Thoughts On The Economics Of Giving It Away

By Dharmesh Shah on February 1, 2009

Chris Anderson has a new article in the WSJ titled “The Economics Of Giving It Away”.

This whole idea of free+premium (freemium) is one I’ve been fascinated by for a while.  (See my article about the challenges of the freemium pricing model).onstartups free

The article was good, but not a bit repetitive in places and didn’t quite have as much richness as other works from Chris.  Having said that, there were so many sound bites and quotables that I couldn’t resist just grabbing a few and sharing them.

Here were my favorite bits:

1.  “For the Google Generation, the Internet is the land of the free.”

Agreed that Google has trained us to expect things for free — but this makes it no less troubling.  Google (at least until recently) had a relatively simple business model:  Create the best search engine, make a ton of money on AdWords and do other fun stuff that helps one or the other (or just makes employees happy).  They’re reducing some of the “it’s ok if it just makes employees happy” projects, but the core model hasn’t changed much.  The troubling part is that you and I are not Google.  Google has a reality distortion field that nobody else has.  So, though it’s fine for them that they built a generation of people that expect a bunch for free, many of us have to actually figure out how to make money.

2.  “The minority of customers who pay subsidize the majority who do not.”

Yep.  Subsidize.  That’s the right word.  The trick is getting the ratio right.  At some level, you need to charge a price to paying customers that matches the value being delivered (and is competitive) but that alsos makes sure that there’s enough money to pay for all those other users.  Though costs for lots of things (hardware, software, tools) are falling steadily — they’re still not zero.  This is one of the things I disagree with Chris on.  Though he says the costs are “basically” zero, “basically zero” does not pay the bills.  Often, the level of scale required to ensure that costs really are near-zero is high, and most startups will likely never get there. 

3.  “…when you have no money, $0.00 is a very good price.”

No argument here.  In a down economy, people are even more price sensitive.

4.  “The Web has become the biggest store in history and everything is 100% off.”

It’s an interesting sound bite, but not entirely accurate.  We are sellers more than we are buyers.  We’re selling our attention.  Or perhaps even more accurately, we’re trading our attention for access to “free” stuff.

5.  “The standard business model for Web companies that don't actually have a business model is advertising.”

It has taken a while for us to figure this out (again) but yes indeedy we’re back to a world where business models might actually be fashionable again.  Who would’ve thunk it?  You and me, that’s who.  Let’s get to work.

6.  “It's now time for entrepreneurs to innovate, not just with new products, but new business models.”

One of the areas that I was fascinated by, going through grad school, was how many of the tech successes of the past decade were as much about an innovative business model as they were about technology.  We’re just starting to figure out how the internet can help us efficiently reach customers, build relationships and (gasp!) make money.

7.  “Free is not enough. It also has to be matched with Paid.”

8.  “Today's Web entrepreneurs have to not just invent products that people love, but also those that they will pay for.”

9.  “Free may be the best price, but it can't be the only one.”

#7, #8, and #9 all say the same thingI could not agree more. 

I’ll take this one step further.  Just matching free with paid is not enough.  You have to get the price that people pay “somewhat right”.  The temptation for many is to make the price really low, and assume a certain (high) scale to overcome fixed costs.  Don’t rationalize a really low price by assuming really high scale.  To some degree, we have some anchoring (“hey, we’re giving a lot of this away for free, so people won’t pay much for the premium product”) — but that’s still no excuse. 

Summary:  The old strategy of simply getting a bunch of users and expecting that the details will somehow sort themselves out (like with an acquisition) just isn’t going to work right now.  Probably not for a little while.  Even the really successful folks like Facebook, digg and twitter haven’t figured it out yet.  It’s a bit naive to think you’re not only going to get significant scale but that you’re also going to be able to monetize advertising even better.  If I were you, I’d get practical and see if you can figure out a way to write software and charge for it.  You know, like we used to do back in the good old days. 

What do you think?  Will many entrepreneurs start shifting back and tackling that highly unpleasant task of generating revenues?  What are you going to do?

Topics: strategy
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More Reasons Why Now Is The Time For Hatching Something New

By Dharmesh Shah on December 29, 2008

The following is a guest article by Neil Davidson.  Neil Davidson is co-founder and joint CEO of Red Gate Software. He also runs the annual Business of Software Conference with Joel Spolsky. His blog is at http://blog.businessofsoftware.org and you can follow him on Twitter at http://twitter.com/neildavidson.

A couple of weeks ago, Jason Cohen of Smart Bear wrote a guest post on 6 reasons why this economy is good for startups. Damn you Jason, both for your perfect timing and for writing the blog post I wish I had written. So I'm going to have to ride on your coat tails, scrape the barrel and come up with 6 more reasons why now is as good time as any for startups.

Here they are:

1) VC money is hard to get. Yes, this is a good thing. You only need VC money for a software startup in certain, very narrow circumstances: if this isn't your first startup, and if having the money would genuinely accelerate your growth (if you're Dharmesh, for example).  It takes time to get to used to running a software company. Mulla Rasrudin once said that good judgment comes from experience, and experience comes from bad judgment. Lots of money and bad judgment don't mix well. If you've not done this before then you will make many mistakes. Make small ones, not million-dollar ones, and make them without VCs breathing down your neck.

2) Even if you are unlucky enough to get VC funding, the odds are still good. In the late 1990s, in the days of Webvan, pets.com and Boo.com, the five year survival rate of VC-backed software companies was still close to 50%.

3) You need constraints to build great software. If there's one thing we've got plenty of in this economy, it's constraints. Make good use of them.

4) Constraints enforce discipline. You'll need to, among other things, manage your expenditure, focus on making products that people actually want to buy, learn the difference between cash flow and profitability and figure out how to market on a shoe-string. Now is an excellent time to forge those skills. You will need them the next time things go bad.

5) Times are turbulent, but the turbulence contains many pockets of opportunity. Big companies will be too large, or too clumsy or too slow to fill these pockets, but you, as a startup, can. And you only need the tiniest market niche to start up. Once you've started, you'll gather momentum, and you'll figure things out. Don't overanalyze: odds are you'll find success doing something other than what you intended anyway, so whether you pick a small market niche or a billion dollar opportunity doesn't matter. You'll end up doing neither.

6) In difficult times, skill and hard work, which you can control, become more important than luck, which you can't. I like this soccer analogy. If you want to compare my soccer skills with David Beckham's then don't put us both six feet away from an open goal and ask us to kick a ball into the net. I might get lucky, and he might show off and miss. Instead, start us off from the other end of pitch against a couple of defenders and a goalkeeper. Then you'll get a true picture.

Starting a business is risky, but not as risky as you think. The oft-stated fact that 90% of startups fail within their first year is an urban myth. In reality, the four year survival rate for IT startups is over 50%, and there's no evidence that this is significantly lower for companies founded in a downturn. And most start-ups that fail don’t crash and burn, owing people money and bankrupting their founders. They are quietly wound down, or sold on, and the founders set something else up or return to employment, with the added skills that even attempting, and failing, to build a business bring.

Starting up isn’t for everybody, but don't use the state of the economy as an excuse for inaction. Research shows that external factors such as the economy, or the industry you're in, aren't the only – or possibly even the main – factors that determine success. How much you love your product, and how deeply you're prepared to commit, count just as much. So choose something you are zealous about, think things through, save up some cash and quit your day job.

Topics: guest
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