Designing freemium with usage limitation: When is it a viable strategy?

Abstract

• This study models the usage-limiting variants of freemium operations. • Two freemium strategies emerge from analyzing users’ response to usage insufficiency. • A full coverage strategy results in a high free-usage limit and price but low demand. • A partial coverage strategy results in low free-usage limit and price but high demand. • Market parameters determining the optimal strategy are identified. The freemium business model has seen wide adoptions to acquire new users quickly and inexpensively in recent decades. Its effectiveness lies with the promise of a particular form of free usage that is available indefinitely. This paper focuses on the freemium model that limits usage for free users and allows unlimited usage for paying users. We formulate a two-stage model that incorporates the responses of users who are heterogeneous in both their total usage and corresponding valuations. Two freemium strategies with distinct market-coverage approaches emerge, where the first strategy aggressively attempts to acquire the whole market while the second strategy selectively targets heavy users. When benchmarked against a conventional subscription strategy, we find that the dominance of a freemium strategy relies on users’ intolerance towards insufficient usage and the proportion of high-valuation users. High users’ intolerance to insufficient usage compels the firm to increase the free usage limit. The proportion of high valuation users determines the dominance between a selective freemium strategy and a conventional subscription strategy. We also find that a firm should expect a lower conversion rate when implementing an aggressive freemium strategy. Finally, we extend our study to consider the implications of new users’ forward-looking behavior.