The 10 Laws of Freemium

Have you considered adding a “forever free” version of your product? Lots of successful SaaS businesses use a freemium model, like:

• MailChimp and ConvertKit in email marketing software
• Dropbox and Google Drive in cloud storage
• Clickup and Notion for project management
• Slack and Zoom for meetings and team communication
• Wave and Zoho Invoice for invoicing tools
• Typeform and Tally.so for forms

…the list goes on.

Does this mean you should switch over to a freemium model as well? 

It can be very successful. Mailchimp introduced freemium in 2009; one year later they had gone from 85,000 users to 450,000. In that year their profits increased 650% and their paying customers increased by 150%

But people tend to forget that Mailchimp also had a conventional subscription model for 9 years before that and had 85,000 paying customers at the time they decided to switch to freemium.

That’s why, as a general rule of thumb, I think it’s a bad idea to bootstrap freemium. At least in the early days where you have to be extremely capital efficient.

So let’s talk about when freemium makes sense, and for whom.

There are 10 conditions under which a freemium model can work.

I’d strongly advise you to go through this list and make sure your business meets at least 6 of these conditions before you think about switching.

1 - Free distribution is a competitive advantage

If offering your product for free does not give you any advantage over your competitors, there’s absolutely no point in a freemium model.

Note that this is why freemium tends to be better suited to companies selling to consumers and small businesses.

Enterprise buyers don’t really care if your product is free because the biggest cost is always driving adoption, training staff and switching over from the previous solution anyway.

Enterprise customers also value reliability above all else so offering your product for free can make them doubt whether you’ll still be around in 5 years - and that can kill the deal.

2 - There is a huge Total Addressable Market of at least tens of millions of users

Typically only about 3% of users will convert to a paid subscription when you have a freemium model. 97% will happily use your product but never pay for it. So you’re going to need a lot of users to be profitable!

3 - The marginal cost to serve additional users is negligible

The marginal cost is the cost of taking on one additional user. If each free user is paying you nothing but costing you even a few dollars a month to support, you can end up in an ugly cashflow situation very quickly.

SaaS businesses generally have very low marginal cost because it costs pretty much the same amount of money to build and maintain a software product whether you have 1 user or 100,000 users. 

But you’ll run into problems if you have a product that uses a lot of resources or requires a large customer support team.

4 - Your product has a simple and straightforward value proposition and is self serve

This is related to point #3 above about marginal costs. 

If your product requires salespeople to sell it, marginal cost will go up.

If your product requires customer success people to onboard and support customers then marginal cost will go up. 

Either way it’s going to be really difficult for a freemium model to work.

5 - Your business is funded or you have been around long enough to build up significant cash reserves

You’re going to still need to spend money on marketing in the first place to acquire users, 95% of whom won’t be paying you anything. You’ll need to spend more money supporting those free users as well until some eventually convert

This means you’re looking at a really long sales cycle with a freemium model; it can literally take years for even a tiny percentage to convert to paying customers.

So you’re going to need a lot of money in the bank to push through that and still lose money on each new user you acquire.

A good rule of thumb is: never bootstrap freemium.

6 - If you have some other way to monetize

This is the exception to point #5 above: attracting free users might actually make a lot of sense if your software product is basically a loss leader for another product or service you own. Think courses, services, membership, premium support or affiliate offers. 

Neil Patel famously bought keyword research tool Ubersuggest, made it free, and used it to generate leads for his marketing agency NP Digital. 

He now offers a premium subscription plan as well but this is a drop in the ocean compared to the revenue he makes from his agency through leads generated by Ubersuggest.

7 - If your product lends itself to usage gating (vs feature-gating)

There are two common ways SaaS companies tend to delineate their pricing tiers: based on product usage or based on product features. 

Basing your pricing tiers on product usage is generally a good idea because this creates opportunity for expansion revenue. 

Over time as your customer’s business grows, they will naturally use your product more and more and eventually find themselves having to upgrade to a higher pricing tier.

While usage gating is a good idea for most SaaS businesses, it is even more important for those using a Freemium model because ideally you want a proportion of your free users to eventually find themselves having to upgrade to a paid plan over time as their business grows. 

For example, Beehiiv’s free plan allows you to have up to 2,500 email subscribers on your list; after that you have to upgrade to a paid plan even if you don’t care about any of the additional features.

If Beehiiv allowed their customers to have as many contacts as they wanted on the free plan and only pay to unlock advanced features, many customers would stay on the free plan forever.

8 - If your product has natural network effects 

Slack can be a pretty lonely place if you’re the only one using it - but it becomes a LOT more valuable if your coworkers are also using it. 

This is the network effect: some products become more useful/valuable if they have more users. Workplace collaboration tools like Slack, Trello or Notion are great examples of this.

This can be a great way to sell into enterprise customers: offer a great free product to one of their teams so they can adopt it without needing budget or approval from a manager.

Then encourage them to invite coworkers to drive adoption.

And then once the product becomes embedded within that organization, push them to upgrade to a paid plan. 

9 - If there is a baked-in or bolted-on viral loop

What if your product doesn’t really benefit from network effects - but you can still harness those free users and turn them into an army of evangelists? 

If your product allows your customers to contact other people, you can “bake in” a viral loop to your free plan.

Hotmail did this in the early days of the internet by adding “PS I love you - get your free email account at hotmail.com” to the bottom of every email sent via their platform.

Apple copied them with a “Sent from my iPhone” message added at the bottom of every email.

Zoho adds “Powered by Zoho” in the footer of all invoices sent via their platform; you can only remove this if you upgrade to a paid plan.

But what if there is no natural “baked-in” viral loop in your product?

If you’re clever, you can find a way to add one - a “bolted-on” viral loop so to speak. A great way to do this is to offer both a free plan and an “even better free plan”.

For example, when you sign up to Dropbox you get 2gb of storage for free, forever. But you can unlock extra storage - also free forever - by referring friends. You get 500mb per friend referred, up to a maximum of 16gb of free storage.

Sure, it would be much easier just to pay if you want more storage space. But by offering both a basic free plan and an even better free plan that they “pay” for via referrals, Dropbox has essentially added a powerful viral loop to its product.

Mixpanel did a similar thing in the early days. They offered a very basic free plan with a limited number of data points. To actually be useful though, you realistically needed more data points than were provided on the free plan. 

So Mixpanel gave their users a choice - either upgrade to paid, or add a “powered by Mixpanel” badge to your homepage to unlock an even better free plan that included a more generous amount of data points you could use.

Lots of early stage startup customers opted to do this - which gave Mixpanel a whole bunch of backlinks and visibility early on, because those startup customers were both very vocal on social media, and were growing their own traffic rapidly.

As their businesses grew, the amount of people being exposed to Mixpanel’s brand grew as well.

There’s nothing inherently viral about a cloud storage product or an analytics product. 

But by offering a free plan to make signing up frictionless, and by offering an even better free plan that could only be unlocked by making referrals or adding a powered-by badge, both Dropbox and Mixpanel we both able to turn free users into an army of evangelists spreading the word and giving them lots of free distribution.

10 - If you have a deep understanding of your metrics and won’t cannibalize your own customers

The very worst thing that can happen when you introduce a free plan is that a huge chunk of your customers downgrade to it from a paid plan. 

So you want to be really certain of your metrics before adding a free tier. Really certain. Make sure that you set the usage threshold below what most of your cheapest paid plan customers are using. Or make sure you exclude some features that most of your paid customers cannot live without.

If in doubt, don’t risk it - if you subsequently retract the free plan you’re likely going to see most of those users churn rather than move back to a paid plan

Conclusion

Having a freemium business model has the potential to be enormously successful - but only under the right conditions. 

If you’re about to launch a SaaS business, or are considering switching your business model to freemium, please make sure your business meets at least 6 of the above criteria before going freemium.