Pros and Cons of Freemium Model

In the previous article, we have already learned what a freemium business model is. We now know that this model is widely used amongst the start-up community. We also know that this business model has several variations. In this article, we will have a closer look at what are the pros and cons of a freemium business model.

Pros of a Freemium Model

The freemium model has several attractions which are what make the model more attractive to entrepreneurs and investors. Some of the main advantages have been mentioned below:

• Increased User Base: The biggest advantage of having a freemium business model is having an increased user base. The Freemium model attracts a lot of users to the app. This may not work well if everyone in the competition is also offering the freemium model. However, in that case, also, offering the freemium model can become a basic necessity.

  The ability of an app to sustain a large user base over a long period of time is considered by many companies to be proof that it has a viable business model which is adding value to the users. A larger user base is often a talking point during fundraising from investors. The valuation of a company can be positively impacted if it has a large user base.

• Ability to Upsell: Once the start-up company has a large database of potential subscribers, it can be used in many ways. For instance, the company can up-sell various products and services to these users. The conversion rate i.e. the rate at which free users are converted into premium users is also an important metric that can help raise the valuation of a start-up firm.

• Different Revenue Streams Possible: Once a company gets a large number of users to access their application, they can generate other sources of revenue as well. For instance, they can earn money by allowing advertisers to interact with users on their platform. On the other hand, they could also use the data generated by users in order to understand more about the likes and preferences of these users. With the help of big data tools, this data can be converted into actionable market intelligence which can then be sold to advertisers.

• Better Market Research: A large user base also acts as a good focus group for testing new features and also for conducting market research. The company can interact with a larger number of users to understand the problems being faced by them. This helps them develop newer features faster than the competition. Also, the company can then beta test the new features on the same user base before they release them to the paid users.

• Barrier to Competition: Last but not the least, a freemium model can be used effectively to act as a barrier to competition. Websites like YouTube have used this strategy to establish a virtual monopoly over their business. Since the services provided by YouTube were free and good, there was no reason for customers to go to a competitor’s website.

  Over time, YouTube became so big that every new user had to join YouTube because everyone else was already there. This acts as a deterrent to potential competition since they know that taking market share away from a company like YouTube would be next to impossible.

Cons of a Freemium Model

The freemium model has been successfully used by many companies. However, there are a lot of other companies which have failed because of using the freemium model. Some of the common issues associated with the freemium model are as follows:

• Faster Cash Burn: A freemium model accelerates the cash burn rate of the company. This is because a freemium model attracts a large number of users. Now, when a large number of users start using the app, the maintenance cost also goes up. The company has to operate more servers with larger capacity in order to provide service to these free users. At the same time, a lot of these customers are not paying revenue to the firm.

  The end result is that free users cause the expenses to rise exponentially while not making any significant contribution to the revenues. If this is not controlled, it can lead to bankruptcy over a longer period of time.

• Low Customer Retention: The freemium model tends to attract a lot of freeloaders. These are customers who hop to a new application every few days. They use the services when they are free but when the time comes to buy a paid subscription, they hop on to the next free app. A higher churn rate negates some of the advantages which accrue as a result of having a large user base.

• Higher Overheads: Start-up companies may have to hire more people in order to provide service to these free customers. Also, they may have to spend more money on setting up computing infrastructure. These costs are generally not one-time costs but instead tend to be recurring costs that can negatively impact the finances of the start-up in the long run.

• Brand Dilution: Brand dilution is another important factor when it comes to the freemium model. Since anyone can access the services of a brand, it is often associated with being free. This ends up dissuading people who actually want to pay for the service.

The bottom line is that the freemium model can be considered to be a double-edged sword. On the one hand, it has enabled a lot of businesses to succeed. However, at the same time, it has also led to the failure of a large number of companies.