From Freemium to Premium: The Economics of Free Products
In grocery stores, we sometimes come across tables or kiosks offering free samples of new products. Occasionally, we try a free sample and come across a new taste that we simply must buy. If enough customers feel the same way, the seller ends up making a long-term profit from giving away free samples. This is the goal, obviously, and not all free samples end up turning a profit. Is the use of free samples, with the hope of attracting long-term paying customers, a viable economic strategy?
Requirements for Successful Free Sample Models
Low Marginal Costs
Free samples are most economical for the seller when marginal costs are extremely low, meaning either mass production (food) or very low variable costs compared to fixed costs (digital products). The product must also be capable of being broken into individual units that can be enjoyed by the consumer while still leaving a desire for the full-size product. For example, a single chicken nugget is enjoyable but usually part of a larger package, such as a ten-count. A partial digital product is also enjoyable, but consumers may quickly come to desire the entire range of options (game layouts, streaming entertainment, software capabilities, etc.).
Tiered Product Lines
Similar to having “sample size” individual units, sellers can offer free samples more effectively if the sample is a base model with simpler features and less capability than the standard unit sold by the firm. For example, a demo video game may be offered for free that allows the player to play only one level or character. If the player enjoys the free demo game, he or she may be willing to pay for the full model and access numerous other levels, characters, maps, missions, etc.
The full model may also allow online and multi-player gameplay, while the demo is limited to single player only. To keep customers engaged, additional tiers of access can be offered with additional features. This may entice some customers to consider paying for higher tiers as they master all the features of their current tier, especially in terms of video game memberships.
Freemium Memberships
Similar to demo models of video games are freemium memberships to streaming services or software. Customers can use a partial product for free, often requiring them to see ads, and be routinely targeted for appeals to upgrade to the paid membership. In this regard, the freemium product serves as a conduit of targeted advertising for the seller: to continue using the free model, the freemium members must watch the seller’s ads. By offering a partial-access or partial-product freemium membership, the seller can gain valuable advertising access.
The Economics Behind Free Samples
Psychology of Free Products
People love free products, and will quickly take advantage of offers for free goods and services. This can benefit the freemium-offering seller right away by granting it access to consumer data. Simply by purchasing the free service, the consumer is giving the seller valuable insight into consumer trends. This can be considered a cost savings, as the firm might otherwise have to conduct or pay for market research. Consumers are now giving away their opinions and spending habits in exchange for the free sample.
Free Advertising
Because people love free, firms that offer free samples enjoy positive word-of-mouth, which is effective advertising. The company may be seen as generous and humanitarian for offering a freemium membership, especially if it targets that membership toward groups like students. Now the company is seen as “giving back” to society, regardless of whether this is actually its intent. In addition, willingness to offer free samples make the seller appear confident of the quality and desirability of its products, which can draw in consumers.
Free Market Research and Feedback
Making a better product can be expensive and time-consuming, requiring lots of research. Instead of focus groups, however, firms can simply offer free samples to customers. Customers may be enticed to offer up more of their data, including completing lengthy surveys, in exchange for temporary upgrades to paid status on apps, streaming services, software, or video games. Ideally, some of these customers would agree to purchase the paid status after previewing it. But, even if most do not purchase, they have provided valuable feedback on the product that the company can use to upgrade it.
The Challenge: Making Freemium Good Enough, but Not Too Good
In the digital realm, freemium models present a significant challenge for firms: how to make it good enough to attract a large customer base while not giving away too much? The freemium product must be usable enough to attract users and show them that the product is sound and desirable. However, the model must still leave out enough features to leave the user wanting more. If the freemium model is too basic, customers will quickly walk away after experiencing the few good parts. If the model is too advanced, however, customers will find their needs met and only use the freemium model without upgrading to paid status.
Firms Must Highlight Desirable Features and Content of Paid Tiers
Users may only seek to upgrade if and when they see something specific that they want. For streaming entertainment services, this could be a new television show or movie. Subject to constant advertising while using the freemium service, they see the popular new show is only available on the normal service, and so they decide to upgrade. They may intend to cancel their paid service and return to freemium after consuming the new show, but many might forget. As a result, each new show released on the service causes many freemium users to upgrade permanently, either forgetting to cancel or deciding consciously to remain on the paid tier in order to access more new content.
Firms Must Make it Easy to Convert From Freemium to Standard Model
The decision to choose to upgrade for a desired feature or piece of content may be fleeting, so the ability to upgrade must be a simple process. Many freemium services subject users to regular options to upgrade, allowing the firm to capture them in moments where they may be considering upgrading. If consumers have to go to a different portal or website, they may lose interest, especially if they have to start a whole new account. Allowing users to keep their freemium account information, simply with a method of payment added, streamlines the process and leads to higher conversion rates.
Strategic Bundles Can Make Paid Memberships Seem Too Good to Pass Up
Firms may convince some freemium users to sign up for the base package by making the base package seem very elaborate and generous. Similar to how a firm sells a Medium and a Large size product, with only a small increase in price between Medium and Large in order to steer more customers toward the Large, sellers of digital products may intentionally make their first paid tier seem like a super deal compared to more expensive tiers. The freemium customer may decide to upgrade to the first paid tier because it seems like “too good a deal to pass up” compared to higher tiers. This makes sense, because few customers likely subscribe to higher tiers as newcomers.
By strategically bundling numerous desirable features into the first paid tier, rather than spreading them throughout the lineup of tiers, the seller is likely to convince more freemium users to pay. Economically, it is worth it if there is a low marginal cost of granting new customers access to these bundled features. Freemium customers will say “look at how much we get!” when comparing the base paid tier to higher tiers, not realizing that it costs the firm virtually the same amount to service each customer, regardless of tiered access.
