Freemium is a difficult business model to execute but can create a valuable, sustainable company when things go well.  I helped to conceive of and execute the freemium business model at LogMeIn, which is now valued at over $800m.  Since then I’ve helped optimize the model at another 14 startups including Dropbox, Xobni, Eventbrite, Lookout, Webs, WordPress.com, etc.

Through these roles I’ve discovered the following three elements always seem to be present with successful freemium businesses:

1) A free version that provides users with a lot of value and at least one premium version that also offers users a lot of value but is clearly differentiated from your free version

2) Precise metrics-driven execution with a very optimized conversion funnel

3) Deep understanding of customer perceived value and use cases

There are times when freemium doesn’t make sense.  For example, it rarely works with products exclusively targeting enterprises (open source has done well with enterprises, but that’s probably more a function of product flexibility than price). Also, freemium requires that the marginal user cost for the free product is zero or low.  Finally, freemium shrinks the potential revenue of the total addressable market for the category, so the overall market needs to be big enough to still be interesting after a successful freemium company shrinks it.  Of course incumbent players serving the category are unlikely to want to shrink the market, so freemium generally comes from disruptive startups with nothing to lose.

If these startups are able to gain traction and meet the three requirements above, they generally gain strong organic growth and are very defensible businesses.

As startups get better at executing the freemium business model I think we will see a lot more of it in both existing and emerging categories.  Why?  Users have always loved free and the freemium business model makes it viable to offer something of value for free.  Already the model extends well beyond software to dating, identity protection, music, video, phone service…