How To Optimize Your Business Model With Freemium

2013-09-11 17:17

In the past I have written quite a bit about the importance of defining the business model for your business. And in this article I want to share some of my latest thoughts on this subject. Specifically, I have been thinking and talking to people about a particular business model called the Freemium business model which repeats itself everywhere in our daily life.

First, let’s cover the necessary definitions:

Business model - a design for the successful operation of a business, identifying revenue sources, customer base, products, and details of financing. In other words, it is how your business will generate revenue. And notice that inside a single business model, there can be more than one revenue model.

Freemium - a business model that works by offering basic Web services, or a basic downloadable digital product, for free, while charging a premium for advanced or special features.  Notice that this is mainly an online business model. But in this article we will discuss how the winning elements of it can be applied to every other kind of business.

Business Models Overview

Sometimes people defined the business model as the way that your company gets paid. I have sometimes used those concepts interchangeably. Don’t confuse a business model with a revenue model. There can be a number of revenue streams in a single business model. So think of a business model as something that contains inside it not only the revenue streams, but takes into account how you get customers, your expenses and other costs, and the greater financial picture of your company.

Different business/revenue models

While there are a number of different kinds of business and revenue models such as transactional revenue model where there is a direct exchange of payment for goods or services, or ad-driven revenue model where you make money by placing ads, what I want to discuss is the implications of business models that only focus on paid users vs. freemium business models.

It might seem that the direct transactional model is better. Every business prefers to have paying customers and the freemium model is predicated by having a mass of non-paying customers. What business wants non-paying customers, right? I want to agree, but let’s examine how this plays out in the real world.

Examples in the real world

Let’s imagine that you have an online business. It would be ideal if you could charge hundreds of dollars for whatever that online business is offering, or better yet to everyone who visits the site if that was possible. But surely, very few people would actually buy or visit at that since the price would be prohibitive for many people. But that is ok because you can still make lots of money from the few paying customers.

The real challenge arises in that people will see the success of your business. And many people will try to copy that success. Since your business will be more established, your competitors will charge a lower price. And their competitors will charge an even lower price until the price is driven down to free or something low enough where they lose money and go out of business. But that ruins the price and costs structure of the market.

But as long as there will be people trying to give the product out for very cheap or free, most customers will use the company that provides the free product. Even if your product has better quality, the free option will draw the most people to it. And very soon after that, the brand which was able to attract the high volume of people will have buzz. And the brand which charges expensive prices will lose that buzz.

The only exception to this is if you are in a market where new competitors cannot easily get started. And when they do, there is an accepted culture of charging a certain fee. But even then, any day you can wake up to the news that a new company is trying to undercut you by offering something at a lower price.

The solution

To solve this scenario, try to consider how you can use elements of the freemium business model. One of the premises of the freemium model is that you attract a mass of people with something free. This is key. Whatever revenue model you end up with, your overall business model must account for getting a mass of free customers who are likely to eventually become paying customers.

If you do not attract the non-paying people, another company will. And that will cause them to get more buzz, more social recommendations, and eventually overtake you as the leader and the company that people think of first within your niche.

For more information about freemium, you can take a look at this blog post about why the freemium business model is overall the best business model. And for ideas to make money from the freemium model, take a look at this article about the different possible revenue streams. But keep in mind, since there are so many different business situations and types of businesses, try to always think about how it applies to your particular business. Here is a small video I made to help you understand the freemium business model better and to be able to apply elements of it to your own business.

http://www.youtube.com/watch?v=8IqWwNLHIsU

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