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Will a Freemium Pricing Model Kill Your SaaS Company?

By Emily Smith on Wed, Nov 2, 2016

With big-name SaaS companies like Slack and Evernote using the freemium pricing model to achieve rapid growth and attract an ever-expanding user base, it’s easy to think that freemium is the secret to success in the ultra-competitive SaaS space.

But is it really as great as it seems, or will committing to a freemium model stifle your company’s growth, and eventually kill your SaaS product completely?

Today I’m exploring the pros and cons of the freemium pricing model, as well as how to work out whether it’s a good fit for your own SaaS company.

Pros and Cons of the Freemium Pricing Model

Pro: No Barriers to Use

One of the biggest challenges faced by SaaS companies is persuading potential customers to sign-up and try out their product. With a freemium model, it’s low-risk: you remove the potential for them to be put-off by the cost, which makes it easier for them to just try it out.

This means that it’s super-simple for users to assess the value your SaaS product provides, so they can decide whether or not to keep using it.

Pro: Potential for Viral Growth

As a result of removing potential barriers to use, it becomes easy to sign-up for freemium SaaS products, and also to share them with your network. It’s easier for a user to convince their colleague to try out your SaaS product if it’s free, compared with if they needed to pay to try it out.

This means that, with a good referral program in place, you have the potential to unlock viral growth for your SaaS product, even reaching a point where your growth through referrals becomes self-sustaining.

Con: Free Users Won’t Value Your Product as Much as Paid Users

The more we pay for things, the more we value them. While a free-to-use version of your SaaS product makes widespread adoption simple, it also makes it easy for users to adopt a throwaway mentality when it comes to your SaaS product, because they're not financially invested in using it.

Con: Freemium Can Be a Real Revenue Killer

The biggest drawback with the freemium pricing model is that your free users don’t generate any revenue for your company. This means that your paid users need to generate enough revenue to support the cost of acquiring and serving all of your users - paid and free.

This makes it harder for your SaaS business to become profitable, and if your freemium users are devouring all of your resources, you have less time, money and effort to invest in growing your company.

Can Your SaaS Company Support a Freemium Pricing Model?

With a premium (fully paid-for) pricing model, your SaaS business will become profitable if the costs of acquiring and serving a new customer are lower than the revenue they generate over their lifetime.

In contrast, with a freemium model (where your user base is split between free and paid-for packages), your business will become profitable only if the revenue generated by your paid users is more than the costs of acquiring and serving both your paid and free users.

Furthermore, your free users will greatly outnumber your paid users, because your free service will be more immediately attractive to potential customers, so each paying customer will need to support an ever-growing number of free users.

Calculating the Costs

Mathematically, if you’re using a freemium pricing model, your SaaS business will only be profitable when your paid users' lifetime value (LTV) is greater than the combined costs of acquiring new customers (CAC), serving free users (CSF) and serving paid users (CSP):

$$\text{LTV}>(\text{CAC}+\text{CS}_F+\text{CS}_P)$$

It’s likely that your freemium user base will grow much more quickly than your paid-for users. Therefore it’s also important to track month-on-month growth, because there will be a clear tipping point when it is no longer profitable to support such a large proportion of free users.

Left unchecked, a freemium pricing model can quickly cripple your SaaS company, if your number of free users grows at a rate that can't be supported by the revenue generated from your paid users.

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