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Every time an economic bubble develops, many will tell you how “this time it’s different,” how “this time the rules have changed.” The lie of the Web 2.0 bubble is that free is the way to succeed in the new economy. That’s not true. The rules of economics have not changed. The best way to make money in the new economy, in the Web 2.0 economy, comes down to the same fundamental business model that has always existed: create something of value for people who will pay for it.
Josh Kopelman of Redeye VC notes the penny gap:
scaling from $5 to $50 million is not the toughest part of a new venture – it’s getting your users to pay you anything at all. The biggest gap in any venture is that between a service that is free and one that costs a penny.
Then he suggests that the existence of this hard-to-cross chasm means you should look for someone other than users to pay–advertisers perhaps.
However, the reason there’s a huge gap between people paying you nothing and people paying you something is because that’s where you go from hobby to business. Between zero revenue and positive revenue lies your business model. Going from zero pay to a penny is where you’ve discovered how to make money–and that’s what businesses are about. The penny gap separates the winners from the losers, economically speaking.
VC Fred Wilson wrote in defense of free in 2005: “free is a great way to make money. You just have to know how you are going to get paid for being free.”
That’s the key to having a business: getting paid, not whether you offer free samples in the morning newspaper to convince people your shampoo smells really great.
To be fair to these VCs, they’re not advocating doing everything without pay. They’re suggesting free as a tactic towards getting paid in other ways: through advertising, or by premium services (as in a freemium model), or maybe even through being acquired by a company with a large wallet. Free is only a tactic, though, not a business model.
Conflating the two misleads web application developers into thinking they don’t need to do the hard work of figuring out what’s really of value to users before they build and launch their online service. Who loses? Users, because we have to suffer through introduction after introduction of half-baked web apps that we’re not willing to pay for with our money or our attention.