And whether you should consider it for your business
Pricing is critical to any startup and can often be one of the main drivers of adoption. Nailing your pricing and basing it off the value being produced is key to gaining adoption and hitting your growth targets.
The world of SaaS pricing in particular is hard to navigate; COGS is often insignificant and your payback period (time to repay your customer acquisition costs) is typically many months or sometimes over a year. SaaS startups are often left setting prices based on intuition, simply following the lead of competitors, or anchoring your price off large incumbents like a Salesforce license — Tomasz Tunguz recently wrote a great post on this.
For a long time, there has been a large debate as to the efficacy of a freemium pricing model for a SaaS company. In 2011, Lincoln Murphy first published his list of 7 types of freemium and the accompanying slide deck below.
Written out below are his seven different models with a little re-examination and some new thinking on the new era of enterprise cloud startups. I also added a new model that is becoming more and more popular I call the “Free Tool.”
1. Traditional Model
This is the most commonly understood version of “Freemium.” Usually it describes a fully-functional product that is free forever, but either has significant feature limitations or rate limits. This model tends to have extreme difficulty converting customers from a free version to paid version — called the “penny gap.” A Dropbox Basic account, Apple’s free iCloud subscription, or Zapier’s Free Forever plan are all perfect examples of this. Dropbox — now a $1B+ revenue run-rate — has been able to successfully scale a more profitable business solution, though.
2. Land & Expand
Land & Expand refers to getting individual users to sign up for a product for free — hopefully hitting a sizable threshold of users in the same organization — and then monetizing your product at the organizational level. The concept revolves around keeping the users outside the flow of funds and locking it into the organization. Yammer is probably the most iconic example of this model as they would sign up users for free and sell to an organization after hitting a certain threshold of free users. Yammer reportedly had a phenomenal 10–15% conversion from free to paid.
Slack also employs this model, letting users sign up for free without organizational approval, and then selling to an organization when it gets to a point that they want to have organizational control over the system.
3. Unlimited “Free Trial”
This is a mix between a “Free Trial” and a traditional freemium model. It usually involves a feature-crippled version of the product that renders it mostly unusable. The expectation is that the customer would understand the value of the product and upgrade accordingly. This version often is risky due to the mixing of a free trial and the psychological aspects of freemium where users expect to be able to stay on the free version forever. As Lincoln noted, Echosign and Basecamp both used to employ this pricing model.
4. Freeware 2.0
Freeware 2.0 is a free-forever, fully-functional product. It is usually the company’s main product or a standalone product line in a larger company. Companies usually monetize through add-ons for power users or special features. Mobile games are a great example of this in a B2C perspective as only a small portion of the population actually pays for micro transactions usually to speed up the game or buy game extensions. In the SaaS world, some great examples include Evernote or Skype.
“The easiest way to get 1 million people paying is to get 1 billion people using.” — Phil Libin, CEO of Evernote
5. Alternative Product Strategy
We often see this model used by a company with an existing premium product line that wants to branch into new areas or a division of their core offering. This is oftentimes used as a strategy to get the “foot-in-the-door” without a direct upsell path — the intention is usually to cross-sell other offerings from the company. An example of this is join.me (created by LogMeIn), Intercom’s free “Platform”, or HubSpot’s CRM.
HubSpot’s CRM is a prime example. In 2014, HubSpot first launched their free CRM as a whole new product line to their marketing automation platform, giving it away to users for free whether or not they were a Marketing customer. They used this as a foot-in-the-door, though, to cross-sell their Marketing software, which starts at $200/month.
This model requires a forever-free base product (usually with 100% functionality), but monetizes through revenue-sharing with 3rd party developers. We oftentimes see this model utilized with marketplaces or products that rely heavily on add-ons from 3rd party developers. Examples in the consumer world include iTunes or the Google Play Store. Some great examples in SaaS include Siftery, G2 Crowd (a High Alpha portfolio company, Capterra, or the Salesforce AppExchange (although the Salesforce base product is not free).
7. Network Effect
This model relies on monetizing users, traffic, or behavioral data you collect in aggregate due to your “network effect.” Typically, these products collect extremely useful and relevant user data for the benefit of others — “if you aren’t paying for the product, then you ARE the product.” Examples of this include social networks, Mint, Google, and [apparently] Unroll.me.
8. Free Tool
I am adding an eighth model to Lincoln’s original seven: the “Free Tool”. HubSpot was one of the pioneers of this strategy when they first launched Website Grader in 2006, and they have since launched a number of “graders” and other free tools.
This model uses engineering resources to develop free micro-tools and resources that perform a very basic — yet still valuable — task. On their own, these tools could never become big, profitable businesses, and they usually look more like an open-source project. Successful companies are using tools like this as marketing “assets” — just like an ebook or whitepaper — becoming a massive lead generation source and a big opportunity to make their marketing a utility to their audience. Dharmesh Shah, the HubSpot CTO and Co-Founder and inspiration behind Website Grader, says these products are “marketing assets with ongoing returns.”
Some great examples of these Free Tools include:
HubSpot’s GrowthBot: a Slack chatbot for marketing and sales.
Clearbit’s Company Logo API: a simple API that takes a company’s domain and returns the company’s logo.
Better Error Pages by Atlassian’s StatusPage: a free tool to build 404, 500-level, and maintenance pages.
Drift Profiles: a free digital business card with a customizable page to help schedule meetings faster and showcase your digital identity.
Without knowing your business, it’s hard to say whether you should pursue some sort of freemium model — or a combination of different models. Freemium is a tough game, though, and requires a very large market size to truly be successful. In most of these models, it is incredibly rare to convert a high percentage of the users (2–4% on average convert). No matter what, your product should be your top priority — the perfect freemium product will market, acquire and onboard new users, and facilitate customer service itself. If your customers are asking for pilots, RFPs, RFIs, etc, your product is likely too complex for freemium.
In SaaS, I generally gravitate away from the freemium model, but I am a big proponent of the surge in the “Free Tool” strategy and recommend many marketers to pursue their version of HubSpot’s “Website Grader.” I also believe we will see the freemium models continue to evolve as AI/ML-driven software platforms continue to emerge, needing vast amounts of data in order to learn and build effective algorithms.
Have you employed any of these models in your SaaS business? I’d love to hear examples and case studies (both good and bad), so be sure to leave them in the comments below!