Freemium products are taking the Net by storm. These are all call-to-actions that brands and B2B firms are using to get you to start using a product for free, then ask you later to pay to unlock premium features or to remove ads.

Some of the most popular companies and products that are currently using this model include: Spotifiy, Clash of Clans, LinkedIn, Evernote and Dropbox. The model is shifting the way that companies do business, so much so that even YouTube is creating a freemium model.

What are the freemium models?

Freemium models can be lumped into two categories: free to use, but you have to suffer through ads, and free to use but you don’t get all the fancy features. The cloud-based note-taking app, Evernote, is a perfect example of the first model. You can use it for free, no ads attached. If you want more storage, security or editing features you can pay $10 per month. A good example of the second model is Gmail, where a paid subscription removes advertisements but also unlocks more storage space and a variety of customization options.

Can it be profitable?

The answer here is yes, freemium can be profitable. But just like any other businesses, your revenue model is just one of the many pillars that create a profitable company. Mobile app developer SuperCell made $1.7 billion in 2014 with $565 million in profits. They even ran a primetime commercial for their flagship game Clash of Clans during this year’s Super Bowl. Other firms have publicly commented on the profitability of their freemium model.

Email marketing service provider MailChimp reported the total number of paying customers has increased over 150 percent, and “profit has increased by a whopping 650 percent. Profit has increased primarily because cost of acquisition has dropped,” as GigaOm wrote. What is working for this startup?

MailChimp’s co-founder Ben Chestnut explains in his post that for many freemium services, the ratio of non-paying to paying customers is 10:1. As GigaOm explained:

For a freemium business to work, the revenue from that small number of paying customers has to support the large number of non-paying customers. As Chestnut notes, many startups make the mistake of solely focusing on growing their user base, assuming that they’ll be able to monetize the product later. MailChimp had already developed a solid product that was demonstrably generating decent profits. Adding a free component helped the company to get that product out to a much larger audience. Freemium doesn’t automatically mean success, but when coupled with a solid product with a proven ability to generate revenue, it can be a very useful marketing tool.

Should I consider it for my company?

This is the harder question to answer; typically we have seen businesses within the digital space such as mobile apps, social networks and media streaming be successful. The question that you have to ask is, “will this product provide enough value that my users will pay for a higher level offering?” For the most part this is only going to work with a subscription or service where the lifetime value of the customer is worth enough to overcome the cost to support all of the free users.

In the tech sector, once the app is created the cost to host more users is incremental, Therefore you can use the app its self as a loss leader for the premium product.

Know your product, know your customer

Using the wrong revenue model can make or break your company. Do the proper research to make sure that your product has a gap in the market between open source, and more expensive solutions. Freemium can be much easier to market, although the conversion process is longer. It is easier to sell a product that is free to use than one that takes a monetary commitment. Make sure you have a model that gives users enough motivation to pull out their credit cards.

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