Manager - Tech & High Growth UHY Hacker Young
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Freemium model spells investment success for Grammarly

With online spell-checker Grammarly hitting the venture capital jackpot, Robert Collings digs into the ‘freemium’ business model behind it and asks why it has succeeded where so many others have failed.

16th Oct 2019
Manager - Tech & High Growth UHY Hacker Young
Columnist
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Screenshot of Grammarly tool
Grammarly

Grammarly, the cross-platform grammar and spell checker, recently raised $90m to help grow its workforce as it further develops the capabilities of the product. Grammarly is one of the few companies that successfully operates a business model known as the ‘freemium’ model.

The freemium business model works by giving away a free version of your product for people to use indefinitely, with an optional upgrade to a premium tier. The free version on its own isn’t enough to create a sustainable business, hence why the premium tier is a very important part of this model.

The premium version of the product usually contains more enhanced features which are attractive enough to tempt users to part with their money.

Grammarly does this well, as some 20 million global users can testify. You can download the free product and it’ll check for basic spelling and grammar issues. It’s generally smarter than the spell checker that comes with word processing software, hence why people decide to download it, but it still only offers basic features.

Every now and then, it’ll prompt you with some more advanced errors it has found. However, in order to know what they are, it asks you to upgrade to the premium package which includes tools such as plagiarism checks, alternative vocabulary, readability detection and tone suggestions.

This freemium business model is already very popular, especially with software-based companies, but it’s especially difficult to make work.

Balancing the features

The free product is essentially a marketing tool. It needs to be good enough for a user to be satisfied with, otherwise they’re unlikely to upgrade, but restrictive enough to give people a reason to upgrade.

The free product needs to be useful enough for people to start to rely on so it becomes an integral tool for their life. Once they’re reliant on it, they’re much more likely to see the value in upgrading to premium, assuming the premium option is carefully packaged.

It should be noted that a free trial isn’t the same as a freemium business model. With a free trial, there becomes a crunch point where you either win or lose the customer. With a freemium model, you could retain a user for years but make no money from them.

The cost of being free

Operating a free product always costs money, no matter which way it’s framed. There will always be people who exclusively use the free product and never upgrade. It’s not necessarily a bad thing, but the cost needs to be covered somehow.

The conversion rate from free to premium is a key factor in setting a price for the premium package that covers the cost of the free product. If you know the number of free users you need, on average, until one converts, then you can start to work out the minimum value that the premium user needs to generate to cover the cost of the free user.

Watching the upfront costs

It’s easy to look at Grammarly, Spotify and Dropbox and think the freemium business model is a great model to follow. It is, but it takes a lot of work to get it off the ground. In the early days, a good free product needs to be developed at a time when there is no revenue coming in. It can take a lot of upfront investment which needs to be funded somehow.

This is where pre-seed or seed investment comes into play – it can be used to fund the initial costs of getting a working product up to the point where revenue can be generated.

Anchoring on free

The problem with the freemium model is that people don’t usually value things they get for free, and they anchor on the free price point which makes it hard to convert them into paying customers. They become a continuous cost for the company which can be difficult to recover if there aren’t enough paying premium users.

Getting a good premium product is vital to this process. If people aren’t interested in upgrading, there is no long-term business. Spotify does this well – their free product offers a huge collection of songs you can listen to at no monetary cost, but the features are restricted and there are adverts between songs (with one prompting you to upgrade every now and then). The premium plan removes the adverts and restrictions and makes the experience a lot smoother.

Ultimately, making the freemium business model work is the result of continuous trial and error. If it works, it can work really well, but if it doesn’t, it can bring a company to its knees just as quickly.

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