# Freemium Business Model: Definition, Examples, Pros & Cons

> **Definition**
>
> Freemium is a business model that provides basic features of a product or service for free while charging a premium for additional or advanced features.

## What Is Freemium?

A combination of the words “free” and “premium,” freemium is a type of business model that offers basic features of a product or service to users at no cost and charges a premium for supplemental or advanced features.

Companies using a freemium model offer basic services for free, often as a trial or limited version, with advanced features available for a premium.

### Key Takeaways

*   Freemium combines free and premium services, offering basic features at no cost and charging for advanced features.  
    
*   The model is popular with software and internet businesses for acquiring a large user base.  
    
*   Companies benefit from free users by collecting data and showing ads to generate revenue.  
    
*   A key challenge is converting free users to paid ones, often requiring strategic upsell tactics.  
    
*   Successful freemium models include Spotify, Skype, and Candy Crush Saga, leveraging limitations on free versions to entice upgrades.

## How the Freemium Model Works

Under a freemium model, a business gives away services at no cost to the consumer as a way to establish the foundation for future transactions. By offering basic-level services for free, companies build relationships with customers, eventually offering them advanced services, add-ons, enhanced storage or usage limits, or an ad-free user experience for an extra cost.

The freemium model tends to work well for internet-based businesses with small customer [acquisition costs](https://www.investopedia.com/terms/a/acquisition-cost.asp), but high lifetime value. It allows users to utilize basic features of a software, game, or service for free, then charges for “upgrades” to the basic package. It is a popular tactic for companies just starting out as they try to lure users to their software or service.

Since the 1980s, freemium has been common practice with many computer software companies. They offer basic programs that are free for consumers to try but have limited capabilities; to get the full package, you have to upgrade and pay a charge.

It is a popular model for gaming companies as well. All people are welcome to play the game for free, but special features and more advanced levels are only unlocked when the user pays for them.

Freemium games and services can catch users off guard, as they may not be aware of how much they (or their kids) are spending on the game since payments are made in small increments.

> **Important**
>
> The term “freemium” is attributed to Jarid Lukin of Alacra, a provider of corporate information and workflow tools, who coined it in 2006.

## Pros and Cons of the Freemium Business Model

Freemium models are popular because they attract many users with free trials, making it easy to try new apps or services. Most people are willing to take a new app or service for a spin, giving the company an easy way to acquire potential users and study their usage behavior.

Companies benefit from free users by collecting data, showing ads, and boosting business numbers to improve the app. Especially for [startups](https://www.investopedia.com/terms/s/startup.asp) or companies that are trying to build a following for their product, the freemium model brings a large amount of brand awareness while not having to provide a lot of customer support.

However, a downside is that free users might never become paying customers. Ultimately, though some companies are perfectly happy with their free users (and have accounted for these free users to make up a majority of their forecasted [earnings](https://www.investopedia.com/terms/e/earnings.asp) through their ad consumption or time spent on the app), they may offer too many features on the free version that prevents users from ever upgrading to the premium version.

Users might get bored with the free version and face barriers or reluctance to upgrade to premium.

Pros

*   Companies can easily acquire potential users and collect their user information and data.
    
*   Companies can make revenue on ads and boost their own business numbers to enhance the application.
    
*   For startups, it provides a large amount of brand awareness without requiring a lot of customer support.
    

Cons

*   Free users never convert to paid users.
    
*   Too many features on the free version may prevent users from upgrading to a premium version.
    
*   Users may get tired of a free version that doesn’t offer additional bells and whistles.
    

## Strategies to Convert Free Users into Paying Customers

Converting a free user to a paid one is at the crux of many businesses’ dilemmas. Especially when a business’s longevity is hinging on converting users, there can be additional pressure to upsell their free users and make a larger [profit](https://www.investopedia.com/terms/p/profit.asp) margin off them.

Ultimately, for the freemium model to work and move people along to more expensive plans, companies must do a mix of the following:

*   Limit the features offered to free users, so that they will be enticed to upgrade for a better experience.
*   As free users increasingly use the product or service, offer increased storage, more flexibility or time allowed on the app, and customizations.
*   Offer additional personalized or customer service associated with an account.

## Real-World Examples of Successful Freemium Models

[Spotify](https://www.investopedia.com/articles/investing/120314/spotify-makes-internet-music-make-money.asp) is one of the best-known companies with a highly successful freemium model; the online music streaming service boasts an impressive 615 million users, and 239 million of those users are paid subscribers.

While users of the free version of Spotify are able to access all the same music as premium users, they have to listen to ads and have a limited number of “skips” on songs they want, among other drawbacks. For some, these limitations don’t pose a challenge. But for music aficionados who want more control and higher audio quality, paying for the premium version is well worth the price.

Another example of a company that uses the freemium business model is [Skype](https://www.investopedia.com/articles/investing/070915/how-skype-makes-money.asp), the firm that allows you to make video or voice calls over the internet. There’s no cost to set up a Skype account, the software can be downloaded for free, and there’s no charge for their basic service—calling from a computer (or a cellphone or tablet) to another computer. But for more advanced services, such as placing a call to a landline or a mobile phone, you do have to pay, albeit a small amount compared to conventional phone company charges.

A third employer of the freemium model—one of the earliest to do so—is [King](https://www.investopedia.com/how-activision-blizzard-makes-money-4799286#:~:text=10-,King,9), the developer of the highly popular internet game Candy Crush Saga. The addictive activity, available on the king.com site, on Facebook, and on apps, is free to play. It allows users an allotted number of lives within a certain time frame, but charges for extra lives if someone wants to play more during that window. Users also can pay for “boosters” or extra moves to help win the levels and advance through the game more easily.

## Is a Free Trial the Same As a Freemium?

Free trials and freemiums are slightly different. Free trials are typically time-bound and only allow a user to “test out” a few parts of a product or service. Meanwhile, freemium models allow their free users to access the full application indefinitely.

## Do Freemiums Increase the Number of Customers?

Freemium models lower new users’ barriers to entry, increasing a business’s number of total customers by allowing some to test out a limited version of the product without financial commitment.

## Which Companies Use Freemium?

Many companies use freemium models, including Spotify, [Dropbox](https://www.investopedia.com/articles/markets/082015/startup-analysis-how-much-dropbox-worth.asp), Hinge, [Slack](https://www.investopedia.com/articles/investing/012616/how-does-slack-work-and-make-money.asp), and [Asana](https://www.investopedia.com/asana-asan-ipo-what-you-need-to-know-5080476).

## Can Freemium Lead to a Loss of Income?

Theoretically, businesses with freemium models can lose money if their conversion rate to premium users is too low.

## The Bottom Line

Freemium is a type of business model that offers basic features of a product or service to users at no cost and charges a premium for supplemental or advanced features.  

> **Article Sources**
>
> 1.  Alacra, via Internet Archive Wayback Machine. “[The Freemium Business Model](https://web.archive.org/web/20210921200756/https://www.alacra.com/blog/the_freemium_bu/).”
>     
> 2.  U.S. Securities and Exchange Commission, via Spotify Investor Relations. “[Form 6-K for the Month of April 2024: Spotify Technology S.A.](https://s29.q4cdn.com/175625835/files/doc_financials/2024/q1/SPOT-2024-03-31-6-K-1.pdf),” Page 26 (Page 29 of PDF).
>     
> 3.  Skype. “[Make International Calls Around the World](https://www.skype.com/en/international-calls/).”
>     
> 4.  King. “[Candy Crush Saga](https://www.king.com/game/candycrush).”