Freemium: A business model startups can’t ignore

The word “freemium” may be less than four years old, but the business model it describes – offering basic service access for free and then charging for advanced features – has been around for decades.

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Jason Katz is Founder and CEO of Paltalk, an interactive video community. This story first appeared on VentureBeat.

Pandora: Since its launch in 2005, the company known for giving away “free” music to users has expanded to 20 million unique visitors. In 2009, it brought in $50 million in revenue – all the while as a freemium business.

Drop.io: Founded in 2007, Drop.io, a real-time online collaboration and file-sharing service, offers an upgrade to 25 GB of storage for $10 a year. Through the freemium model, Drop.io saw a 500 percent increase in revenue in 2009.

For freemium companies, growth comes not only from new customers, but more often from existing ones. If clients are happy with the free portion of a service, they’re substantially more likely to pay a small fee to get additional services. More importantly, they’re the ones who evangelize your business on social networks and blogs, as well as tout it to friends and family. Furthermore, the customers who trust the product so much they are willing to pay are even more inclined to refer their friends and family.

Converting free users is a tricky dance, but the best way to do it is to make premium customers feel especially important. This can include sneak peeks at beta versions and first crack at new products and features from your company. (Ironically, this can bring user referrals full circle.) It’s also a good idea to give free users a taste of what’s behind the pay wall.

Though it may seem counterintuitive to give a product away for free in hopes that a customer would pay for an upgrade, the success of the companies above (not to mention the overwhelming success of social network game companies like Zynga and Playdom) speaks volumes.

There isn’t a universal business model that fits every company, of course, but as you explore options, don’t obsess over the “free” part of freemium and rule it out automatically.  With a high conversion rate and its ability to create an incredibly loyal audience, freemium has become a cornerstone of many successful startups.

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