Strategic Considerations for the Free Trial/Freemium Model in SaaS & Internet Businesses

The free trial/freemium model has proved a successful customer acquisition strategy for many SaaS & internet companies, though such is not the case for all. Whether (and how) you as a founder or executive choose to execute the free trial/freemium model depends on the specifics of your business model and sales pipeline.

Having represented 75+ SaaS companies for M&A and capital raise transactions over the past few years, here are our thoughts on what founders and executives should take into account when considering offering a free trial or freemium product.

Note: Freemium vs. Free Trial

To avoid any confusion, here is how we define free trials vs. freemium products. The main difference is in how the product is limited: free trials are limited by time and freemium products are limited by feature set (i.e. unlimited access to a limited feature set).

Free Trials and Freemium as a Customer Acquisition Strategy

The main goal of offering a free product is aggressive customer acquisition. The logic is as follows:

1. Remove the purchase barrier/cost that keeps prospective buyers from realizing value from the product.
2. Limit access via a trial period or a limited feature set so that users upgrade once they recognize the value of the product.

As evidenced by massive companies who have employed this strategy to great success (Slack, Dropbox, Atlassian, and Zoom as some examples), the free trial/freemium model can work exceptionally well under the right conditions.

Whether you operate on a B2B or B2C model will have a strong bearing on which (if any) of the free models you employ, depending primarily on three factors:

• Product implementation & maintenance costs
• Self-service product design and usability
• Marketing and sales maturity in your organization

SaaS and internet founders/executives should consider whether their company is well positioned in each of the above areas before moving forward with the free trial/freemium model. You’ll find that your business model (B2B or B2C) will be strongly connected to all three factors.

Product implementation & maintenance costs

Implementation & maintenance costs are any costs incurred by a SaaS provider to service a new user. These costs include:

• The cost of labor to onboard new customers
• Data hosting costs
• Potential integration costs such as an API
• Other servicing costs, like support or training costs

For free trial/freemium users costs, implementation & maintenance costs are not offset by any revenue and therefore don’t play into the traditional profit equation.

Because the free trial/freemium model is by nature a customer acquisition strategy, to evaluate the viability of a free trial or freemium product, founders and executives should include implementation & maintenance cost as part of customer acquisition cost (CAC) and then determine the effects of these costs on their LTV:CAC ratio.

In a nutshell, here’s the question founders/executives need to answer to determine if the free trial/freemium model is appropriate:

Does the average cost to acquire, onboard, and service a free trial/freemium user exceed the average revenue generated per user (based on the LTV and close rate of free trial/freemium users)?

For example, consider a SaaS company whose average marketing cost to acquire a user equals $5K, with implementation costs of another $5K for a $10K total CAC. For this same example company, say the LTV of a paying user is $100K.

For this company’s free trial/freemium strategy to work, the company would need to convert 10% of their free-tier users just to break even (a 1:1 LTV:CAC ratio). In order to reach the industry standard 3:1 benchmark, this same company would need to convert 30% of free trial users to paying customers.

Before committing to a free option, founders and management should do the math and make the judgment call of whether or not such a strategy is appropriate.

Self-service product design and usability

Related to implementation costs, for a company to successfully use the free trial/freemium model, their product has to be intuitive enough that users can get up and running with limited or no assistance from a member of your organization. Having a self-service product minimizes support costs and makes it possible for the company to build a large user base to convert from.

To use Slack as an example, the sign-up is completely automated and the product is intuitive. Because of the self-service product design, Slack’s implementation & maintenance costs are pennies on the dollar spent on data hosting costs.

Before implementing the free trial/freemium model, evaluate how well users can serve their own needs without a high level of costly setup or support.

Marketing and sales maturity in your organization

An aspect of the free trial/freemium model that is often overlooked is whether or not the organization is prepared to handle the influx of new "customers" with varying capacities to purchase.

When you offer a free trial/freemium option, the effect will be to dilute the quality of your prospect pool with free users who are not and will never be qualified to buy. If your sales & marketing processes are not sophisticated enough to filter out unqualified buyers, you will decrease the efficiency of your sales team.

Aspects of your sales & marketing organizations that you should take into account before employing the free trial/freemium model include:

• Marketing automation: How mature are your marketing programs for nurturing and converting users to paying/premium users?
• Sales Org: Does the company have a few highly compensated enterprise sales people or a larger volume of inside sales reps?
• Lead scoring: Can you successfully identify qualified buyers?
• Sales enablement: Do you have the right materials and technologies for upselling customers into a revenue-generating tier?

The Free Trial/Freemium Model in B2B vs. B2C

As mentioned, your approach to the free trial/freemium model is strongly affected by your business category, whether B2B or B2C.

Free Trials/Freemium in B2B

For B2B SaaS companies providing robust, highly customizable software to enterprises (like ERP), the implementation costs tend to be high, resulting in an expensive onboarding burden when employing the free trial/freemium model. As a result, free trials/freemium products often don’t make sense for highly customized enterprise SaaS.

Such is especially the case for the freemium model in enterprise SaaS, as limiting the feature set on a highly customizable piece of software curbs the value users need to receive in order to justify purchasing the premium product, resulting in a lower conversion rate. Inversely, expanding the freemium product’s feature set too much can also inhibit conversion because the free tier meets the user’s basic needs.

Adding to the challenge of offering a free trial/freemium product in B2B, enterprise products are often intentionally complex to meet a wide array of customer use cases and work functions. This complexity makes creating a fully self-service user experience or a straightforward marketing/sales process challenging.

In situations where the B2B SaaS provider wants to reduce friction but a free trial is not viable due to high implementation, sales, or training costs, one solution is to offer a paid trial. Doing so provides buyers with a proof of concept while enabling the SaaS provider to break even on the cost to offer the trial.

Free Trials/Freemium in B2C

For B2C SaaS & internet companies (and in some cases B2B SaaS companies serving SMB), the free trial/freemium model is more likely to work, since:

• Implementation & maintenance costs tend to be lower
• The budget of potential customers is likely fixed and tight, making price an important competitive differentiator
• B2C companies usually require a huge user base to be profitable on a tight price point, making a free product attractive for aggressive customer acquisition

B2C companies tend to succeed best with the freemium model as compared to the free trial model. Under the freemium model, B2C SaaS & internet providers offer a near complete feature set but are able to monetize customers at different levels of value. (Consider Spotify, which monetizes freemium users via advertising and premium users via subscriptions.)

Should You Offer a Free Trial/Freemium Product?

While B2B and B2C companies will approach this strategy differently, the general principles are the same:

• Can you justify implementation & maintenance costs as part of your CAC when you take into account conversion rates and LTV?
• Can users service themselves or will you incur significant costs offering setup and support?
• Is your organization prepared to handle an influx of leads, many of which will be unqualified to purchase?

If your company meets the necessary criteria, then the free trial/freemium model could be superior to other customer acquisition strategies and a good move for your company.