Free: a Tactic, not a Business Model

68 Comments

no_free.gifEvery 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.

68 Comments

eep

Whatever. Here’s the relevant quote:

“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.”

So, the whole article is calling the people who do free web 2.0 style stuff idiots, basically, and then this paragraph is like, ‘oh, well, to be fair, none of the stuff I’ve been saying actually applies to any of these people because they’re all really making money in other ways anyway.’

And then all the commenters are like, ‘oh, Anne Zelenka, you’re so right, why do people still think free is a viable option!!1!’

Next time she wants to complain about how free is not a business model, she should take a look at radio or network TV. Or, um, Google.

She’s just playing with semantics; no one thinks free is a business model; everyone who makes free products is using it as a tactic toward ad revenue or the goal of being bought, or else they are hobbyists and have no intention of being anything else. What’s the point of this article, again?

Anne Zelenka

Google’s revenue model is advertising, not free services. The argument is not that you can’t use free as a way to drive revenue, but that free isn’t a substitute for an actual revenue model.

And on a tangential note, many customers cheered when Google introduced non-free apps for your domain because it means they’re supporting it as a real service. That’s yet another nail in the coffin of free as the center of everything Web 2.0.

Justin Davis

I don’t pay a penny to use Google search, Gmail, or Google Analytics, and the company is absolutely struggling, isn’t it?

Jeremy Pepper

Reminds me of the old Yiddish joke about “trust me.”

If you look at some sites, there are sites that people go from free to pay, such as Flickr or Skype. But, are there enough services out there, or is most of the stuff out there feature-sets for other companies/sites?

Mia Dand

Great Post!

I couldn’t agree more, ‘free’ is a tactic not a business model but it’s amazing how many folks confuse the two.

I am all in favor of network effects, which means the more people you can get to sign up, the more valuable your network becomes and being ‘free’ helps. But once you build your network, that’s when the ‘free’ bit ends and the real challenge begins – how are you going to make money?

Here’s the twist in the tale that your post mentions briefly, many of the founders don’t care about making money. Most are sustained by VCs and plan to cash-out as soon as they find a buyer and there seem to be plenty of takers out there. Then, it becomes the next guy’s problem to figure out how to make money off this ‘free’ model or go bust.

Most of the Web 2.0 companies are counting on advertising revenues to save the day, but I am leery about advertising as a sustainable revenue model.

Mia Dand

Great Post!

I couldn’t agree more, ‘free’ is a tactic not a business model but it’s amazing how many folks confuse the two.

I am all in favor of network effects, which means the more people you can get to sign up, the more valuable your network becomes and being ‘free’ helps. But once you build your network, that’s when the ‘free’ bit ends and the real challenge begins – how are you going to make money?

Here’s the twist in the tale that your post mentions briefly, many of the founders don’t care about making money. Most are sustained by VCs and plan to cash-out as soon as they find a buyer and there seem to be plenty of takers out there. Then, it becomes the next guy’s problem to figure out how to make money off this ‘free’ model or go bust.

Most of the Web 2.0 companies are counting on advertising revenues to save the day, but I am leery about advertising as a sustainable revenue model and here’s my rant on that:
http://marketingmystic.typepad.com/marketing_mystic/2007/03/clueless_market.html

Once again, great post! Good to see someone’s looking beyond the hype.

Anne Zelenka

Don – I have to thank Om for the shortness and sweetness of the post. He only gave me 400 words to say it! ;)

Of course there are caveats to this and all sorts of detail/case studies we can get into–like the issue of open-source Linux someone brought up. Open source hackers do have a business model for what they do. Building free software raises their profile in the community and leads to paying work.

VCMike: Google’s revenue model is not about free, it’s about advertising, so it’s not a counterexample to the argument that free is a tactic not the center of a business model. Blogger and YouTube are owned by Google. SixApart sells software and services. Hotmail is owned by Microsoft, which has mostly a license-based revenue model. I’m not sure where your examples support free as being a viable business model.

Don MacAskill

@VCMike: I posted this on your blog, but I’m lost in moderation. :(

Since this is where the conversation is, anyway, here we go:

Re: “in the vast majority of cases you can build a much more valuable web based business by offering a service that is free”

Hmm. Seems like the “vast majority of cases” that are free end up as failures. Those that don’t most often end up as acquisitions.

Now, don’t get me wrong, I’m not knocking acquisitions – but when you get acquired because you’re running out of gas in the tank , as is the case with many free-fueled startups, that’s hardly a success. A startup in that position rarely ends up being anything more than a shadow of the potential they once had.

Don MacAskill

Great article. Short, sweet, and to the point. I already blogged about it.

I’m always amazed that in the middle of all of this innovative thinking going into “Web 2.0”, there’s very little thought about how to actually make money.

Thank goodness someone’s still thinking about it. :)

jeremy liew

Anne,

Offering your content or service for free implies that you need to rely on an advertising based business model. If you aspire to build a big online media business (say $50m in revenues) you can do it in one of three ways:

  1. If you’re broad reach, you need to grow to be one of the top 10 websites in the US by traffic
  2. If you’re demographically targeted, you need to grow to be one of the top 25 websites in the US
  3. If you have content that attracts endemic advertisers, you need to grow to be one of the top 150 websites in the US

Analysis and math that gets to these conclusions is at the Lightspeed Venture Partners blog (click on my name in this comment).

laddie

Is this it for revenue models? Charge/don’t charge, B2B, B2C, nothing more? In the world of hyper linked internet networks and the non linear relationships that have arisen, do we not have imagination enough to dream up anything more than such conventional (two dimensional) approaches to the business model?

Perhaps Web 2.0 will bring upon a 1.0 revolution to such definite approaches to revenue streams.

Just Me

Ok. Now lets all (the non-enterprise users) pay some money for the Linux kernel.

hunter

my take on this is that ever business should have a “free” strategy but not necessarily a free business model.

That is, figure out how to give away as much of your product as possible, decide where the line of value is, and then charge people to cross it.

At Second Life, we first thought that line was admittance to the world (i.e. subscription to get in). Once we realized that the line was beyond admittance but more about creation, ownership, etc, the access model became free (since there’s a low cost to each incremental casual user) with various upsells and other ways of monetizing your activity in-world.

Scott

I would have to agree with Joss that for the vast majority of web 2.0 outfits the business model is to get bought by Google, Yahoo, News Corp etc, and ‘free’ allows them to build up a user base quickly to make themselves a more appealing target. Those with smaller user bases hoping that google ads etc will make them rich will have a very quick and nasty surprise. But at the end of the day if you create something that fills a gap in the market or provides a new twist on an old process etc then you’ll be able to charge for it and people will pay fo it – and lets not forget there is money to be made in supporting products/services – offering upgrades etc.

Alexander Marktl

Jason

You’re right with Businesse charging for their services.
In my opionion Web 2.0 is focusing by far too much on the Consumer Internet. There’s so much value you could provide to businesses with all this Web 2.0 technology and they’re gonna pay for that stuff…

Josh Morgan

The ‘business model’ for many of these companies is to get acquired before their money runs out. If that is the ‘actual’ business objective, as opposed to the publicly stated one, then FREE is a business model because it allows them to grow more quickly.

On a personal note, I don’t think this is sustainable or smart for the long run.

jc

Well, this must be the first drumbeat that the web 2.0 bubble has burst, eventhough the vcs have rose colored “me too” glasses on. How many more light weight FluffLications do we need in the real world.

Micah Davis

First of all…Anne, excellent post and great comments by Jason, Om and the others.

I agree, creating a product/service/site that is of value should be paid for accordingly. However, the dilemma that I see has more to do with a specific set of websites such as social media, community oriented sites and just simply fun applications. These ideas/apps don’t hold the weight of say an “Office” as they’re used more for leisure than productivity.

My take is that people are less willing to pay for apps of leisure…advertising model enter stage right.

But this doesn’t mean that advertising has to be the ONLY method of generating revenue. What products complement your app/market? What services? I think that people are a little too narrow minded when it comes to this. It seems to be that when it comes to an advertising model that it’s “All or None.”

Why not search for a comination? Albeit not a sacrifice for a lack of focus. Most publicly traded companies get their sales/revenue from a mix of different offerings/products. LOL…you don’t see the analysts going nuts over a stock that has all of it’s business tied up in 1 product do you?

Micah Davis
http://foodforethought.wordpress.com

Hasan Luongo

“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…”

This quote highlights the Web 2.0 version of the “technician mindset” that has plagued small businesses for decades.

In Webland people mistake 3rd party tools that monetize content as revenue models, and think they can focus purely building a product and let AdWords worry about the revenue side.

Solving real problems with elegantly simple tools is worth money to users, and should be the path a startup chooses over one off functionality that could someday snap into Yahoo or Google.

Om Malik

Jeffery

You are spot on – there is a ton of software products that make money by getting customers to pay for it. If you are a mac user, there is a good chance that you paid for at least two pieces of software on your machine. I just calculated – I have about nine apps that cost me between $20 and $40.

They were free to try but buying them wasn’t hard because they solved a specific problem. I think the same logic holds for web products as well – some of the web 2.0 products need to stop free access after a little while and get people to upgrade./

Jeffrey McManus

Great post, Anne. I’m starting to get pretty bored by people (mostly VCs) who say that my business sucks because it doesn’t leverage search. Yes, there is a ton of momentum behind search. But somehow, software products made money before search existed, and they will continue to make money long after the search pie has been sliced infinitesimally thin.

Jason Fried

Thanks for paying for Basecamp, Mark!

Regarding free free free… It’s unbelievable how often people ask us “What’s the secret to monitizing your product?” The answer is simple: You charge for it.

No one is going to pay for something unless you ask them to pay for it. I’m constantly amazed by the timid strategy of many web-based companies. They are afraid to charge for their products. That’s basically saying “what we’ve built is of little value.” When you go into it like that you’re in trouble from the start.

So bottom-line: Build something worth paying for and charge for it. Businesses charge for their products and services. It’s a much easier road than trying to make money from advertising or a lottery-ticket buyout.

Mark S

Excellent post. 37Signals is one of the services (basecamp) that ‘hooked’ me into paying.

As a community, however, we have to be ready and willing to pay for exceptional products. Using free as a business model, or even as a tactic, is precarious at best. I think it’s part of the reason we see such junk brought to market. You get what you pay for.

Most applicatons are launched on 50K or less . The VCs make it worse by chasing any of this junk that gets some users behind it. There is a serious lack of innovation and technology advancements because of this. IMHO.

Matt_

An advertising suported bussiness model is only free to the end user and most of Google’s services are free to the user so they can sell eyeballs to the advertisers .

David Repas

Right on! Free has become the default model of choice for most Web 2.0 startups chasing after traffic and in turn advertising revenue. Even if at the end you decide to utilize alternative revenue streams, the goal of any startup should be to create something that users are willing to directly pay for. If you can do that, you’ve got something that that 99% of startups don’t have – a product or service that has real value.

Adrian keys

A great post…could not agree with you more.

It is amazing that even after the Internet bust, some people still think “free” is a business model.

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