Designing Freemium with Usage Limitation: When Is It a Viable Strategy?

This paper focuses on the freemium paradigm that imposes a usage limit on free users and allows for paying users unlimited usage. We formulate a two-period model that incorporates the responses of users who are heterogeneous in both their valuations of marginal usage and total usage. Two freemium strategies with distinct market-coverage approaches emerge. The first strategy is an aggressive strategy that attempts to acquire the whole market, while the second strategy selectively targets heavy users. Optimal strategic decisions are derived for both freemium strategies and benchmarked against a conventional subscription strategy. We identify the strategic dominance criteria and examine the benefits of freemium strategies. The degree of intolerance towards insufficient usage and the proportion of high-valuation users determine which strategy is dominant. The need to alleviate users’ inconvenience drives the free usage limit higher and thus weighs against the performance of freemium strategies. In such circumstances, a more aggressive freemium strategy that offers generous free usage at a high price underperforms a selective variant that offers modest free usage and a lower price. The proportion of high valuation users determines the optimal strategy between a selective freemium strategy and a conventional subscription strategy. The latter outperforms if the proportion of high-valuation users is either very small or very large. Additionally, this study discusses the appropriate level for the conversion rate by showing that a firm should expect a lower conversion rate when implementing an aggressive freemium strategy.