Elena Verna is a Reforge EIR and Partner on Experimentation and Monetization Deep Dive programs. Elena is a Growth Advisor to Miro, MongoDB, Maze, and others. She was formerly SVP for Product & Growth at Malwarebytes, and also an SVP at SurveyMonkey. She has a breadth of experience across freemium, self-serve, and free-trial subscription revenue models for both B2C and B2B companies. To learn more from Elena and other Reforge Partners, apply to become a Reforge Member.

I've heard every excuse in the book from companies on why they don't consider freemium.

"We're an enterprise product and freemium doesn't work for enterprise."
"If we implement freemium, it will cannibalize revenue from sales teams."
"A freemium product will erode the perceived value of our product."
"Freemium will only drive low quality users."

But the most prevalent reason I hear is:

"We did the math and our freemium product just won't be cost effective."

These are all myths. Especially this last one. In this post, I want to explain why in three parts:

The simple freemium formula that has led many astray.
How market shifts have led to different freemium math.
The 6 indirect growth effects of freemium that change the equation.

The Freemium Formula That Has Misled Many

When freemium products first became popular in the early- to mid- 2000s, they were considered valuable if the free product generated enough new paid users to offset the cost of developing and maintaining the free product. The problem is that times have changed. It's not the early- to mid- 2000s anymore, and this reductive view of when freemium makes sense is no longer valid.

Even though times have changed, a lot of companies' mindsets haven't. Many companies still only consider freemium models if they think they will pay for themselves. They take an approach similar to this article, "A simple formula to gauge a freemium model's success," where the author boils a freemium model's value down to four factors:

The cost of marketing and selling to a user in a paid model
The cost of serving a free user
The cost of acquiring a free user
How effective you are at converting users from free to paid

The problem is that this approach falsely assumes that only the direct monetization value from a freemium model should be considered. However, in the past several years, indirect monetization value has become much more significant due to a few market shifts.

Market Shifts Lead To Different Math

There are four core market shifts that lead to a different formula to evaluate freemium:

User expectations have shifted.
Self serve purchase price points are increasing.
Usage is now a key purchase criteria.
Acquisition and retention are becoming harder.

Users' Buying Expectations Have Shifted

People Don't Like Talking To Sales People 😡

Traditionally, when new products came to market, especially when they offered a new and differentiated value proposition relative to other products, organizations relied heavily on marketing to drive awareness, consideration, and ultimately conversion events. In B2B companies, sales teams would double-down on identifying potential decision-makers, and building custom demos to demonstrate the value the product could create.

Today, customers expect to see and experience the value of the product without ever talking to sales. Large sales teams are often replaced by lighter weight sales development teams that complement the freemium, fully self-serve experience.

Free Trials Are Typically Not The Answer 🆓

While self-service removes the need to build a lot of custom demos for potential customers, it introduces a new challenge: How do you effectively communicate a product's value proposition to a wide variety of users and use cases without any human touch?

The solution is always to reduce friction while creating easy to use, delightful customer experiences. And many companies look to reduce friction with fixed-time free trials to get users to understand their product value. These trials are a "one-size-fits-all" answer that ends up leaving a lot of potential users behind.

Different types of users take different amounts of time to get to know your product, so if you have a 3-week trial, you're artificially cutting out users who are going to take more than three weeks to get to know your product. In particular, larger customers usually have a larger consideration window, so by implementing a fixed-time trial, companies unintentionally discriminate against larger-potential customers. Fundamentally, trials put pressure on time, not value created, to trigger conversion & retention — this is not a user-centric approach.

The Pressure Has Shifted To Product ➡️

Creating a freemium product allows users to learn the value of your product on their time. As an added benefit, this puts pressure on your product (not your marketing and sales) to drive monetization. When your product can communicate value proposition on its own, you get much more naturally occurring, predictable, and sustainable habits that drive long term retention and revenue.

Self Serve Purchase Price Points Are Increasing

One of the common excuses I've heard before is that freemium doesn't work for enterprise or products with large prices. This barrier is disappearing quickly. Customers are becoming more and more comfortable purchasing higher-priced SaaS products without ever talking to anyone. For example, I don't need to contact a sales rep to set up a large scale Jira Data Center. I can make a 6-figure purchase just by using their self-service website.

Usage Is Now A Key Purchase Criteria

Top Down Sales Leads To Lack of Usage 👎

Many B2B products formerly were driven from the top down, where companies would try to sell into a CEO or somebody at the executive level, and the decision about the software was really made by checking the boxes on the necessary features, or the lowest price. That software would then be pushed down on to all of the different professionals and employees within an organization, and they would be expected to use that product.

But this led to a lot of instances where companies would purchase large-scale licenses for products, only to find that their employees, those who actually need to use the product, hated them. This created situations where companies were stuck paying for products that only a fraction of their employees were using, and even fewer were using effectively. One of the biggest questions buyers now evaluate is, "If I buy this, is my team actually going to use it?"

Is My Team Actually Going To Use This? 🧐

Today, existing usage is a huge driver for B2B purchasing. If a company is considering purchasing a license for Miro, one data point they can look at is how many employees already use some version of Miro in their personal lives, on individual teams, or for ad-hoc use cases.

Blissfully, a Comprehensive IT platform, published a great report on why. On average, a company has:

7.6 Duplicate SaaS Apps (overlapping apps being used across the org)
7.1 Abandoned App Subscriptions (where usage has declined to zero)
$135K Wasted Per Year on Un-Used SaaS Purchases

This means that driving widespread bottoms-up usage is critical, and freemium products are the best way to do this. Most importantly, many employees don't have the ability to make purchasing decisions for your product, so allowing free usage can help you enter an account without any friction.

But this doesn't just apply to B2B purchases. Historically, consumers acted similarly. They would read reviews and product descriptions and come to a conclusion on whether to buy or not. Now users expect to be able to use a product before buying it to validate that it's something they're going to get value from. Short trials or demos often aren't enough to do that, and so freemium is the best way to build that usage and therefore confidence in a consumer's purchasing decision.

It Is Harder to Acquire and Retain Customers

It's no secret that the software market is becoming more and more competitive, making acquisition and retention more difficult. In Retention is Hard and Getting Harder, we said:

"There are 3 market dynamics that have created a perfect storm:

Increased competition
Channel fatigue
The rise of monopolies in tech

These three things has made it harder to do 3 things:

Onboard Users - Time to create a good first impression is decreasing while the required delta in value over competitors is increasing.
Building Habits - With more competition, it becomes more difficult to rewire user behavior. This is compounded by the challenge of overcoming channel fatigue, which is required to rewire their existing habit.
Maintain Habits Over Long Term - Even if you establish the first impression, and build the initial habit, monopolies like Facebook have shown zero qualms about outright copying features and products and pushing to their larger distribution."

The 6 Indirect Growth Effects of Freemium

These shifts have increased the value of 6 indirect growth effects that are not accounted for in the simple formula, which changes the math on when you should consider freemium.

Higher Willingness To Pay
Increased Network Effects
Stronger User Habits
Growth Loop Acceleration
Lower CAC By Getting Your Foot In The Door First
Better Product Insights

1. Higher Willingness to Pay

When organizations or individuals make purchasing decisions, they are consciously or unconsciously evaluating whether the following formula is true:

Purchase Price < Potential Value * Probability of Realizing Potential Value

Individuals and companies know that the value a product promises isn't always what they'll get once that product is fully adopted. Everyone has a story of a product that looked great, but once it was fully set up, it didn't deliver as promised and ended up being a wasted investment. Because of this, buyers are always making sure that the purchase price they're willing to spend accounts for the probability that the product will actually be a bust. In the same way, you'd be willing to spend a lot more on jeans if you knew after a few wears they would fit perfectly and become your go-to pair.

Freemium products help customers get a much better sense of whether or not a product will be valuable for them than a free trial or no free experience at all. This raises the factor of Probability of Realizing Potential Value, which raises the Purchase Price buyers are willing to pay.

Reviews, product descriptions, and short-term product demos/trials are only able to give buyers so much confidence in there being a high probability that they'll actually be able to get the value that a product promises.

2. Increased Network Effects

Many products leverage different types of network effects to create additional value for users. Free products allow you to build a large network of users to increase that value proposition even if they are not paying. In this way, a free product can increase your product's value to paid users. Spotify is a common example here. A large portion of Spotify's value prop is their amazing ability to help you discover new music. Discovery is driven by a data network effect that is fed by their free users. This data network effect has multiple other effects: Increased retention of both free and paid, increased virality, and increased monetization.

In fact, many great freemium products are able to create paid products that can only exist because of their free product. Take LinkedIn, for example, which was able to launch new products like LinkedIn Sales Navigator and LinkedIn Recruiter to monetize the strong network it had built with its free product.

3. Stronger User Habits

Free products allow users to develop a habit before they pay, creating not only more opportunities to convert but most importantly ensuring that customer retains. As a consumer, if I pay for a month of usage, at the end of that month I will be quick to churn if I haven't developed a strong habit around the product. However, with free products, users can be nurtured into developing a habit over a longer period of time. Therefore, users who do convert tend to already have stronger habits in place, increasing their expected retention and therefore LTV. In this way, free products can increase your paid user LTV.

I saw this first-hand with Miro. A lot of people want to try Miro, but it takes some time to understand all the different ways you can use Miro. If Miro charged for product use right away, a lot of people would churn quickly. Instead, the free product (which gives users 3 free boards) helps build strong user habits, so by the time a user converts to paid, they are much more likely to retain longer since their habit is stronger.

4. Growth Loop Acceleration

Growth loops are the engine of any growth machine. Freemium can both enable product-led growth loops and accelerate existing ones where free trials and other models cannot. Companies that hide their entire product value behind paywalls typically create too much friction in the loop to make it effective (especially content and viral loops).

At SurveyMonkey, the free product was critical to driving user generated content loops and word of mouth. Customers were doing our marketing for us just by using the product and creating surveys and sending them users who had never heard of SurveyMonkey.

5. Earlier Customer Acquisition, Decreasing CAC

One of the more overlooked methods of indirect monetization is getting users into your product before they become more expensive to acquire. This can manifest in a couple of different ways. First, in emerging product areas, free products can help you acquire users before competitors with similar products start investing in acquiring those same users. However, in B2B contexts, building free solutions for small businesses can also help you acquire those users while they're cheap, and build a path for them to grow into more upmarket and more monetized versions of your product.

Notion, for example, gives their product away for free to students, hoping to create habits with future decision-makers now rather than later. In doing so, they acquire lower value (and lower cost) customers early with their free product, and therefore need to rely less on acquiring high value (and therefore high cost) users later on.

6. Better Product Insights

Organizations that understand their target audience, customer problems, and behavioral patterns better than their competitors win in the long run. No matter how good your user research is, the best way to validate a product's value proposition or optimize a user experience is to see how people actually use your product.

Creating a free product means that the number of users you have to learn from is so much bigger than just those who have committed to pay. This can decrease your research, R&D, and even experimentation costs just by having more people using your product and extracting insights from their usage data. Furthermore, you now have a much larger and more targeted user base to run experiments to learn what drives longer-term key acquisition, retention, and monetization metrics

Get On Board Now, or Get Disrupted

Competition in every industry segment is hotter than ever - and we are only getting started. The consumer has all the power, and we are in a grueling race to capture their attention by providing better, easier, faster, cheaper solutions to their problems.

If you're only looking at direct monetization, freemium models often don't pay for themselves. To understand the real value a freemium model can actually create, you need a much more nuanced view than the "simple formula." In my opinion, too many companies today are leaving value on the table and will get disrupted long term by not leveraging a freemium model.

To learn more from Elena and other Reforge Partners, apply to become a Reforge Member. Solving real problems, requires real depth. Reforge is a professional development network combining Career Accelerator Programs, an ongoing knowledge base and a network of ambitious and action driven professionals to help solve on-the-job problems.

Workshop: Executing A Freemium Model

Reforge Members can RSVP here. If you are not a Reforge Member, apply here.

With Elena Verna - Growth Advisor at Miro, SurveyMonkey, MongoDb, and more.

Date: Tuesday - February 9th, 2021

Time: 11am - 12pm PT