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Why You Should Never Pay for a Premium Online Subscription

Pandora, Hulu, YouSendIt, and other companies offer their services for free, then nudge users frequently to upgrade to paid accounts. Hey, but if you don't, that's totally cool with them. (Now listen to this ad.)

To the average user, free media sites such as Hulu, YouSendIt, Rhapsody and others operate on the same business model as a corner crack dealer: Take a taste for free. When you need more, you'll pay.

After hooking millions of U.S. users, Hulu, for example, recently unveiled a $9.99/month Hulu Plus service in hopes of converting its free user base into paying customers who want more and newer content. Free photo sharing site Flickr offers unlimited uploads and storage in an upgraded pro account for an annual fee. Free online streaming music services such as Spotify (in Europe and supposedly soon in the U.S.) and Pandora offer commercial-free play or mobile downloads as premium services in hopes of increasing subscriptions.

But the assumptions most people have about the freemium model are wrong, say some of the most successful service providers. They're not dependent on your premium bucks. "It's not the goal," Pandora founder Tim Westergren tells Fast Company. "We're fundamentally believers in free. The subscription business is growing nicely, but it's not the cornerstone of our business. It's not that we are trying to push people into subscription, or cripple our free service. That's not our strategy."

Instead, Westergren is focused on one thing: expanding market share. It seems to be working. Currently, Pandora has about 65 million users. It controls more than half of the Internet radio market and represents more than 2% of all radio listening. The service is adding around 100,000 new users a day, just on smartphones alone. As Internet-connected devices become more ubiquitous (especially in cars), Westergren believes Pandora will steal more market share away from broadcast radio. Without a big freemium-to-premium conversion rate, revenue is still growing from advertising, even in the face of large royalty rates and high bandwidth costs.

For other businesses, a conversion rate under 10% might sound like a failure, but not for file-sharing service YouSendIt, according to founder and CTO Ranjith Kumaran. "There's no one golden conversion rate," explains Kumaran. Some businesses that are based on a free model draw big revenues even with just 1% conversion rates, he says.

"Our huge free user-base acts as a mouth piece," Kumaran explains. "It's not a loss of consumer value—it's a marketing expense."

YouSendIt has around 14 million users, and has been adding more than 300,000 monthly. To send a large gigabyte-size file online, one must only provide an email address. Payments plans and one-time fees are available for people who want to send larger files or more data, but Kumaran is not worried about losing the potential revenue from the more than 90% of its non-paying users.

"You either spend money supporting a free user base that grows incredibly organically," he argues, "or you're running Super Bowl ads to get that type of exposure."

Services such as Pandora and YouSendIt demonstrate that conversion rates are not necessarily crucial to a company's success. And with the average user still incredibly hesitant to pay for anything online (news, music, etc.), their success suggests an ad-supported model may be the safest bet for now, in order to balloon their market share through expanding free services.

"That's the Holy Grail," says Westergren.