The Complete Guide To Freemium Business Models

TechCrunch reporting:
The idea of offering your product or a version of it for free has been a source of much debate.
Pricing is always tricky. Unfortunately, many entrepreneurs don’t give it enough thought. They will often copy the pricing strategy of similar products, base their decisions on pompous statements made by “experts” or rely on broken rationale (we worked hard so we should charge $X).
Free is even trickier and with so many opinions about it, we thought it would be refreshing to take a critical approach and dive deep into why some companies are very successful at employing the model while other companies fail. We’ve looked into economics academic papers, behavioral psychology books and strategies that worked for companies to come up with the key concepts below.
The Law of Marginal Cost
Pricing plays a huge part in competing for customers. Here’s an economic law that holds almost as much truth as the law of gravity: in a perfectly competitive market, the long-term product price (aka “market clearing price”) will be the marginal cost of production.
Guess what? Because of declining hosting and bandwidth costs, for most Internet products the marginal cost today is practically … zero.
In other words, if the cost to serve a customer (support aside) is zero, the long-term price of the product in the market will be zero (because of competitive pressure).
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The Psychology of Free
Much has been written about the Psychology of Free. Two books that looked specifically into the subject are “Free” by Chris Anderson and “Predictably Irrational” by Dan Ariely. Putting it simply, Free is an emotional hot button that immediately reduces the mental barriers for the customer. Free makes people think that they have “nothing to lose” since many ignore time as an investment.
From this perspective, free is a huge accelerator of adoption. The flip side of this is that after using the product for free, it is very hard to get the customer to start paying for it. This phenomenon was broad enough to get its own name: “The penny gap”—the hardest part is to get your customer to pay you the first penny. This is why it is so critical to choose your premium features wisely...
http://techcrunch.com/2011/09/04/complete-guide-freemium