Benefits and drawbacks of the freemium plan for startup and early-stage SaaS companies, and our recommendations on how to evaluate whether freemium fits for your product
April 2022
Author: Bryan Belanger
The freemium model conundrum
We recently worked with the founder of an e-commerce marketplace SaaS platform on pricing strategy. One of his most pressing questions for us was, “Should I continue to offer a free plan?” In his case, he’d launched his product with a free plan and onboarded a significant number of users to the free plan quickly after launch.
This was, of course, really positive for the viability of the marketplace and helped to greatly expand the product’s brand awareness, but the user growth wasn’t translating to revenue. We talked through a number of options and ultimately agreed that his hybrid approach, which incentivized a free plan for a limited number of early customers, was well aligned to his situation and goals.
This founder is not alone in his challenge. We’ve had similar conversations many times and seen countless versions of this conversation play out across the relevant corners of the internet, such as Reddit’s r/SaaS channel and Indie Hackers, where freemium conversations crop up frequently. For every article espousing the benefits of freemium models as the cornerstone of a product-led growth strategy, there’s a founder post or blog like this one or a case study in freemium-gone-wrong from an established vendor, like this one from Baremetrics.
It’s no surprise that the average SaaS founder is left with more questions than answers on free plans after hearing these stories. In this blog, we dissect the benefits and drawbacks of the freemium plan for startup and early-stage SaaS companies and provide our recommendations on how to evaluate whether freemium fits for your product.
Struggling with a freemium pricing strategy challenge? Interested in free analysis of your current freemium strategy?
The state of freemium SaaS models
A “freemium” strategy is a product packaging and go-to-market strategy in which a basic version of a product or service is provided free of charge for a defined set of features and/or amount of consumption, and an additional premium version(s) of the product are provided for a fee, adding additional features and/or usage.
In SaaS, this most commonly amounts to a vendor offering a “forever free” plan as part of a tiered SaaS packaging strategy, in which the freemium plan is the first in a series of three to five plans offering successively premium features and usage.
A freemium strategy is different from a free trial strategy, in which a customer is provided access to a paid plan free of charge for a defined amount of time (most commonly 14 days) for the purposes of commercial evaluation of purchasing the product.
Freemium plans are not new. Freemium has been utilized since the 1980s, though the term was not formally coined until the early 2000s. If you want to broaden that to the concept of “free samples,” that strategy has been around since the 1300s. Freemium has entered center stage in the SaaS industry movement toward product-led growth. Product-led growth advocates putting the SaaS product, instead of the sales function, at the center of a company’s customer acquisition and growth activities. Freemium is typically a lynchpin of this type of strategy, since it lowers the barriers to adoption of SaaS products (there is no cost to use the product) and can be deployed via a self-service model that does not require outbound sales.
While freemium has been heralded by leading SaaS pricing thought leaders like Kyle Poyar of OpenView, and rightfully so, our XaaS pricing data suggests there is still much room for vendor adoption of freemium models. Approximately 35% of the 300-plus products we currently track in our open beta version of XaaS Pricing offer a free plan. Free trials are currently a much more commonly used vehicle.
The benefits and challenges of free plans
Many articles have been written on the benefits of offering a free plan for your SaaS business. OpenView is the most notable and reputed advocate for product-led growth broadly and writes frequently on the value of a freemium strategy (see the link above).
When well executed, the benefits are clear and the performance metrics back them up. Freemium strategies that work can create a customer acquisition flywheel, promote product virality, decrease customer acquisition costs, and reduce contractual barriers. All of these factors have positive downstream impacts on key SaaS metrics.
Case studies like the one I shared from Baremetrics earlier in this post articulate the ground-level challenges with freemium strategies better than any other content that’s out there. For any SaaS vendor considering a freemium strategy, learning from peers is great place to start. Like everything in SaaS pricing strategy, the freemium strategies are highly vendor- and market-dependent, so stories from similarly positioned peers are really helpful.
We believe the following are the primary challenges that can surface with a freemium strategy:
- Free plan customers show a low propensity for converting to paid plans.
- Free plan customers have high churn.
- Free plan customers can burden technical resources (e.g., data storage and processing costs).
- Free plan customers can burden customer success and support resources.
- Free plans can be costly (due to any combination of the above).
- Free plan users can misrepresent your brand in feedback.
- Free plan usage can misrepresent your total addressable market and ideal customer profile fit.
Freemium model advice for startups and early-stage companies
There are obviously a number of nuanced considerations vendors must make when evaluating a freemium strategy and a number of places where unexpected roadblocks can arise. Even the list above, while intended to be comprehensive, is unlikely to capture all of the issues you may find when testing a freemium model. Like most things in SaaS, a customer and market data-driven, agile pricing strategy is the best way to experiment with concepts and iterate based on results from the market.
There’s no simple “yes” or “no” answer we can offer to the question of whether freemium strategies make sense for startups and early-stage companies. Our answer is something closer to, “generally in most cases, yes, but with a lot of caveats and as long as you are committed to rigorous data collection and agility as foundations of your pricing strategy.”
With that in mind, there are a few bits of practical advice we can offer that will hopefully make answering that essential question easier:
- Make “what’s in the box” your No. 1 focus: The binary decision of “should we or shouldn’t we” with a free plan is certainly an important strategic question, but the more important one might be: What should be in the free plan? This is where we see perhaps the most potential for issues to occur. If too much is given away, this reduces the incentive for customers to migrate to paid plans and, worse, can explode costs and have a downstream negative impact on serving paying customers (see the Baremetrics example). We recommend throttling free plans aggressively based on the key usage-based factors that drive value for free plan customers.
- Consider your likelihood of virality: This is a little bit like calculating the odds of winning the lottery or of me becoming a Tik-Tok sensation. Freemium models work best when they are supported by network effects. Step outside your product and evaluate with a TAM and ICP view. If you offer a product that targets individual users and your product is broadly applicable to users at a wide range of companies, regardless of industry vertical, size, buyer function, and other related criteria, you may have virality potential. If you serve a particular industry, work with a particular buyer function and/or serve larger enterprises, virality may be inherently more challenging given your offering.
- Look at the strategies of similar competitors: Break down the past and current approaches to freemium by your closest direct and proxy competitors. Consider their positioning, value proposition and key ICPs relative to yours. If you are swimming in similar streams and they are having success with a freemium strategy (or by not using a freemium strategy), that is a good indicator to investigate further and learn from what they’re doing.
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