To note: This post was written during a time in which we weren’t a fan of freemium. Our views have since changed and we now recognize freemium as an effective acquisition model. ProfitWell offers a free metrics tool, which you can check out here.
Recently I moved into a new apartment after living the past year in a school dorm, and let me tell you, transitioning has been a tremendous challenge. For example, I am now the proud owner of a kitchen, which of course means I can no longer rely on an endless supply of ready-made food from the school dining halls. Instead, I have to rely on my meager cooking abilities to make sure I don’t starve to death. Eggs for dinner, anyone?
This experience has forced me to reassess the value of free food offered by the various student organizations on campus. Eating free pizza for dinner a few nights a week doesn’t sound so bad anymore. It saves me the time and trouble of cooking and cleaning dishes, plus it tastes better too!
photo credit: Stéfan via photopin
So what do my college food woes have to do with your pricing strategy? Well, when my previous food supply was cut off, my general appreciation for free pizza (or any other free food for that matter) increased dramatically. In a similar vein, you can boost the value of your product by taking it away from your potential customers. This isn’t to say you should disregard paying customers and discontinue your service, as that would obviously be a detrimental business move. Rather, it refers to implementing a limited free trial of your product, which can help you attract new customers without requiring you to give away the whole shebang indefinitely. Let’s dig a little deeper into the psychology behind this phenomenon before we discuss the benefits of applying free trials and the potential downside of freemium models.
Loss Aversion and the Endowment Effect
Through years of study, researchers have developed two psychological principles that are critical to understanding the effect free trials and freemium offers have on your bottom line.
The first principle is the endowment effect, which states that consumers are willing to pay more for a product when they are able to interact with it. In fact, an experiment was done in the 1990’s where researchers asked two groups of people how much they were willing to pay for a ceramic mug. The first group was only allowed to look at the mug, while the second group was allowed to hold it and inspect it close up. After the trial, the researchers concluded that the second group valued the mug almost twice as much as the first group. It was as if being allowed to touch and take ownership of the mug added sentimental value to the object and increased its overall quality.
photo credit: H is for Home via photopin
The second principle is loss aversion, which refers to the inclination for people to staunchly prefer avoiding losses than acquiring gains. This was illustrated by two college psychology professors, who performed a brief psychological study among their students. They offered their students a variety of bets and found that they needed a payoff of at least $40 before they would take a 50/50 bet that might cost them $20. Simply put, the pain of a loss was twice as intense as the pleasure of a gain.
Enough with the Theory, How Does This Apply to My Pricing Strategy?
The two principles we just discussed allude to three critical implications that you need to consider before using free trials and freemium plans to attract new customers.
1. Freemium and Free Trials Both Demonstrate Value, but That’s Where the Similarities End
Offering potential customers a taste of your product ensures they will appreciate more of its benefits simply because they feel a sense of ownership and have the opportunity to interact with your brand. By allowing customers to experience the value of your product first-hand, you can use the endowment effect discussed above to raise the perceived value of the product. This is similar to the impact physically holding the mug had on the second group of research subjects. No amount of cutesy videos, testimonials, or feature lists can compare to a prospect actually getting a chance to use your product, and it’s the most effective way to fully demonstrate the value of your offering.
However, the problem with using the freemium model is it provides very little incentive to upgrade to paid*. Giving away the value you’ve created for an unlimited time frame can lead to a flood of problematic prospects who will churn out after they lose interest, and if you strip many of the features from your free plan to create incentive, the right customers may never get an accurate picture of all the benefits your product has to offer.
*A caveat here is if you properly set up your freemium throttle to act as a free trial, meaning as soon as the free user starts to get more than a taste of the product (slowly becoming an average user) they are forced to upgrade to a paid plan.
2. The Risk of Loss Makes Free Trials More Effective
The goal for any business is to demonstrate enough of a product’s value to justify a profitable price. Free trials enhance your customer’s understanding and are one of the best ways to demonstrate that value while increasing your customers’ willingness to pay.
Free trials are especially effective because you’re limiting the amount of time a prospect gets to use the product, which forces them to make a purchasing decision once the time is up. At the end of the trial (usually 30 days), they either pay to continue capitalizing on the perks of your service or lose access. Due to the principle of loss aversion, the customer is more likely to buy when the time’s up to avoid being deprived of the value your service provides (that is, if it’s a great product). Just make sure to price your product in accordance with its actual value and engage your customers throughout the free trial period to maintain healthy conversion rates to paid tiers.
3. Zero Risk of Loss Makes Freemium Less Effective
So what about freemium strategies? Like we discussed earlier, freemium offerings can demonstrate the value of your product but they often fail to motivate customers to buy. Unlike free trials, which take advantage of people’s natural tendency to avoid losses, free plans require you to give away a portion or all of your service indefinitely. While this might work for big companies like Spotify that depend on continual rounds of funding and capital investment, it probably won’t work for you.
We’ve said this before, but freemium is a marketing strategy, not a revenue model. While free plans can widen the pipeline and bring in a swarm of leads, they don’t necessarily attract your ideal buyers or ensure you’ll be able to entice prospects to upgrade to profitable products, especially if you haven’t uncovered which features actually drive customers to purchase. In addition, to find a balance between giving away too much or too little of your product is incredibly tricky. Many potential customers won’t see the need to upgrade, either because your free plan doesn’t demonstrate enough value (causing them to abandon ship and look for alternatives) or because it provides them with such a huge portion of your service that they don’t see any benefit in paying for additional features.
In Summary: Don't Give Away the Farm
I know it feels like we’re beating a dead horse, but we’ll keep saying it until the cows come home: freemium is a marketing strategy, not a revenue model. You need to be smart with how you’re opening up your product to increase conversion rates, otherwise mitigating your customer acquisition costs might become a huge obstacle. What’s the alternative? Transition your product from a stripped-down, freemium offering to a full-featured free trial. Not only will you be demonstrating more value in your product with the extra features, but you’ll also increase your conversion rates by tapping into people’s natural tendency to avoid losses.