Freemium vs All-Paid Model: Which Is Better For Your Software Product?
Last decade has been truly phenomenal for Software startups as almost every Industry has gone through digital transformation and both Enterprise & Consumer software startups have mushroomed everywhere focussing on a specific use case of an Industry / segment.
10 years back, ‘software product’ meant software being installed on a desktop/ laptop either via CD-drive or via download from the internet. Those were the days of client heavy applications and the very architecture of the applications restricted the usage to people who had higher configuration systems. With the advent of mobile & internet, the pace of digitization increased 20x and software products evolved from being front-end heavy to server heavy applications making the deployment of applications super easy and thus started an era of inclusive digitization where anybody who had a smartphone could use any of these software applications.
In the earlier era, software monetization models rested on having the entire application downloaded but locked it after a certain usage period and users could only unlock it by putting in the product key. Since the application was only downloaded on users' systems, people figured out ways to break the software and software piracy became a big Industry.
Cloud based applications killed the software piracy industry as the application access was controlled via server and that also ushered new business models. Freemium became the mantra as that ensured quick adoption and one could offer different variants to different users depending on their need, budget and appetite.
Lot of new software products face this conundrum on whether they should launch a product with the Freemium model or focus on the All-paid model. It might always look that Freemium is the best approach but it comes with its own issues and the founders should think deeply about the landscape before deciding on the approach.
What is the Freemium model?
Freemium model rests on the hypothesis that customers should be onboarded quickly and have them experience the product with basic features. In some freemium products, part of the features are free for life-long and others are available on paid upgrade; while in some freemium products the entire product is free to use but the usage is restrictive and full usage is only possible with paid upgrade. A good chunk of these customers will become power users and demand either more features (if features are locked) or more usage (if it has time / duration restriction) and will be upgraded to paid bucket.
Freemium Model Types
Premium Features are locked and needs subscription ( e.g .Dropbox)
Premium Features require you to refer & earn (e.g. Airtable)
premium Features can be purchased as one time upgrade (e.g. add-ons in Google Workspace)
Product can be used for free for x days (e.g. Workday)
Points are consumed for every activity and points are limited (e.g. Lusha)
Product can be used by limited users. Multi-user requires upgrade (e.g. Slack).
What is the All-paid model?
All-paid model is fairly simple as it requires the user to start paying from day 1 and the product only gets enabled after that. Software products which typically have ‘Free Trial’ request which is basically a lead capture form to assess the potential of the client and give him a limited free trial. All-paid model typically work with products which require a lot of initial setup and cannot be onboarded without Sales & Ops intervention.
Now that we have understood both the models, it is important to delve into pros & cons of both models. While the Freemium model offers lower cost of sales and quick customer growth, it also means that infrastructure has to support a lot of free-riders and it therefore increases the running costs. All-paid model on the other hand has a higher cost of sales, but at the same time it is more Ops efficient as it does not support free riders.
Lower Cost of Sales
Word of Mouth Publicity
Increases Product Complexity
Higher cost of Infrastructure
Lower cost of Infrastructure
Cons- High Cost of Sales
Which model to adopt therefore should largely depend on the nature of the business of the software product company. If the software requires a lot of initial setup, the freemium model is less efficient as product usage will not happen just by signing; customers need to be guided on setup & proper training is required to ensure usage. Freemium model typically works in cases where the initial product experience is simple yet powerful to demonstrate the utility of the product and customers can then choose which upgrade they want to go after depending on the segment they belong to Before we delve into the framework of which model is better for the software product, let me also introduce a concept popularly known as “Network effect”. While ‘Network effect’ is a topic in itself and cannot be explained in one line, network effect is said to happen when more people using the product increases the perceived value of the product and makes it more useful for all members. One example, in the software product world is Slack. If Slack is being used by a large number of people in the company, it becomes the lifeline of communication and it becomes immensely valuable.
Startups need to think of these two vectors - Setup costs and Network effect to understand which monetization strategy they should adopt. Below is the simplified pictorial which depicts the decision matrix. One can further break it down into the sub segments the company is operating into and evaluate for each of these segments the setup cost and the network effect and design a strategy for the segment.