This approach is known as the "freemium" model -- and it is gaining traction in the tech world. In fact, one of the most successful practitioners is social game-maker Zynga (Nasdaq:ZNGA). The company does not charge to play its games, but it sells in-game content like farm equipment or specialized weapons. Last year, the business produced more than $1 billion in revenues.
So in light of this, should your company use the freemium model as well? To help answer this question, I recently interviewed YouSendIt CEO Ivan Koon. His company has a free cloud-based collaboration tool that currently has more than 28 million users -- of which 550,000 are paying customers.
Here’s his advice:
Real Value: The free offering must solve real problems for customers. If not, then it is really a free trial. "You need to treat free users as you would paying customers,” Koon said.
Marketing: Giving away a product essentially is a replacement for traditional marketing. Ivan said it easily would have cost YouSendIt more than $100 million to get its current user base. This would have been from aggressive spending on search engine marketing (SEM) and other paid channels.
“The cost of getting a user under the freemium model should be near zero,” Koon said. “It also needs to be viral. This means a free user should lead to even more users and eventually paid users.”
Conversion: The industry standard for free-to-paid is about 2%. This means you generally will need millions of users to get any critical mass with the business model.
YouSendIt has a conversion rate of 7.3%. Then again, this has taken a lot of work, such as experimentation, engagement with the user base and ongoing innovation.
Word of Mouth: This is key for success. To this end, YouSendIt uses the Net Promoter Score (NPS) to measure the enthusiasm for its offering. This asks users a simple question: Would you refer the service to your friends and colleagues?
A good NPS is over 40%. YouSendIt is around 68% to 69%, which is within the range of companies like Amazon.com (Nasdaq:AMZN), eBay (Nasdaq:EBAY) and Apple (Nasdaq:AAPL).
“To make the freemium model work, you need to have highly satisfied users and customers," Koon said. "And this must be a constant focus.”
Tom Taulli runs the InvestorPlace blog IPOPlaybook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of "The Complete M&A Handbook," “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli.