traditionally priced products. For example, if there's not enough "value" in the premium version, it's possible that even customers that upgraded will eventually revert back to the free version.

Of course, there are lots of benefits to the freemium model too -the most important of which is efficient marketing. It's a greaty way to get early users to use the product and have a pool of potential people to upgrade.

What are your thoughts? Have you tried the freemium model? If so, what has your experience been? Are there other challenges that I missed? Would loveto hear your ideas in the comments.

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About the Author: Dharmesh Shah is a serial software entrepreneur. He is the author of the widely read startup blog OnStartups.com which focuses on advice and ideas for startup founders and management teams. Dharmesh is also the co-founder of HubSpot.com, a software company building applications that help small businesses transform their website into a marketing machine.

Startups The Challenges Of The Freemium Pricing Model