Book Marketing

How Companies Can Get the Most Out of a Freemium Business Model – HBR.org Daily

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It’s hard to resist the allure of free. One key reason user adoption of the Internet has soared globally is the rise of the “freemium” business model — where users get to use a basic product or service for free, but must pay for a premium version with additional features.

When done right, the freemium business model can help drive massive traffic to companies’ websites, offer a “try before you buy” experience that overcomes user resistance to paying, and convert free users to paying customers. Dropbox is a master of this model. The company has 500 million registered users who receive two gigabytes of free storage. Once they exceed that capacity, however, customers are offered the option to upgrade to one terabyte for a monthly or annual subscription fee. With this model, Dropbox generated $1 billion in revenue in 2017 from 11 million paying individual and business users and continues to grow its user base.

Obviously, someone pays the price for free products. When companies can’t convert enough users to paying customers, they suffer — something we’ve witnessed with media companies such as The Guardian, New York Times, Washington Post, and others. Other companies may even fail. So how can companies better position themselves to succeed in the freemium wars?

Past research demonstrated that adding new, high-quality products as premium offerings can cause customers to elevate their perception of the brand overall and be more willing to pay for premium alternatives. The Wall Street Journal famously proved this strategy by expanding digital content, adding new paper sections such as Mansion, and introducing events, which created a membership experience that has quadrupled prices in less than a decade, ending the paper’s previous reliance on heavy discounting.

However, freemium products often subvert this strategy because customers perceive the benefits of the free product to be higher than what a cost-benefit model would predict, preferring it disproportionately to other offerings because of the zero-price effect. Simply put, when customers anchor on free, it can be hard to dislodge them. Thus, in addition to extending the premium product lines, companies need to also understand customer behavior and what they respond to.

In the Software-as-a-Service (Saas) space, this strategy is called versioning, where different versions of the premium product or service can be made available to the market. Does this strategy work in moving customers to let go of the free and move to premium versions?

Our research published in the Journal of Marketing assessed the effectiveness of this strategy by analyzing the sales of scholarly content by the National Academies Press (NAP), which offers free online PDFs of its book titles, but charges a price for paperback versions. We conducted a randomized field experiment of customer downloads and purchases on NAP’s website between January and August 2016. We tested three different offerings: 1) the control version, with the free PDF and moderately-priced premium paperback titles; 2) a test version with the free PDF, moderately-priced premium paperback, and a new premium e-book that cost as much or less as the paperback; 3) and another test version with the free PDF, the moderately-priced premium paperback, and an even more premium hardback with a much higher price.

We found that extending the premium product line, either with the hardback or the e-book, led to a positive impact on the sales of the existing premium option, the paperback.  When customers were offered a new premium product that was of higher-quality and higher-priced, such as the hardback, they chose the paperback more. Adding the hardback increased the paperback revenue by 8.9%. That is, they chose the middle “compromise” option more often, moving away from the free PDF, leading to this compromise effect.  This is similar to what a salesperson does when you buy an appliance — they show the lower-end product and the very high-end and sell you the middle option.

When customers were offered the lower-quality, somewhat lower-priced product, such as the e-book, they also moved away from the free PDF and chose the paperback more often. Adding the e-book increased the paperback revenue by 21.5%. Why is this? Adding a similarly priced lower-quality e-book made the paperback look much more attractive in comparison, leading to higher sales of the paperback. This is the “attraction effect” that makes the paperback version a dominant option. This effect occurred only when the price of the e-book was closer to that of the paperback.  When the prices of the e-book were much lower than paperback, they cannibalized the paperback sales. So it is important that the price of the lower-quality version is closer to the existing premium version.

Marketers can use our findings to strategize how to extend their product lines — from which products to offer to what prices to set — to motivate zero-price-loving users to pay for premium goods. Any company that uses the freemium model, including online media sites, cloud services, or digital services, can use this research to drive product revenues and create a more sustainable business.

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