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Freemium is a fantastic model for web products. Its free to play, but you've gotta pay for additional features. It's great as it lets the user taste your application with no strings attached, and if they enjoy the product and require additional functionality - they totally can.

Freemium is a business model that works by offering basic services for free, while charging a premium for advanced or special features.

-- wikipedia article on freemium

Sounds great for iPhone apps right?

Nope. iPhone free applications cannot sell up the premium application:

Free or “Lite” versions are acceptable, however the application must be a fully functional app and cannot reference features that are not implemented or up-sell to the full version

This means you can't have an alert when you tap a premium feature that says "want to share this story? purchase the premium version!" - now, I don't think this is a terrible thing. You can imagine every single free application badgering users to upgrade to make this and that feature work.

It should however not be a carpet rule like this - there are numerous times when it should be okay to encourage the user to purchase a different, premium, version. Maybe when you've completed the four levels of your Lite iPhone game you wish to prompt the user to "check out the premium version for extra levels!" or to be able to remove adverts in your twitter client which when toggled says "purchase this twitter client to remove ads!"

However, the real shame is that you cannot have in application purchases for free iPhone applications. This kills the possibility of freemium. Here's an example:

Imagine a developer created a twitter notification service. He wanted the user to be able to track direct messages for free,  but @replies and additional accounts cost. How would you do that? Isn't receiving direct messages a great way for a user to trial your software, and then you can make revenue by offering additional features for a small upgrade?

I suspect Apple could allow in application purchases and it'd all be okay - some developers may abuse the system - but thats why we have user reviews. Applications would quickly be ripped apart if they were Free and simply required purchasing to do anything.