You are about to put on your headphones and listen to the latest episode of your favorite podcast on Spotify. Just before you tap play, you can’t help but wonder how you have been using this app for free for all these years. How is this company even surviving if it’s giving its product away at no cost?

The answer is simple to understand yet challenging to implement: the freemium model.

The freemium model is best explained by Fred Wilson, co-founder of Union Square Ventures, aka the powerhouse investor in Web 2.0 companies like Twitter, Tumblr, and Etsy:

“Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced value-added services or an enhanced version of your service to your customer base.”

Now that you know what the freemium business model is, let’s take a closer look at how it works and what a freemium product should include in order to be effective. 

Understand the customer psychology behind paying for a product

If the ultimate purpose of a product is to make profits, why does the company risk “giving away” a good portion of that product to acquire customers?

Pendo CEO Todd Olson highlights the importance of customer success in his latest book, “The Product-Led Organization:” “The rise of the subscription economy means that it has become easier than ever for customers to switch between vendors or even back out of contracts with few, if any, consequences. This has made customer retention an integral aspect of growth.”

Going back to the Spotify story, it’s true that you have more than one choice when it comes to listening to your favorite podcast. Within seconds, you can browse Soundcloud to see if your podcast is offered for free there, should Spotify decide to charge for it.

Does that mean that every product on the market has to be offered through a freemium model, or perhaps via a free trial?

Showing the customer what the product can do and limiting its features in the free version can motivate them to actually become a paying user. Many customers feel either too comfortable or indolent to cancel their subscription when the free trial is over.

But still, are freemium or free trials the only options for a venture to stay afloat in today’s economy?

The short answer is no. Here’s how and when that’s not true.

Know that freemium is not always the way to go

A product is only as successful as the customers who reach their goal(s) by using it. Product success is significantly harder to achieve in certain industries. One example is education. The institution offering knowledge can only stay in the market if its users learn something and then effectively apply it.

Many learning platforms charge their customers upfront. Then they demo their product through success stories and a sneak peek of their offering. The ones that provide more value require a greater amount of effort and time from their clients. Typically, they also make sure that the lead first talks to an education coach to ensure that both sides are on the same page about whether the product will benefit them.

“We make sure that our leads have a free consultation with our career coach before they sign up,” says Richard Chen, co-founder of Product Gym, a global learning platform that helps people transition into product management. For Product Gym, acquiring a qualified member is more important than getting numerous leads.

“Product Gym has to ensure that the member is ready, able, and willing to put in the effort to land a product manager job,” he continues. “We would rather spend the time to find our next success story than to lose time on refunding a member because we acquired the wrong lead.”

Regardless of your business model, learning what the customer wants and what they are willing to pay for is crucial.

Determine what to make free vs. premium

Providing music is Spotify’s principal value to the customer. Then, why is the whole value offered for free?

If Spotify charged its members upfront, then it would “be vulnerable to other networks offering it,” as Fred Wilson puts it in his blog post on “freeconomics.”

So, what do we charge the customer for?

After destroying the threat of vulnerability, the main challenge becomes how to make the product tiered. The product has to offer some kind of value that the customer is ready to pay for under certain circumstances.

If you are an avid party host (pre-COVID times, of course!), you wouldn’t want your guests to listen to the ads in between every few tracks. So what do you do? You upgrade to the premium version.

Finally, freemium is all about customer acquisition. Therefore, its success depends on playing the numbers game. The product has to go viral to have a high reach. Unlike an education product, any user can consume music and entertainment applications. The more opportunities your product has to go viral, the higher the chances of converting a lead into a premium user.

For example, you can listen to Spotify anywhere in the world. Music on the app comes from all around the globe. Depending on where you connect to the app, you get to pay for it in the local currency. Should you decide to use the free version, you end up listening to regional ads. So, language and culture are no barriers, making it so easy for different people to share it!

Genius, right? So, who comes up with these complex product models in an organization?

Learn the role of the product manager in creating and running a freemium product

In today’s world, product managers drive a product from ideation to release. Therefore, it should be no surprise that they are the ones in charge of thinking through the freemium model.

Product managers act as the voice of the customer to the internal teams building the product. They also assess the availability of resources. This makes PMs the best candidates for making a cost-benefit analysis to ensure that the product is not going freemium with a high chance of failure.

According to Pendo’s customer success guide, in today’s product-led companies, “Customer success is based on the constant monitoring of [their] users’ in-app data, behaviors, and engagement, along with assessments of customer health.”

Product managers, as the primary evaluators of customer success metrics, have to know what kind of data to look for. They also need to know how to acquire and analyze that data to see if the freemium model is working.

Neither creating a freemium product nor keeping it alive in today’s competitive landscape is easy. It is by no means a safe way for founders to push their products to the market. Instead, it requires a significant amount of risk and plenty of creativity to forge a new path for your product. 

About the Author

Duru is currently a product manager at AIG, where she is working on bringing the latest technology to help asset managers and quants to make the best use of financial markets data. She is also mentoring Product Gym members by teaching them the lessons she learned during her job hunt. Duru graduated with a Bachelor of Science degree in Computer Engineering from Columbia University.