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Understanding User Acquisition in Freemium

For my Master's thesis I've interviewed 10 companies that use freemium. What I found when analyzing these interviews is that we can create a model for how freemium-based companies aquire new users. I've divided this process into three "loops":

The User Acquisition Loop

User acquisition in freemium consist of four parts:

  1. Potential and Existing Users. First of all, the market must be big. If it's not a very big market opportunity, the chance of success with freemium is very small, as most likely only a single digit percentage of users will convert to pay.

    According to one respondent "the standard wisdom is that you'll see 2-3% conversion rate in the consumer internet, 5% or perhaps a bit higher on business users, prosumers." Thus, if the market is not big enough it will be very difficult to get enough paying customers.

    Second, from the interviews there is a conviction that successfully having free users using the product or service relies on having a culture of free — fully accepting that potential and existing users may not now or even ever pay. You must see value in free users. One of the respondents said that "you will by definition get less serious signups — I think that's kind of a given," while another similarly says that "there is an inverse relationship to cost and churn." One explained it as follows:

    There's not a lot of established companies that understand that it's not just a "we'll put it on our website, we'll do a little bit of email marketing, and then people understand it and start to use it and convert."

    In total, this step is about finding the right user and fully accepting that most of these users will never pay for your product or service.

  2. Add Value. The free version must have considerable value. Freemium is about using the product as marketing, and thus if the users don't get any value from it, you will see a very low amount of conversion. As one respondent said: "It begins and ends with great product. The product is the marketing, and that's why you have a free version." One respondent says that an incontrovertible offer is needed — this is what "will get the initial people in the door."

    According to one respondent: "We'll get a bigger return and we'll get a bigger brand affiliation if the people who are using the freemium offer are actually getting something of significant value."

    But this value is however not only about the product itself, as one respondent explains:

    And the product is not just about what the user experience is online, it's the whole package. It goes back to the importance of loving your users, giving them massive hand holding and support. That whole experience is really key to building a large engaged user base.

    Thus, adding value is also about building a relationship with the users, not just letting them use a product or service for free.

  3. Customer Engagement. Word-of-mouth is the nucleus of freemium. Without engaged user, there will be no WOM, and without WOM there will be no business. As one respondent said: "word-of-mouth was paramount, without it we wouldn't exist."

    Word-of-mouth was mentioned as key by all respondents. As one clarifies about WOM:

    That's one of the prerequisites I think you need for a freemium model. If you are giving something away for free, and are looking to covert 1, 2, 10, 20% of those guys to paid, if they are not telling other people or they are not taking something they use at home to work, then subsidizing that free use is not worth the time.

    One of the respondents call these engaged users "word-of-mouth agents":

    Now 18 months later we've got an army of over 100 000 people that have signed up, and we have word-of-mouth agents that feel somewhat indebted to our organization because they've got such a good deal. And they've become word-of-mouth agents for our brand.

    Another respondent uses the term "goodwill" to describe this phenomena:

    With us they can use it for free forever, and that goodwill gets people talking. When that promoter star goes up we expand in the community.

    Several of the respondents mention that they have not done any traditional marketing at all, they have mostly focused on word-of-mouth and the products own virality. However, the more mature the company, the more traditinonal marketing was a part of the mix.

    Another aspect that was mentioned by many of the respondents is that it is important that the company is focused on a vocal niche, especially in the beginning. Without a vocal niche it is very difficult to get existing users to get new users in. One respondent said:

    You've got to be focused, you've got to have a very defined, interconnected group of prospects that talk.

    To get the word going in this vocal niche, the respondents talk about different strategies, but there is a strong focus on creating "viral loops", e.g. as explained by on respondent: "if there's a viral loop that's baked into your product, then [the free users] are adding to your user base because they're helping attract new users." Another respondent go as far as stating that "anything that promotes virality should be free to keep your viral flow going," and adds:

    Don’t inhibit your own virality by limiting usage of the product in silly ways that don’t actually cost you anything — most costs in a SaaS business are marginal when it comes to usage.

    One of the clear upsides of building in this virality is in customer acquisition. One respondent talks about how they have done very little to acquire customers, as every user that use their tool end up "telling 10s, 100s or 1000s of others about" it. And this is from a company that sell to several Fortune 500 companies without having a sales team at all.

  4. Simple Choice. This is explained very good by one respondent:

    You've got to have a product that is easy [...] to understand. It's got to be easy to understand, easy to become aware, easy to get started and using it, easy to gain value, and then easy to talk about it. Those are really paramount.

    There are several core elements of creating this simple choice: that the product is free is, of course, one of them. Another is that there must evident value in the free version to get people to try it out. A part of this is also just to "minimize friction". As one respondent says: "avoiding feature creep is critical, only expose things that are relevant for at least 80% of your audience."

    According to one respondent, as the attention span of most users are very short it is important in freemium to have an awereness-to-use benefit measured in minutes. One relates this to free trials:

    Free trial is also an interesting model, but it typically requires a credit card up front, and can scare off consumers unnecessarily — you end up with more qualified leads, but much less volume.

    We can see another perspective on this from another respondent. According to him, when they created their product they had the following goal: "We do one thing, and we do it better than anyone in the world, and we are going to do it better than anyone for the rest of our lives."

    What this simple choice entails seems to be very different from case to case. Some want the hurdle to be as low as possible, others want a somewhat larger hurdle to "[weed] out the free-riders that always want to get something for nothing." The point is to create a simple choice for the users you want to get in. Here we see an interesting perspective from one respondent who had failed in their use of freemium:

    If you had just encountered our website — just stumbled across it — you had not known what on earth you'd use it for.

    The respondent also said: "We had so much complex functionality that needed to be explained." For the companies that have had success with freemium, there seemed to be a strong focus on simplicity. As one respondent summarized: "make a simple product that is easy to use."

    So what we end up with, is that the difference between this step and Add value, is that this is about making the choice to test your product or service as simple as possible. It is about enticing user to try it out. And as one respondent said it, there should be "no risk for the user."

So to summarize this loop: You have some users, you give them a lot of value for free, you get them engaged, and they get other people interested, so you have to make it dead easy for these new users to get in and start using your service. This grows your userbase and the loop continues.

The Learning Loops

To successfully use freemium it is essential to learn from existing and potential users. For many this involves being obsessed with metrics, but for others this is mainly about being focused on having a relationship with the users from who one can learn about how they view the product. The learning loop is about learning what works, what doesn't work, and also about getting ideas and thoughts from the userbase. As one respondent says:

We're looking for quick reach, looking for basically more customers, more insights, we want more people to tell us "We like your applications because of X, we don't like them because of Y."

The reason this step is very important in addition to the user acquisition loop, is because "everyone has a different journey of freemium." It is about seeing where customers get value, and finding out what they are willing to pay for and how much.

The general knowledge seems to be that freemium is a "numbers game", and as it is far more opaque than regular payment models, having a deep knowledge and understanding about the users and how they behave is critical. According to one respondent it is "very easy to build a non-profitable business." One of the reasons this is important is, as one state:

There's room for permutations. We didn't have a formulae. We just experimented. That's how we found out what works for us. It's just trial and error.

This learning is about finding and improving the right value for the target customers, and finding the right way to create a simple choice to get the user in.

The Conversion Loop

And then the final step — conversion. And let us start with the obvious: There is no golden rule. On the one side respondents stated that "most users that will upgrade typically do so fairly quickly," while on the other side respondents stated that "there is a very long customer life cycle — a person might be a free user for 18 months before they convert." Generally the focus seemed to be more on the latter than the former — and thus implying that conversion usually is based on experiencing the product or service. As one said: "you need to have a way to keep people engaged."

One of the most important elements to get right in this step is finding the right balance between free and paid. As one of the respondents who had failed with freemium stated: "[the free users] didn't understand why they needed the paid offering." Especially one respondent had an interesting view on this. They had decided that they wanted to go for a 10% conversion rate, and they were very focused on not nagging at all the free users to convert:

So I always look at "how do I do it so that I don't bother 90% of people, but it really resonates with the 10% that I think can be paid users?"

Two things that the respondents were very similar with regards to, were first to have a clear upgrade path, or as one said, "just kind of a natural progression of things where you start paying them," and second that value-based pricing, instead of cost-based, is the way to go.

Putting It All Together

Putting these three elements together, we get the following model:

The Freemium Loops

Based on this, we can say that the value of free users is in driving the user acquisition loop — I call it crowdsourced user acquisition — and in being the basis of the learning loops and the conversion loop.

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