Ten tips for creating profitable "freemium" startups

Online services with a large number of free users can still be profitable. Here are some tips for budding entrepreneurs...
Written by Tom Foremski, Contributor

"Freemium" is a business model that relies on offering free services and converting some users to premium paid services.

It's been a successful strategy for some companies but it's not as simple as it seems. Getting the right balance between what is offered for free, and what costs money, is essential.

And there is the risk that a competitor can shave-off your premium services because the cost of offering online services is often marginal.

Recently, I took part in a discussion between the general partners of Silicon Valley VC firm Emergence Capital and five of their top "freemium" startups:

David Sacks, CEO, Yammer

Ivan Koon, CEO, YouSendIt

Brent Chudoba, VP Business Strategy, Survey Monkey

Umberto Milletti, InsideView

Jason Lemkin, CEO, Echosign

I distilled ten points for a successful "freemium" business:

1- Don't try and guess how your users interact with your service, and which features to offer, perform multiple tests of usability, features, and pricing. Intuition is the starting point but test it out against multiple variants.

2- Create a business service with business processes that act like a machine, so it is scalable and doesn't need large numbers of people to grow.

3- Pay attention to all of your user data. It will reveal problems and opportunities for additional services, and it will give clues on how to convert more of your users to paying customers.

4- Make sure you are creating a service that has plenty of value, so that your users become your salespeople, they will evangelize your service without you needing a large marketing budget.

5- Don't try to get rid of your "deadbeat" users with bait-and-switch strategy. Continue to think up new ways of enticing them to purchase a subscription.

6- You don't need that many paying customers, for some businesses as few as 4 per cent of premium users can create a profitable business, you then have 96 per cent of upside -- users that you can potentially convert.

7- If your premium service has a high enough cost, it's best to have some human contact with the customer rather than have them interact with an automated sales system -- this makes a big difference in retaining customers. It's also an opportunity to up sell or cross-sell other services.

8- Avoid free trial periods, they are usually not long enough to convert users into advocates, and they establish an adversarial position where the company has the power to take away services.

9 - Be careful in setting price points, if they are too high it might attract competitors that can easily undercut your business. Having a lot of free users means it is difficult for a competitor to compete with "free."

10- Make sure that you have a truly useful service in the first place otherwise "freemium" or otherwise, no business model is going to help you.

You can read more about the discussion here.

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