There’s a war of opinions going on in the B2B software world, and one side is winning. The war is over one fundamental question – how should I price my product or service?
No doubt, pricing is an incredibly nuanced and complex topic. I wrote a rather simplistic piece as a thought experiment, and had redditors suggest I should go back to school and understand price elasticity. Thanks, guys.
I’ve read a lot about SaaS pricing, including some very convincing arguments against Freemium. They basically boil down to these points:
- Free-to-paid upgrade rates are incredibly low (true)
- Free customers are often your worst customers (also, often true)
- Free customers suck up support and engineering time while giving nothing back (true)
- You lose out on users that would have paid you but opted for the free plan instead (true, though hard to quantify)
- They cost you money if they come through any paid marketing channels (ads, affiliate, etc.)
The prevailing thinking among software startups (led by people like Jason Cohen and Patrick McKenzie) is that extended free trials, or software trials with money-back guarantees are the best way to convert prospects to real, paying customers. For the most part, I agree.
However, I think there are also benefits to the Freemium model that don’t get talked about besides the fact that you’ll likely have a higher visitor -> signup conversion rate. Some other ways Freemium is useful:
Allows for risk-free testing of product features. At any sort of scale, an effective Freemium program means you have hundreds or thousands of free users. This gives you a lot of flexibility in terms of features you can test with your audience. You can build a very basic version of a new feature and see if your free users like it – all without worrying about whether or not they’ll cancel if it doesn’t work exactly as expected. You can also run cheap tests where you message or email your free users, pitch a feature and see what excites them. What features do they use and what don’t they?
Test referral programs. Having a large group of free users can be beneficial in terms of testing referral programs and getting new users. For one, an effective referral program takes a while to get right. If you’re constantly running tests to get your paying users to share your product, there’s a risk that they’ll get angry and cancel their service. Small risk, but still something people worry about.
On the other hand, having free users gives you the opportunity to test many different variations of a referral program – both because you can run more tests and because there are (presumably) more free users than paid. All else being equal, if you have an effective referral program, and 5x as many free users as paid, referrals could be an effective marketing channel that comes at the marginal cost of supporting free users. For any company with a product that requires group communication or social interaction, a referral program that utilizes a large cohort of free users can be very effective.
Test upgrade levers. Having free users also gives you the opportunity to test what makes them want to upgrade. Does a certain feature drive lots of upgrades? How about hitting a certain number of users? Or a storage limit?
Whatever it is, you can measure the main reason why most of your free users upgrade to paid. Once you have that information, you can then design your product’s onboarding process to move them in a direction where they get to a “quick win” moment sooner. For example, if most customers upgrade after hitting a certain user limit, you could design your onboarding process and create triggers that cause them to invite more users as they naturally engage more with your application.
As a side note, Freemium can also be valuable if you have a whole suite of products you can cross-sell or upsell into your audience. In this case, Freemium becomes a cheap marketing channel that comes at the cost of supporting your free users.
Have a larger audience. Assuming that having a free product tier means you’ll have more signups, adding a free product tier means that you will have a larger audience than if you went paid-only. Having access to this larger audience – and an easy way to reach them – makes other marketing activities easier. Things like partnerships, co-marketing, joint webinars and referral programs are all easier to land if you can tell a prospective partner you have several thousand customers, rather than several hundred who are paying.
This makes sense. Partnerships and other co-marketing activities take a long time and are tough to get right. What makes them attractive is access to a large pool of potential new customers. The smaller this pool, the harder it is to get interest.
A more attractive acquisition target. Earlier I mentioned that a cohort of free users can be great if you have a suite of products to upsell into a captive customer base that isn’t paying you yet. Developing a suite of products (not to mention supporting, improving and marketing them) is really hard and takes time. But guess who does it well?
Big companies have tons of products they’re just itching to sell into new markets. When a large company looks at your company as a potential acquirer, you can bet they’re going to price the number of users into the acquisition. They’d much rather acquire a company doing $X per year with 5000 free users than one just doing $X per year – it gives them new segments to sell into and can be a competitive advantage.
I’d love to hear your feedback in the comments. Or, sign up to get irregular emails about marketing, SaaS and startups.1