Monetization Law Number #11

Freemium rocks; but not for revenue.

freemium is not a monetization strategy, but it is a powerful marketing customer acquisition & growth strategy.

Freemium’s role in monetization is crucial but often misunderstood. 

This chapter is about how freemium should be viewed in conjunction with growth and monetization.

The Rule provides a quick monetization heuristic i.e. a rule of thumb in operation, a kind of —do this— and you’ll be 80% of the way there.

Rationale explains why the rule works with deeper insights and its use in practice.

Rabbit hole provides more in-depth resources and recommendations for anyone wanting to spend more hours researching each topic.

⓵ Rule 📖

⓶ Rationale 🧠

⓷ Rabbit Hole 🐇

⓵ Rule: Monetization Law #11 📖

Don’t think of freemium as a monetization strategy. Instead, think of it as a growth strategy, the customers from which, can eventually be monetized.

⓶ Rationale: Monetization Law #11 🧠

Freemium; What it is and, What it ain’t

The use of freemium has no first-order impact on monetization so cannot be called a monetization strategy.

However, it has been proven to have second and third-order impacts of customer acquisition costs [CAC], retention, and overall satisfaction of customers that sign up, all of which lead to higher customer lifetime value [CLTV] and hence better unit economic monetization. 

⓷ Rabbit Hole: Monetization Law #11 🐇

Marginal Costs 

While the technology industry did not originate ‘freemium’ as a concept, it has taken root and expanded immeasurably in the software era as a de-facto consideration for all software firms.

Software businesses are often lauded as a substantial upfront investment, zero marginal cost businesses.

Not true. Whereas the minimal cost of supplying the product or service to a customer is close to zero as the customer numbers scale, the cost of acquiring these customers takes on the role of marginal costs.

Marginal costs are not dead, they’ve just morphed from costs of production to costs of customer acquisition.

Unit Economics

These are the familiar terms that software companies obsess about;

average revenue per user/average customer value (arpu/acv) - these are just two of the many variants that denote the amount of revenue generated per user for a chosen period.

This is the division of total revenue by the total number of users.

customer lifetime value/lifetime value (cltv/ltv) - these indicate the total amount of money a customer will pay you before they leave or cancel.

customer acquisition costs (cac) - as highlighted above, represent the new marginal costs of software businesses.

The cost of acquiring each customer being a combination of marketing, sales and other ancillary costs incurred in securing new customers

positive unit economics (pu-econ) - an overview of unit economics would be average lifetime customer value less average customer acquisition costs.

Free Trial v’s Freemium

Another debating point has been around free trial v’s freemium.

While offering the same utility during the assigned period, they have a significantly different impact on acquisition retention and overall customer satisfaction.

In part, this may be due to the behavioural economics concept - zero price effect - that suggest traditional cost-benefit models can’t fully explain the psychological positives of unbounded ‘free.’

🐇 Additional Research 🐇

Dan Ariely is a grand-master in the behavioural economics field, so his paper on the zero price effect is a gem for deep–deep dive into the psychology of freemium.

An extract from his work is below:
”When faced with a choice of selecting one of several available products (or possibly buying nothing), according to standard theoretical perspectives, people will choose the option with the highest cost-benefit difference.

However, we propose that decisions about free (zero price) products differ, in that people do not simply subtract costs from benefits and perceive the benefits associated with free products as higher”

– in essence, he’s saying that a product that costs 1p and yields 15p value is not the same as a product that cost zero and yields 14p value. Both yield a net value of 14p [15-1] vs [14-0] yet psychologically, the zero-cost option will seem better and therefore convert higher.