A final word on ‘free’

When I left to go on holiday two weeks ago I had one chapter left to read in Chris Anderson’s ‘Free’ so instead of taking the book with me I picked two that I hadn’t started yet to save space (Tara Hunt’s The Whuffie Factor and a novel called Little Bee by an author called Chris Cleave who I went to school with but subsequently lost contact with) – but I picked it up when I got home and read the final section, which is all about where ‘free’ as a business model goes from here, and I now stand convinced that Chris is right to argue that it goes from strength to strength.

The first point is that I want to make is that the argument for ‘free’ is complex and nuanced, and that it is easy to produce soundbites which purport to shoot down the theory by attacking it in misleadingly simplified form.  The core of the thesis is that as variable costs drop the price of many things, and in particular of digital goods, is heading towards $0.  The book is partly a justification of the thesis using economic theory, but it is more a discussion of how companies can make money with $0 price, and indeed how they have been doing so for over a century. 

Two quotes from the book to make this point:

What about those companies trying to build a business on the Web?  In the old days (that would be until September of 2008) the model was pretty simple: (1) Have a great idea; (2) Raise money to bring it to market, ideally free to reach the largest possible audience; (3) If it proves popular, raise more money to scale it up; (4) Repeat until you’re bought by a bigger company.

Now steps 2 through 4 are no longer available.  So Web start-ups are having to do the unthinkable: come up with a business model that brings in real money while they’re still young.

From the final section “Fifty Business Model’s Built on Free” (emphasis mine):

Free 1: Direct Cross-Subsidies

  • Give away services, sell products (Apple Store Genius Bar tech support)
  • Give away products, sell services (free gifts when you open a bank account)
  • Give away software, sell hardware (IBM and HP’s Linux offerings)
  • Give away hardware, sell software (the video game console model where devices such as the Xbox 360 are sold far under cost)
  • …..

Free 2: Three-Party, or “Two-Sided” Markets (One Customer Class Subsidises Another)

  • Give away content, sell access to the audience (ad-supported media)
  • Give away credit cards without a fee, charge merchants a transaction fee
  • …..

Free 3: Freemium (Some Customers Subsidise The Others)

  • Give away basic information, sell richer information in easier-to-use form (BoxOfficeMojo)
  • Give away generic management advice, sell customised management advice (McKinsey and the McKinsey journal)
  • Give away online games, charge a subscription to do more in the game (Club Penguin)
  • Give away demo software, charge for the full version (most video games which allow you to see the first few levels to see if its you)
  • Give away computer to computer calls, charge for computer to phone calls (Skype)
  • Give away ad-supported service, sell the ability to remove ads (Ning)
  • …..

This list makes it crystal clear that someone always pays.  Too often in the past that has been the venture capitalist, and that has now changed with the result that there will be fewer free offerings without an associated revenue model, and probably fewer startups overall, but I expect that the percentage that offer something for free will continue to rise.

The other big takeaway that will influence my thinking about startups and markets is the importance of distinguishing abundance from scarcity – recognising that you can charge for scarce resources but not abundant ones, and that each abundance creates a new scarcity.

As I have been writing this post I’ve been thinking about our portfolio and it is interesting to note that internet infrastructure software vendor Zeus Technology offers free developer licenses (throughput limited) and test licenses (time limited) and sells licenses for unlimited software, social network WAYN offers free social networking, sells advertising and charges for a VIP service, natural food ecommerce company graze gives the first food box away for free to new customers, DVD rental business Lovefilm offers a free trial and Tribold has recently started offering selected telcos free trials of it’s hosted product life cycle management software.

 

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