Professors Vineet Kumar, Clarence Lee and Sunil Gupta have been working on understanding the economic dynamics of freemium pricing by looking at customer behavior; their co-authored paper and an article by Kumar in the Harvard Business Review shed light on how companies can maximize profit, get upgrades and encourage referrals.
In a recent interview, Kumar says he has found “patterns,” in the data, although he is reluctant to say they can draw actual conclusions. “The shape of the pattern may change a little based on the setting,” says Kumar. “But what I tried to draw is generalizable and applies to most freemium companies.”
As companies make decisions about how their freemium products are designed and priced, they should consider the following:
- When your product is not attracting enough new users, it means “your free offers are not compelling enough and you need to provide more or better features free.”
- When your product generates lots of sign-ups, but few decide to pay, it means “your free offerings are too rich and it’s time to cut back.”
- When customers don’t understand why they should upgrade, it’s going to be tougher to move people to the paid product. What to do? Kumar gives the example of LinkedIn LNKD -0.57%, where he says “the advantages of upgrading are murkier” than they should be. He believes the company could monetize more users if this was corrected.
- When your conversion rate is too high, you may not be attracting enough trials because “your free product is not very compelling, which will limit your potential acquisitions.”
- Early adapters are less price sensitive than later adapters. Rates of conversion from free to paid users vary over the life cycle of the product, with early adapters to the product probably converting at a much higher rate than later adapters.
- Companies will notice the pattern of a declining conversion rate — initially. When you have “an introduction of new features, the conversion rate starts picking up.” Kumar gives an example using Hulu. They probably see conversion rates increasing when they’ve “introduced a new show, or new episodes of a show that are in the premium version, not in the free. It’s not surprising when you have more of a value proposition from a consumer’s perspective it increases your upgrade probability.”
- Referral bonus programs – where current customers are rewarded for referring new customers– are effective, but if they are too generous, the program won’t encourage multiple referrals.