Changing Your Business Model Series — The Freemium to The Usage-Base Business Model

In our last newsletter, we covered the Xaas (or the Anything-as-a-Service) Business Model and the various types that have come from the mass adoption of Xaas in the last several years.

Today, we’re looking at the Freemium, Advertising, Transactional, and the Usage-Base Business Models.

Here’s the list of business model categories we provided at the start of this series that you can reference as you evaluate the models that you might consider changing your business to —

• B2B (Business-to-Business) — where companies sell their solution to other businesses or organizations.

• B2C (Business to Consumer) — companies that sell to individual end consumers and may use retailers or wholesalers to sell to their customers.

• DTC (Direct to Consumer) — companies that sell directly to individual, end consumers.

• B2B2C (Business to Business to Consumer) — companies that sell their solution to other businesses to help those other businesses sell to consumers.

• C2C (Consumer to Consumer) — companies facilitate consumers selling to other consumers.

• B2C2B (Business to Consumer to Business) — companies who sell to the employees of other businesses who then advocate for their employer to buy the original company’s solution.

• B2G (Business to Government, also Business to Public Administration or Business to Public Sector) — companies sell their solution to government entities.

• C2G (Consumer to Government) — companies facilitate consumers directly interacting with a government entity.

Today’s Business Models — Freemium, Advertising, Transactional, & Usage-Based

The Freemium Business Model includes businesses that provide a free, basic version of their product/service for customers to try and paid options of the product/service when customers decide they want the more advanced features that come with them. Providing users with the opportunity to try the product/service for free before making a commitment to pay for a particular offer allows users to assess whether a product/service fits their needs, as well as the tier of product/service that is best for their use case (if tiers are offered).This model type can fall under the B2B, B2C, DTC, B2B2C, B2C2B, C2C, B2G, & C2G categories.

The Advertising Business Model includes businesses that give a product/service away for free while ad space is sold to advertisers who want access to the users of that product/service. An Advertising model selling to other businesses, organizations, or individuals can fall under the B2B, B2C, B2B2C, B2C2B, C2C, B2G, and C2G business model categories.

The Transactional Business Model (also called a Transaction Fee Business Model) includes businesses that provide a product, service, tool, or technology to customers and collect a % of each sale transaction of that product, service, tool, or technology. This business model type can fall under the B2B, B2C, DTC, B2B2C, B2C2B, C2C, B2G, and C2G categories.

The Usage-Based Business Model includes businesses that provide a product or service and only charge customers for the amount of the product/service that they use. This model can fall under the B2B, B2C, DTC, B2B2C, B2C2B, and B2G categories. 

Mapping The Model: Freemium Business Model

If you mapped out the Freemium business model, it could look something like the following —

The Freemium Business Model

Let’s look into some examples.

Freemium Model Example #1

Spotify is a digital music and podcast streaming service where users can get access to millions of songs and podcast episodes on their personal devices for a recurring monthly fee. Spotify has several tiers of its service including — Free, Premium Individual ($0 for 1 month, then $11.99/mo), Premium Students ($0 for 1 month, then $5.99/mo), Premium Duo ($16.99/mo), Premium Family ($19.99/mo.), and Audio Book Access ($9.99/mo).

Spotify uses a Freemium tier to attract users and allow them to give the streaming service a try before deciding on a plan they’d like to purchase. The tradeoff for Users trying the Free plan is that it does not include Ad-Free listening, downloading of songs to listen to offline, the ability to play songs in any order, access to high quality audio, listening with friends in real-time, or the ability to organize their listening queue. In order to have Ad-Free Listening and those additional value-adding features, users will need to purchase one of the Premium plans.

Freemium Model Example #2

Calendly is a scheduling automation platform that provides its scheduling solution to everyone, from individuals and small businesses to Fortune 100 companies, for a recurring fee. Calendly has a handful of subscription plans including — Free, Standard ($12/seat/mo), Teams ($20/seat/mo), and Enterprise (Starting at $15,000/yr).

In the Free subscription, Calendly allows users to schedule 1 event type, provides 1 calendar connection or integration, an unlimited amount of meetings that can be booked, one-on-one events, meeting polls, one-of meetings, customized booking links, the ability to view contact profiles and scheduling activity, and the mobile app and browser extension. In order to get up to 6 calendar connections — as well as additional features like the ability to view analytics and insights about your scheduled meetings, connect payments, access over 700 app integrations, share availability directly from contact profiles, and the ability to book meetings on behalf of others with event type permissions — users will need to purchase a Standard, Teams, or Enterprise plan.

Freemium Model Example #3

AutoCrit is an online manuscript editing tool that gives fiction and non-fiction writers the power to quickly and effectively self-edit their work anytime, anywhere. Their online manuscript-editing-tool-as-a-service comes with 3 subscription plans — Free Forever, AutoCrit Pro Monthly ($30/mo), and AutoCrit Pro Annual ($15/mo billed annually).

In its Free Forever plan, AutoCrit provides users with a fully-featured writing platform with no word limits where users can write and edit as much as they’d like, digital notecards and cards displayed alongside your writing for planning and research, select interactive editing tools including Adverbs, Word Choice, and Readability, and proven editing guidance based on extensive research into real-world publishing standards.

To have access to features such as summary reports on writing with AutoCrit Score and Editing Recommendations, direct comparison scores with over 100+ selected authors/genres, an advanced voice reader, and private member community with exclusive online workshops, events, and Q&A’s with award-winning authors, users would need to purchase the AutoCrit Pro plan. And if users wanted everything in the Free and Pro plan — plus 6 months free — they’d need to purchase the AutoCrit Pro Annual subscription.

Pros of Using the Freemium Business Model:

• There’s no initial barrier to entry for customers. That lack of friction decreases a customer’s resistance to or suspicion of a product or service and whether it’s right for them. As mentioned earlier, this is attractive to potential customers because they get a chance to try the product/service (decreasing the risk they might feel about buying it) before making a monetary commitment. “Try-Before-You-Buy” helps them get the experiential and technical information they need to support their decision-making.

• It makes it easier to grow a larger customer base. The lack of a barrier to entry for customers is a very attractive feature many people find valuable to help them find the product/services they need. It also facilitates the increase of word-of-mouth referrals to other potential customers because users who try the Free version and decide to purchase can also promote your product/service to other potential customers with similar pain points who would value giving the Free version a try to see for themselves if it is the right solution for them. Making your product/service easier to access can help increase your brand awareness and people’s recognition of your brand.

• It can be a revenue multiplier. If a company decides to use a subscription revenue model instead of one-time buys — and then partners that with a Freemium business model — it has the potential to increase the revenue the company makes from the end customers’ continual use of the subscription plan versus the company only receiving one-time purchases from customers, or additional one-time purchases every so often for potential updates in the service.

Con of Using the Freemium Business Model:

• It can be costly to support a growing number of Freemium customers. Also, if these Freemium users require support in any way, your company will have to allocate resources within your business for value and revenue creating activities to address their support needs. So, it’s just really important to understand what of your product or service will be provided for free in your offering, how that will affect your costs, and how your team will balance what’s needed for Freemium customers versus what’s needed for your paying customers.

Up next is…

Mapping The Model: Advertising Business Model

If you mapped out the Advertising business model, it could look something like the following —

The Advertising Business Model

Here are a couple examples of this model.

Advertising Model Example #1

YouTube is an online video-sharing and social media platform with a mission to give everyone a voice and show them the world. YouTube provides a Free user experience where anyone can post or watch unlimited amounts of shared videos anywhere and at any time. This experience is largely supported by the Advertising model they use that gives advertisers wanting access to certain demographics the opportunity to connect with them and increase awareness of their brand through ad placements played during the videos users watch. In addition to having a YouTube Premium subscription plan (that allows users to watch YouTube ad-free for a recurring fee) and YouTube TV (its live TV streaming service with ads), YouTube’s advertising model helps them create different types of viewing experiences that all help it deliver a value-filled experience that YouTube users desire to have and sustainable revenue through multiple revenue streams from their Advertiser customers.

Advertising Model Example #2

The Saturday Solopreneur is an online newsletter written by Justin Welsh that provides exclusive tips, strategies, and resources to launch, grow, and monetize a one-person internet business. Justin provides a place for other businesses who want to connect with his subscribers to promote their business, product, or service at the start of each Saturday newsletter.

Pros of Using the Advertising Business Model:

• There’s no initial barrier to entry for customers using your free product or service. Similar to the Freemium Business Model, that lack of friction to the customers using your free product/service decreases the customer’s resistance to adopting your solution into their lives. Their experience with it can become a seamless and ongoing one that creates the great ad space opportunities you could offer to your Advertiser customers. It becomes a more frictionless experience for your Advertisers because they get immediate access to your large population of free product/service users.

• It makes it easier to grow a larger customer base. Since the lack of a barrier to entry to both groups of customers is an attractive feature, it can increase people’s awareness of your free product/service, as well as the ad space opportunities you provide. Making your product/service fully and immediately accessible can help increase your brand awareness in the markets you serve and people’s recognition of your brand for both users of your free product/service and Advertisers who are paying for access to them.

• It can create more consistent revenue for companies. Selling ad space to advertisers can create a more consistent stream of revenue because Advertisers of all kinds put a high value on the attention your free product/service receives from its users. Especially, if you have a very large diverse consumer base engaging with your product/service where your Advertising customers can have the ongoing opportunity to get in front of their target markets and potentially convert them into customers. Advertisers desire to capture even greater portions of their target market’s attention to give them a competitive edge over their competitors.

• There’s the advantage of multiple revenue models. With an advertising business model, you could sell end consumer attention via an Ad Placement revenue model, CPC (Cost Per Click), CPM (Cost Per Impression), or CPA (Cost Per Acquisition) revenue model. Ads can be placed in various media like TV, Social Media, Websites, digital marketplaces, mobile apps, magazines, podcasts, and newsletters. So if your free product to consumers is a podcast — but you also have a website people can visit, social media channels, and a newsletter — you have multiple platforms you can sell Ad space of different kinds on to allow Advertisers to connect with your audience on an ongoing basis.

• Your model will be data empowered. By capturing data on the end users of your product/service and your Advertiser customers, you will gain a deeper understanding into their behaviors and what they value. This will help you make their customer experience better over time.

Cons of Using the Advertising Business Model:

• Allowing too many ads will damage your audience’s experience. It may feel like the ads are getting in the way of users’ experience with the free product/service, so their commitment to continue using the product/service may deteriorate. Too many ads can feel like harassment to end consumers and not like the experience you guaranteed them when you initially converted them into customers. Also, ads that are not high quality, are irrelevant, or feel intrusive to the end consumer can damage your business’s reputation.

• Your company needs to have a large and ever-growing audience. Because there are so many platforms to advertise on now, the competition has affected rates for selling Ad space. So, you need to maintain and grow the size of your available audience (since Ad Revenue Per User can be low) and cater to the needs of your Advertisers. If there is an economic downturn or inflection point in the market or advertising industry, your company will be affected by changes on the end consumer side as well as that of your Advertiser customers.

• Privacy & Ethics have to be balanced out. Capturing user behavioral information can create concerns around whether you’re company is respecting your users’ privacy or is ethically using that information. If users feel what you are doing is too intrusive, your business and brand reputation will suffer. Many consumers are now using ad-blockers to reduce the amount of ads they are shown that are damaging their experience with products and services. Ad-blockers may get in the way of revenue in one regard but may help your audience feel more respected. You have to really balance out and consider what you do when it comes to data capture and respecting people’s privacy so you don’t upset your users, lose market share, and with the loss of market share lose advertising customers.

  Up next is…

Mapping The Model: Transactional Business Model

If you mapped out the Transactional Business Model, it could look something like the following —

The Transactional Business Model

Transactional Model Example #1

Stripe is a financial services and Saas (Software-as-a-service) company that powers online and in-person payment processing and financial solutions for businesses of all sizes. Businesses can accept credit cards, debit cards, and other popular payment methods from around the world using Stripe. By using the Transactional Business Model, Stripe starts the fees it charges for its payment processing solutions at 2.9% + $0.30 per successful card or wallet transaction. Other payment methods come with their own pricing.

Transactional Model Example #2

Square is the largest business technology platform serving all kinds of businesses. It started as a payment processor in 2009 with its invention of the mobile card reader for small businesses who could not previously accept credit cards as a payment method. Now, its operating system and tools allow businesses to not only sell anywhere, but also work more efficiently, manage inventory, communicate with customers, book appointments, and order online. They help everyone from mom-&-pop businesses to global chains with the solutions they have created to help power their customers’ businesses.

Customers can start for Free (plus processing fees), choose a monthly subscription plan with features packaged based on the type of business you are (whether Retail, Restaurant, or Appointment-Based), or mix and match services that fit their business case the best (like Payroll, Email Marketing, or Loyalty rewards programs for additional recurring fees). They can also purchase the hardware solutions Square has created to provide businesses flexibility in how they want to receive payments.

Pros of Using the Transaction Fee Business Model:

• It can create sustainable revenue streams from the start. Revenues are made from fees per transaction so customers exchanging products/services with each other don’t have to worry so much about upfront costs that have to be paid. They can begin transacting freely from the start with the possibility of repeat purchases occurring which can benefit your business further as they generate the revenue your company needs to sustain itself and grow.

• Customer loyalty increases. Buyers’ and sellers' enjoyment of the experience around diverse transactions and repeat purchases can lead to an increase in your business’s customer retention. If your fees are acceptable to both buyers and sellers, they won’t be a point of friction but rather a enabler of positive experiences that help both parties get what they need, when they need it, in the way they want.

• The Transaction Fee Model is scalable with a company’s customers. So, the customers of a customer using this model don’t have to worry about the logistics and costs that come into play when the company they’re buying from grows larger and has a greater volume of transactions. And the company doesn’t have to worry about what comes with the logistics of that on their end because their business and revenue model aren’t based on how many products they sell, or features they’ve additionally developed to sell, or the amount and scope of service projects they can sell to accommodate customer growth. The company just makes sure the technology,platform, or tool they already have in place can handle the volume increase in transactions seamlessly.

Cons of Using the Transactional Fee Business Model:

• The company has to get the products/services that would be exchanged. The company using a transactional business model has to persuade companies that sell particular products or services to use their platform/product/service.

• Acquiring customers can be costly. The company would have to acquire consumers and businesses or persuade businesses who already have a customer base to use their product/service to help them transact. Promoting themselves to both customers so they know that the company’s way of processing payments exists can require a large ongoing investment.

• Companies need to be mindful of the regulations for their industry. The legalities around this must be attended to in order to make sure companies can run legally and successfully while using a transactional fee business model. Addressing this could come with some hefty costs.

• Risk of fraud. Since the focus is on transactions (or processing payments), resources need to be invested in mitigating the risk of fraud and combatting it. If an issue arises where transactions are disputed, the company using the transactional fee model needs to have a system in place to deal with those scenarios that could affect its brand and bottom line.

Mapping The Model: Usage-Based Business Model

If you mapped out the Usage-Based Business Model, it could look something like the following —

The Usage-Based Business Model

Usage-Based Model Example #1

Databricks is a data intelligence platform that simplifies unifying all of a user’s data, analytics, and AI workloads across all their preferred clouds. They say Databricks brings AI to your data to help you bring AI to the world. Their pricing varies depending on the cloud service a customer uses. Databricks uses DBUs (or Databrick Units) to measure how much processing power is being consumed by a particular customer’s workload on its platform. The more data processing power is used (DBUs) the higher the price will be for the user. They also offer contracts for certain usage levels that can qualify customers for greater discounts and benefits as their usage levels increase.

Usage-Based Model Example #2

Stytch is a Saas company that built an all-in-one platform for modern auth (authentication methods) — a full site of passwordless solutions and password-based auth. It’s a better way for developers to build simple and scalable auth so they can focus on building differentiated products. By using a Usage-Based model, they provide Authentication to B2B Saas App customers and Consumer App customers with a pay-as-you-go option calculated based on the user’s MAUs (Monthly Active Users) processed by Stytch’s platform. They also provide Fraud & Risk Prevention in a similar pay-as-you-go method based on the number of Fingerprints Stytch processes on behalf of the user.

Pros of Using the Usage-Based Business Model:

• The customer barrier to entry is low. They don’t have to commit so much to a particular price upfront to use the product/service they’re considering. The risk of them paying a lot more for what they don’t need is removed. They have the flexibility to start wherever they’d like load-wise and use what they need of the product/service when they need it based on where they are as they grow. Some companies also use an Overage Revenue Model to allow for a usage-based model that is part pay-as-you-go and part subscription. A customer would pay a certain price from month to month (or annually) for X units of a service. If the customer goes over that amount of units they are charged an additional fee/fees for them. Being scalable in a way that is flexible and in alignment with the customer is of huge value to the customers of a company using a Usage-Based Model.

• This model allows companies to capture data around the details of how people truly use their product/service. This leads to companies being able to improve their product further into something that’s even more valuable to their customers.

Cons of Using the Usage-Based Business Model:

• Customers may rack up a bill they weren’t expecting to have. Their usage of the product/service and potential variable costs that come with that might cause their end bill to be much higher than expected. So, you’ll want to work to mitigate the risk of that so a negative experience like that doesn’t impact your customer experience.

• More administrative work is required. Customers pay for the service at the end of their usage for a given period. Assessing and processing that payment requires more work (than just accepting a flat amount at the start of the service like in a subscription) and happens on the back end.

Key Notes About The Freemium, Advertising, Transactional, Usage-Based Models

The models we discussed today had a running theme within them — lowering the barrier to entry for customers to access a company’s product/service. Making their route to using and deciding to commit to a purchase in alignment with them frictionless.

A Transactional Business Model might be used more by fintech companies or marketplaces with their own payment processing capabilities. But are there aspects of any of these models that might help you address the challenges you're having with your current model and possible changes you’re experiencing in your industry?

These models also use data to provide the value they do to their end customers and to improve upon it. Would changing to one of these business models (to take advantage of their revenue models and user data capture) help you create a better, more predictable experience for your target markets and your business?

Next Steps

We will continue to look at examples of business model categories and the types we covered in our first newsletter over the next several newsletters to help you with your thought process around which business model may be a good fit for your business case.

If you’d like LUSID to help you work through your business model change and strategize around which business model is most appropriate for your company vision, you can set up a free call with us here. We’re excited to learn more about you and your company!

Feel free to reach out with any questions, comments, or additional thoughts you may have at [email protected]. We love connecting with visionary Founders, CEOs, and Leadership teams working on impactful ventures.

Let’s Make Your Vision Your Reality.    

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