Freemium Pricing for SaaS: Great to Improve Customer Acquisition

Published on

July 31, 2023

Growth
7 min

Freemium Pricing for SaaS: Great to Improve Customer Acquisition

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The freemium model is one of many pricing models used by SaaS companies.  While offering a free service to most users, it is primarily a growth strategy, as opposed to a standalone business model. If free users will help promote the brand through word of mouth, a very small fraction of users will eventually convert into paying customers.

SaaS and freemium are a perfect combination since it requires minimal cost to provide free access to existing software for each new client.

But to offer your core product for free, you must be prepared to handle a large number of customers, both paying and non-paying. If you don't have the necessary infrastructure in place, the cost of giving away your product will become too high and will eventually become unsustainable.

The freemium pricing model in a nutshell: 

  • The freemium pricing model is primarily used as a scaling strategy by SaaS companies.
  • The free version attracts a large number of both free and premium users, far more than a free trial does.
  • By using feedback and usage data from free users, SaaS companies can enhance their products, leading to greater customer success and higher recurring revenue.
  • A freemium business model is an effective strategy for SaaS looking to shift to a Product-Led Growth (PLG) approach while cutting down on the cost of acquiring paid customers.
  • Retention rates have increased because customers have a clear understanding of what they can expect from the product.

👉 Also read: Everything you should know about SaaS positioning

Other SaaS pricing models to look into:
- Tiered pricing
- Flat rate pricing
- Usage based pricing
- Per user pricing
- Feature based pricing
- Per active user pricing

What is a freemium pricing model for SaaS?

The freemium model combines the words free and premium. Tech founders and execs use it to invite potential customers to try their product. They only need to pay if they are convinced it's worth the subscription fee.

Free users should appreciate that they received our product for free and then choose to become paying customers. However, the reality is that this doesn't always happen. If it were easy to persuade free users to become paying customers, SaaS companies wouldn't struggle with conversion rates as low as 8-10%.

In today's market, offering free access to your product does not ensure that free-trial users will convert into paying customers. To achieve success with a freemium model, strategic execution is crucial. 

Let's explore some effective strategies to achieve your goals.

The many benefits of using a freemium pricing model…

Great for brand awareness 

Freemium pricing models are a great strategy for boosting brand awareness, especially for SaaS startups in their early stages. This approach enables them to establish a strong presence in the market.

Lower customer acquisition costs 

By increasing awareness, you can lower the costs of acquiring customers and grow your customer base. Plus, there are no or minimal barriers to entry. Users can start using the product without any cost, so it's a no-brainer for them.

Validating your product 

Freemium models are a valuable tool for gathering user feedback and validating your product-market fit. This is crucial when developing your MVP.

The benefit of the network effect 

Freemium models enhance the worth of network-dependent products. As the number of users increases, the tool becomes more appealing to potential customers.

benefits of using a freemium pricing model

…and the big drawbacks

Can drain your resources

The freemium business model has one significant flaw for SaaS: it can drain a company's cash reserves quickly by supporting numerous non-paying customers. Additionally, non-paying users often demand more support, which can divert resources from app development.

Freemium models place a significant burden on a company's resources. While freemium customers do not pay, they still demand customer support, leaving less time to cater to premium users. You are not only experiencing stress on your human resources but also on your infrastructure. It needs to handle increased usage.

No motivation to upgrade 

Additionally, offering excessive free content can hinder user motivation to upgrade, making it difficult to convert free users into paying customers.

The cons of using a freemium pricing model

Who should implement a freemium pricing model?

Not every SaaS business should offer a free plan. There are clear reasons for this decision.

You should consider a freemium pricing for your SaaS if:

Your customer acquisition cost (CAC) is high

Starting a free plan can be a smart move in a situation where high customer acquisition costs are caused by low conversions on the website and pricing page. Free plans have been shown to increase the number of signups, which aligns with the main goal of freemium models - acquiring more customers.

Your product requires time for the value to be realized

Trying out the freemium strategy can be beneficial in terms of delayed gratification for your product's value. Notion, Coda, Slab, and Slite are SaaS are good examples. These tools enable teams to accumulate knowledge gradually. Their true value is only fully realized after extensive use, as a large portion of their value comes from actual usage. 

Your b2b SaaS business offers a distinct and compelling value proposition

If you can create a unique value proposition with a free plan, you should definitely consider it. Take the well-known vector/UI design tools Sketch and Figma, for example. Sketch offers a free 30-day trial, while Figma allows free usage with limited features. When consumers have to decide between Figma and Sketch, the choice is obvious. 

👉 Also read: What is a good retention rate for SaaS?

You should NOT consider a freemium pricing for your SaaS if:

Your business has significant operational costs

Free plans may seem enticing, but they often come with high operational costs per account. Although many software businesses effectively manage these costs, there are exceptions. If your business deals with high bandwidth, server expenses due to videos, or relies on expensive APIs such as SEO software that consumes Semrush's APIs, it's important to consider the potential financial impact. Additionally, your b2b SaaS business may also have a significant onboarding cost to factor in.

Your product requires expensive onboarding

Free plans may not be the best choice if you are concerned about high implementation costs or difficulty with onboarding. Some tools require extensive integration with your existing system, and a lack of guidance during onboarding can lead to customers feeling like the tool didn't work for them. Additionally, if you are using legacy software or a product that was not designed with a self-serve approach, it may put a heavy load on your success or implementation team. It is advisable to resolve these issues before considering free plans.

Short term revenue goals are your priority

To maximize short-term revenue, it's best to avoid considering free plans. Although free plans can increase signups, generating revenue from them takes a long time. Typically, only 3-5% of free plans eventually upgrade to paid accounts in the most successful scenarios. Additionally, it takes a while for the number of accounts to convert into significant revenue. In fact, the timeframe for free plans to begin impacting revenue is longer than expected.

👉 Also read: The ultimate guide to SaaS churn

Who should implement a freemium pricing model

Facts about the freemium pricing model

Freemium conversion rate calculation

Calculating the freemium conversion rate is straightforward. Simply divide the number of converted users by the total number of users on the free plan during a specific time period. 

Freemium conversion rate calculation

What is the average freemium conversion rate?

Freemium conversion rates typically range between 1 and 10%. 

In the SaaS industry, most companies fall within the 2-5% range. However, a few exceptional companies, like Spotify and Slack, have managed to achieve conversion rates of over 30%.

What is the average freemium to premium conversion rate?

​​Unfortunately, not all free users will become paying customers, and that may never change. To gauge your freemium conversion rate, you need to examine your target audience and competitors. According to a Databox study, SaaS companies serving small businesses typically have a monthly conversion rate of 6-10%, while those catering to medium-sized companies average around 3-5%.

freemium pricing model for saas companies

How to calculate the Freemium to Premium conversion rate?

To determine your freemium to premium conversion rate, utilize Expansion Monthly Recurring Revenue (MRR).

Expansion MRR represents the monthly earnings gained from your current users through upsells or upgrades.

How to calculate the Freemium to Premium conversion rate

Freemium pricing versus free trial

It takes time for products to demonstrate their true value. A brief five-day free trial may not provide enough time for your product to shine or for potential customers to fully utilize its freemium features. It also may not allow them to gather accurate data to determine if the product is right for them.

The Freemium model allows users to continuously use your product without any time restrictions or pressure. This generous offering encourages users to keep coming back, benefiting both you and them.

In overserved markets, Freemium is the preferable choice, while underserved markets are better suited for free trials. For products that are low-complexity and don't demand much learning, Freemium tends to be more effective.

Freemium pricing versus free trial

Examples of successful SaaS freemium pricing models

Here are some examples of companies that successfully use the freemium model to drive product-led growth.

Slack

Slack excels with a freemium conversion rate exceeding 30%. How do they do it? By providing a robust user onboarding process and a generous freemium plan that offers free features which demonstrate the tool's value, but doesn't fulfill all user needs.

For instance, they set limits on searching for older messages. When a user attempts to search beyond 90 days, they prompt an upgrade within the app.

SaaS Freemium pricing

Zapier

Zapier uses various strategies to increase conversions from the free version. These include restricting certain features and setting usage limits. The free plan includes 100 tasks per month and 5 Zaps. If users require more, they can upgrade to a higher plan.

With 4 different plans available, users have the flexibility to purchase a specific number of tasks that suits their needs. This simplifies the process of finding the appropriate plan and taking the necessary actions.

Zapier Freemium pricing

Grammarly

Grammarly's freemium model is central to their goal of improving communication and enhancing lives. They provide millions of users with free access to their tool, offering a glimpse into the full functionality.

Through strategically placed modals, users are prompted to upgrade to the premium version, creating a sense of FOMO. This tactic has proven to be successful in driving freemium conversion rates.

grammarly Freemium pricing

What’s the future of the SaaS freemium model?

Freemium in SaaS has proven to be a lasting concept, for 1 main reason:

The SaaS market is now saturated.

Over 30 000 SaaS products are vying for subscribers, including your own. Despite the negative impact of COVID-19, around 114 SaaS tools still aimed to claim a portion of the lucrative SaaS market in 2020.

future of saas freemium model
Source: https://cardconnect.com/launchpointe/tech-trends/rise-of-saas 

It is increasingly challenging for end-users to distinguish between similar products or services, even in the smallest niche markets.

The multitude of options available for just about anything may lead to increased skepticism among users who are wary of wasting time and resources on ineffective products.

New SaaS entrants face daunting challenges in trying to appeal to prospective users in this scenario:

  • How to demonstrate the value of a product and provide evidence that it is not only worth using but also worth paying for?
  • How to demonstrate the superiority of a product over existing and well-established alternatives?

The questions at hand cannot be resolved simply by adding more features or using marketing gimmicks. I can confidently say this because there is very little new information you can provide that we haven't already heard.

New SaaS companies have few options if they want to make an impact. Their best bet is to summarize their user acquisition strategy and invite potential customers to try their product for free. This way, customers can see for themselves if the company lives up to the hype.

Freemium is still in its early stages when viewed from this perspective. Established SaaS giants wouldn't simply sit back and let startups disrupt them by luring away their users through the freemium model, right?

đź“š Additional reading

👉 The SaaS magic number
👉 Your guide to SaaS marketing

Laura Ballarin

I'm Account Manager at Scalecrush. You'll find me here talking about my no-nonsense approach to content marketing.

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