There is a lot of buzz right now about VC’s current favorite business model: the freemium model. Since this is something that we are rolling out for SiteMighty, I decided to explore this a little further.

So, just what is the Freemium Model? According to Katherine Heires in her article in Business 2.0 magazine:

“Freemiums are services that lure users in with a basic product, then charge for more features.”

Basically, the idea is that you offer either a time-limited or feature-limited version of your service to encourage potential users to try your service. Once they sign up they start using the service and realize they can’t live without it and hopefully they are willing to part with the $20 a month to use all the features of your web app full time.

The freemium model isn’t new, its just an update of the old software pricing strategy for shareware and freeware with encouraged donations. It is the same business model of try us out, pay us if you like us updated for a software delivered online, web-app world.

Why does freemium work? Because it leverages the best thing about the internet and software: the incremental cost of a new user is next to zero. When the cost of delivering your services to a potential user for a month is next to nothing why not let everyone try it out, and hopefully a few will stick around. Taking it to the next level, since the incremental cost is so low, why not allow users free access to your web application indefinitely, just limit it to something that will leave them wanting more. Offer your service for free and provide premium services that will get them to put their credit card down.

As we are moving forward in making pricing model decisions for SiteMighty, we’ve been considering just how to structure our freemium model. Where do you create the limitations for the free part of the model.

• Time Limitation - One thing that I didn’t want to do was time limit it. There have been plenty of services that I’ve tried that did this, the problem is that my 30 days ran out and I didn’t actually ever get to try it out.
• Feature Limitation - Another option is to feature limit the web application. The only problem with this is that you may not be able to showcase your best features, the ones that will close the deal with users to become paying customers.
• Usability Limitation - This is the preferred option for us. Figure out how your users are going to use your product. How will they really integrate it into their daily life? Offer everything they’ll need to do this, and then dial it back a little. Just when they are liking your product, and they want to use it more, they can’t … unless they pay just $20 a month or a year or whatever. Now you’ve got them.

So, who is using the freemium model, and how do they do with it?

• BaseCamp - 37signals has this model down pat. For the low price of free, they limit Basecamp to managing just one project at a time, but they let you kick the tires by using all the features. They also are masters of this will BackPack too.
• DropSend - Carson Systems has done it with Dropsend too. You can use it for free for five files a month, but for some reason I keep getting the $5 charges, so we must be using it more then that.
• Flickr - Clearly a great web app, and this is one where you can really use it to its full functionality while on the free plan. But boy do they make it easy and enticing to upgrade. Who can’t afford $24.95 a year for the Pro account. (This annual pricing method is really interesting, because you can bill it and forget it. My inclination is that this leads to more people just deciding to be customers for life).
• Freshbooks - Now, I love the Freshbooks invoicing service, it works great. A few weeks back I called them because I forgot my password, and they helped me out with it. I asked them when they were going to bill me, because they hadn’t yet. Well turns out I am on the free plan. And we use it regularly every month for clients to pay us. I would gladly pay for it because I like it, but they aren’t making me. (I’m sure I’m going to get an email politely asking me to upgrade now that I’ve called them out). But the point is that the fine line between free and paid in their freemium model doesn’t seem to be quite calibrated. As a happy recurring user, they are leaving my money on the table.

So, as we work towards the launch of SiteMighty we are working very hard to position our freemium model correctly. If you’re interested we have decided to offer a full-fledged version of the service for free, but we will limit the number of affiliate offers to 10. This will let people try out the site and all our tools and even make money with it. But if they want an affiliate marketing site with a full complement of offers, they’ll have to pay for it. I’d love to hear people’s feedback on this strategy.

PS: Thanks to Scott Carpenter for the inspiration for this post.