Saturday, March 21, 2009

The Freemium Business Model

The Freemium Business Model is based on the concept of providing a version of something for free and one or several fee-based premium versions alongside. It is basically a way of versioning where the free version is provided to create the lowest possible barrier of adoption. The objective is to gain a large customer base, build loyalty and trust, and convert some of the customers to fee-based premium versions.

To be considered a Freemium Business Model what is provided in the free version has to be something that can be used in and of itself without necessary paying for something else (in comparison with for example the Razor-and-Blade Business Model). Also, the value provided should not be limited in time, in comparison to for example free expiring trial versions of a software.

To be profitable, the Freemium Business Model must create a lifetime value of premium paying customers, greater than the cost to develop, produce, market and distribute what is beeing offered for free and fee. This requires that:
  • the marginal cost of production, marketing and distribution of the free version must be very close to zero
  • the free version must generate a large customer base
  • there must be a conversion from free to fee-based premium versions
  • there must be strong control mechanisms in place, to maintain the premium value from being reduced by competition
Low marginal cost of production, marketing and distribution
Value propositions with low or zero marginal costs have traditionally been limited to the transactions of rights. Long before the Internet it was possible for rights holders to provide free copyright or patent licenses at low marginal costs with the objective to gain adoption of a technology or software. With a free license, a licensee could use and sometimes further develop its own technology or software based on the free license, or chose to pay for another license to patents or code relating to improved features, better performance etc.

The primary use of The Freemium Business Model is however on the Internet where it has become very popular among start-ups. The Internet has become a low cost marketing and distribution channel for information and digital products such as software, ebooks, music, videos and virtual goods. Also, customers can be acquired using low cost search marketing, word of mouth and referral networks.

The free version must generate a large customer base
To generate a large customer base the free version must offer enough value so users become regular customers and tell their friends and colleagues to join. The more value provided the higher probability for word of mouth marketing and adoption of the free version. The main difficulty in The Freemium Business Model is to provide enough value to generate a large customer base, and at the same time leave room for incentives for customers to pay for premium versions. Value is subjective and people attach different value to different services so the challenge is to properly segment users and features such that enough value is provided to both free and paying users.

However, what customers find valuable might not be obvious until feedback is given from users of a free version and often the free version is launched long before there even is a fee-based premium version. The risk of launching an early version to test a product or service is of course that the free version is perceived as good enough and only a few customers choose to pay for additional features and services.

Conversion from free to fee-based premium versions
The premium versions have to be so compelling that a portion of the customer base will convert to the paid versions to cover the cost of developing and providing the service. Even though Internet has enabled one click conversions, paying for something that is already provided in one version for free is somewhat counter intuitive. Examples of premium value propositions are:

  • Exclusive content
  • A version free from advertising
  • Decreased delivery time or delay
  • New or improved:
  • features
  • user interface
  • convenience
  • performance
  • flexibility
  • service and support
  • rights
According to venture capitalist Fred Wilson, the best examples of The Freemium Business Model are when the customer implicitly understands why the premium versions have to cost money, to cover direct expenses for the service provider. An example Wilson mentions on his great blog is Skype and its termination costs on other carriers networks when using its premium services to call out of network.

Lack of control mechanisms
Control mechanisms are rarely mentioned in literature about business models. As I see it creating strong control mechanisms is crucial for The Freemium Business Model to be sustainable. Without control mechanisms, each competitor will offer more free features to win over users until there is nothing premium left for the fee-based version. Examples of control mechanisms relating to The Freemium Business Model are implemented standards such as Real Player and Adobe pdf or having real or perceived switching costs such as Skype, Facebook, or LinkedIn.

The word Freemium
The business model of combining free and premium has been around for some time foremost within the software industry. But the term Freemium was first articulated by Jarid Lukin of Alacra in March 2006, as a response to Fred Wilson's blog post My Favorite Business Model in which he asks for a name on the business model of giving away a version for free.

"Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc, then offer premium priced value added services or an enhanced version of your service to your customer base."

Further Reading:
Making $1.6 Million in a week for music given away for free
Value Proposition Versioning
Tim O'Reilly on Open Publishing

External Reading:
A collection of 37 Freemium links at


  1. Interesting stuff Tim. Thanks for answering my LinkedIn question. This is indeed the model I'm looking for.

    The large customer base: what if all employees of the my client would be a member as well? That would be interesting! Thanks for inspiring me!

  2. Great to hear! Good luck with your business model.


  3. A very nice description of the model.

  4. Thank you Peter, I know it's in your field of expertise.


  5. Thanks Peter for the twit-link. Good post, I'd also emphasize the importance of when and how introducing the freemium model. Many start-ups I know launch their business without a clear business model and a roadmap (!), and then once the service is running they decide how to make money out of it, and of course the freemium model shows up. After a while, they launch some premium services. That might piss their users/community off. That's why I think it's crucial to have everything clear beforehand, so that in the site users know from the very alpha stage that there'll be some great features adding value, premium services...

    Greetings from Spain

  6. I meant thanks ANDERS, not Peter!

  7. Thanks for your comment Elena! I agree with you that ideally one should think through different business model options and create a roadmap.

    At the same time, often companies don't know until they try what users/customers really like so I believe it's important to continuously update the roadmap.

    //Anders aka Tim aka Peter

  8. Anders - you may want to check out this post which explains some problems with the freemium model

  9. Freemium is a great model, but not always the best fit, see this article on phanfare's not so good implementation of it:

  10. Thanks for adding to the discussion on freemium these days. As mentioned segmentation is key to figuring out the free/ paid mix. At a high level, anything that drives virality should be free. Specific features for power users (which become evident over time through usage of your free service) are good candidates for premium. For more information, visit: mlsp review.

  11. The term Freemium as been used in direct marketing circles for over 30 years. Attributing it's creation to Jarid Lukin seems to be questionable.