When entrepreneurs come up with an idea- revenue plans are rarely the first thing that come to mind. After all, asking  “how do we solve this incredibly painful business issue” can be a lot more exciting then “how are we going to monetize this”.

Since the first dot-com-boom, several models for revenue have come, some gone, and most have evolved- from the straightforward ad-revenue based model to the more open-ended-funding model (similar to Twitter).  A trend that’s been getting a lot of attention lately is the “freemium” model. This typically offers users a stripped down version of a web service for free, while enabling users to “upgrade” to a fuller-featured version for a fee.

Clearly this works best for feature rich products and services that can be subdivided in some way- deciding how to price these features is the next step.

What to sell? What to give away?

A good first step is deciding what features users are willing to pay for vs. getting for free. Is there a pivot point in your product or service that can easily separate the paying customers from the free customers? If you’re an online storage backup site, a paid account might give you more storage, or automated backups. A customer relations management site might enable you to track on 10 accounts for a free version, but unlimited accounts in the paid version. In any of these situations, customers should not only be able to smoothly upgrade from a free account to a paid account, they must be incented to do so. Finding that hook in your product will be key to your success.

What’s in a price

Now that you have an idea of what you’d like to charge for- what do you charge your customers? Is there a direct, measurable cost to you for user activities on your site? An example would be Dropbox which offers users online storage syncing. New users get 2gb of storage for free- but to use more than those 2gb costs the users a fee. The cost of those initial 2gb of storage is a loss leader for the Dropbox team, but one that clearly is offset by users upgrading to a more premium level of support. The hook for offering the initial 2gb of storage it build buzz or “virality”- which drives new customer signups. With a free to paid conversion rate remaining constant, more free users means more paid users.  To help decide how to best price your product, construct cost models that can demonstrate where your break even point occurs. This will help guide you in putting together pricing plans that can easily fit into a freemium model.

Looking at competitors solutions can give you some guidance, but don’t let the pricing models set by others limit you. Now why would someone upgrade if they’ve already gotten something useful for free? See Om Malik’s post on this topic to get a great illustration of why a user might make the jump to a premium pricing tier.

Freemium models aren’t the magic answer to all revenue model challenges, but with the right product and the right mix of free, you could turn a handy profit.