There are numerous methods to use when looking to convert customers to your paid tiers like offering valuable content, stepping up your advertising budget or your sales outreach. You shouldn’t, however, write off the potential of freemium to reach a wide audience. Freemium helped Spotify to win big with a reported 27% conversion rate, that means out of its 75 million monthly users, 20 million of them are paying customers!
Within this guide, we’ll disclose the key metrics that’ll help guide you towards a successful freemium model. We’ll cover:
- The recent trend of product-led growth.
- Using active users to work out how many people are using your product.
- Trial to paid conversion rate to measure freemium’s effectiveness.
What is ‘freemium’?
Freemium as a model may seem confusing at first; spending your time creating and developing a product to then give it away for free? However, the freemium model isn’t about giving your product away, just revealing enough of it to entice people to pay for a full-priced version.
The freemium model has come to replace the free trial/demo model. Freemium’s psychology bases itself around the ‘endowment effect.’ The endowment effect is where you value something more because you already own a part of it, compared to owning nothing at all.
Patrick Campbell from Profitwell advises that you shouldn’t see freemium as a revenue model, more an acquisition model instead. Freemium works primarily as a marketing technique, spreading your brand wider by attracting people that may not be necessarily inclined to purchase your product, allowing them to see the additional features that could push them over into a paying tier. So why has freemium become so important over the last few years?
How freemium took the world by storm
Freemium was popularized as a term by venture capitalist Fred Wilson to wrap the meeting of ’free’ and ‘premium’ together. The model has played a big part in the viral successes of companies such as Dropbox, Slack, and Spotify. People connect with products that they can instantly find value in; whilst companies benefited from engaged people who were ready to be converted to a premium product.
While adoption for freemium declined in 2016 with some critics sounding its death knell due to its unsustainability, the model has seen a resurgence as a result of companies making better use of freemium metrics and the role they play in converting people to a paid plan.
Companies such as MailChimp and Zapier now employ hyper-targeted plans that work to convert specific customer personas down the funnel.
Sales+ product =product-led growth
Looking to the latest VC trends, there’s a move towards product-led growth. This trend involves using high usage freemium customers to identify potential hot leads, which your sales team can then sell to. This approach enables businesses to identify product-qualified leads (PQLs), which provides Sales with a powerful new type of qualification.
To score product qualified leads, you could measure whether a freemium customer has used up all of their freemium limits, triggering an option to speak to sales to upgrade. Alternatively, with the right call-to-action, smaller leads can be converted through a self-serve process, further reducing the cost of acquiring the customer.
Metrics needed for freemium success
Following the right metrics will be vital in tracking the effectiveness of your freemium model. These metrics will help you assess everything from customer use to the cost of converting customers down the freemium funnel.
Are people using your product?
Identifying how frequently freemium customers are using your product will help you to understand whether they’re having a valuable experience. To find what drives that value you should be looking at your analytics to identify daily active users (DAU) and monthly active users (MAU). Paul Graham, the co-founder of Y Combinator, reiterates that when you aren’t charging initially for a service, active users are the metric you need to follow.
What’s most valuable part of your product?
Once, you’ve found the number of active users you can work out what part of the product people are finding valuable? Hubspot’s Kieran Flanagan take is that the success of a freemium model depends on having a working understanding of the most valuable parts. Push forward features that you know freemium customers will need so much that they’ll be very inclined to move to a paid tier. Another metric that compliments this is a key feature stickiness which builds on the most popular parts of the product to find what customers perceive to be the core of the product and what isn’t as essential to them.
Alternately, you can offer a ‘freemium forever’ product like Buffer or Canva, whereby the move to premium relates to the customer growth and further need for the product. A freemium model encourages organic growth in this respect by becoming more embedded within the company.
Measuring succesful conversion
Your trial to paid conversion rate is key to working how successful you are at converting freemium customers are to a paid tier. You find the percentage by charting the number of free trials that have converted to active subscribers. For example, if you had 20 customers start a trial over a month, but only 5 converted then that would be a 25% conversion rate.
When looking to convert your freemium to paid, be aware that customers may be prone to experiencing a sense of fatigue. Most average SaaS users “try out” 1-3 services or applications a week, according to Iridize. To ensure users make the jump, they recommend you:
- Provide a service that becomes indispensable.
- Offer engaging and timely customer service.
- Show clear pricing that relates to the value you deliver.
We’d also add that you should:
- Communicate the value of your premium tier.
- Have a seamless upgrade when moving between the two tiers.
- Communicate offers for moving to premium.
For more info on delivering increased value to your product, check out our blog on value-based pricing. Where we cover how you can practically communicate the value of your premium tier.
What happens after converting
We’ve just discussed trial to paid conversion, now let’s focus on what happens next, like the need to retain these customers and keep them satisfied with the product and avoiding churn after they’ve moved out of freemium.
Churn is a fact of life when you’re adapting your business model as we’ve discussed before, but getting to a stage of high retention and negative churn will require you to build on the customer accounts you already have.
The key to getting to this stage is ensuring sustained revenue by:
- Allowing room for the expansion of your product.
- Engaging your sales team to focus on upselling and expansions.
- Stay on top of customers whose card details have expired and need to update them.
There are two main types of churn metrics to focus on customer churn and revenue churn.
Customer churn relates to your customer and the rate at which they cancel their subscriptions. This metric lets you know how well you’re retaining customers.
To work out your customer churn in percentage form you need to subtract your customers from the beginning of the month to the customers at the end of the month; then you divide this number by the customers at the beginning at the month.
There’s also revenue churn, also known as Monthly Recurring Revenue (MRR) churn rate which focuses on the amount lost due to churned customers and downgraded subscriptions. Revenue churn lets you know how good you are at retaining customer revenue.
To work out your revenue churn, you subtract your MRR at the beginning of the month from the number at the end of the month, from this number you take away the MRR upgrades during the month and divide them by the MRR at the beginning of the month.
Your churn rate illustrates how successful you’ve been in retaining your freemium customers who’ve converted to paid. Staying on top of these churn figures will allow you to measure the retention you’re getting from customers, by focussing your sales team on upselling you can fight back against customer churn by offering value and gaining higher value deals from them. Dealing with your revenue churn will help you see how efficiently you’re dealing with retaining and growing your MRR.
The cost of acquiring customers
To assess the effectiveness of your freemium model and the costs involved in acquiring freemium customers; you’ll need to keep track of your customer acquisition cost (CAC).
Your CAC can be calculated by dividing the total costs spent on acquiring more customers through freemium by the number of customers that were acquired in the time you’ve been utilizing a freemium plan. Calculating this allows you to see if you’re getting enough ROI from freemium as a way to acquire customers. Let’s look at ProfitWell who’ve talked about the effectiveness of freemium, saying that companies who use the model have 50% lower CAC with nearly double net promoter scores, which gauges customer loyalty.
The CAC should preferably be low for a freemium tier as the growth should be organically driven through word-of-mouth and referrals. Your paid acquisition budget should go towards the paid plans. Mixmax has advocated for $0 CAC by finding these elements of virality within its product:
- Have your customers provide value to other people (who aren’t users) making their lives easier, simply by using your product.
- Have your customers show off your product, (because it makes them look good).
- Give customers rewards for sharing your product.
- Your customers love to talk about your product, without having a particular incentive.
With these elements, your product can spread fast and reach a wide number of people, who are actively enjoying the experience of using it.
Final thoughts on freemium
Though not built for every business, freemium is a model to experiment with. You can continuously iterate on how customers are converting, and the metrics are a perfect illustration of what can be improved on in the process.
Your main takeaways from this guide should be:
- Seeing the potential of using product-led growth to aid your sales team.
- Tracking active users of your product.
- Staying on top of your churn rate.