Thoughts On The Economics Of Giving It Away

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Thoughts On The Economics Of Giving It Away

 

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?

Posted by Dharmesh Shah on Sun, Feb 01, 2009

COMMENTS

We've been huge fans of Website Grader since Jan of 2007, we blogged about it here http://www.skmurphy.com/blog/2007/01/29/what-is-your-website-grade/ 
 
I think this is an example of getting freemium right. I would be very interested in a post on how you planned and managed that.

posted on Sunday, February 01, 2009 at 10:50 AM by Sean Murphy


You said “It's now time for entrepreneurs to innovate, not just with new products, but new business models.” 
 
 
 
I agree and we did, we understand that the future of our nation's economy depends on the ability of the small business owner to bring his/her vision to life.  
 
 
 
That's why we built  the new <www.Fundingroadmap.com>, the first online business plan and due diligence reporting system that anyone can use to make the funding process faster, easier and more cost-effective. Now funding sources and entrepreneurs can work with a state-of-the-art digital platform to facilitate their mutual success in our challenging credit /investment environment.  
 
 
 
We charge consumers and master license holders because we give value and a product that can't be found anywhere else. We provide a system and information that one would have paid thousands of dollars for before we invented our system, so the price we charge is well worth it and that is the whole point. People are looking for value for their money and they will pay for it when they find it and need it.

posted on Sunday, February 01, 2009 at 10:56 AM by Ruth Hedges - Fundingroadmap.com


Dharmesh, 
 
#5 and #6 reminded me of a Michael Dell quote I've always subscribed to: "The key is not so much one great idea or patent as it is the execution and implementation of a great strategy."  
 
When you build a better business model, and continually innovate ahead of the competition, you stand an excellent chance of succeeding, even in this economy. 
 
Paul

posted on Sunday, February 01, 2009 at 10:59 AM by Paul Roetzer


Great article! I think your topics are typically quite on point. 
 
 
 
I was thinking of how Seth Godin gave away his book "The Idea Virus" for free - now he was probably pretty well known at the time - but I think the business model is to make something of value and allow people to recognize it for free - then the money will follow. I wrote why I think starting a business of value is a long term process because of this (http://corporatepreneur.blogspot.com/2009/01/building-business-is-long-term-process.html). 
 
 
 
Also I couldn't have put it better than you did about subsidizing internet usage - but I have always been amazed that my own website could offer a free game to users and companies would basically pay the costs through advertising. The product is essentiall free to the users! Pretty amazing how the internet has changed the rules! 
 

posted on Sunday, February 01, 2009 at 11:50 AM by Tom


So complicated. What happened to: 
- I want X 
- X costs $Y 
- I have $W > $Y 
- I give vendor of X $Y 
- I take X home 
 
Just go back to that model and leave the innovating for your products.

posted on Sunday, February 01, 2009 at 12:00 PM by Sohail


Yes let's hear it for the innovators of business models like Netflix and Amazon and Ebay. Can't wait for the next wave to figure out how to monetize all the great content on the web!

posted on Sunday, February 01, 2009 at 3:30 PM by Diane


I haven't found internet advertising working for me. (1) I cannot afford Webvertsing, because it costs are equal if not more expensive than print advertising and with so much junk email each day, who has the time to open up emails by the hundreds. 
On a typical morning I receive 100-150 emails, Only 2-emails are directed to me personally, the balance are "JUNK EMAILS", I receive more junk Emails that I do in my GOSLOW POSTAL MAILBOX. 
(2)My business is advertised via the use of Post Cards, Inexpensive, Quick-Read, easy to stick on the cork board by potential customer and not lost in the JUNK-EMAIL on the screen. 
(3) My postcard sticks-out on every mailing, I receive a response of 20%, with 1% to 5% being real orders. 
And finally about "FREE", Nothing is Free, not even "Free-Shipping." 
I never bought "FREE" in any advertisement and When you view the implosion of the First Internet so-called Boom then Bust, Well be ready for Version II, to begin its spiral. 
Their is too much data filling up all the Email space and when it all clears, many will look forward to reading their snail-mail from the postman. 
I don't like online magazines such as Electronic News, I remember how I enjoyed reading the hardcopy, I was able to cut out important products I may need for product development or pick up deals on used assembly equipment, etc. 
With Online mags, it isn't the same. 
I don't even read the Wall Street Journal online, who likes moving the mouse up and down, over and across to read an article, it stinks. I run my BIZ from a laptop, after 12 hours of looking a screen on an average day, my eyes are tired. Give me a printed Newspaper or an industry magazine any time anywhere. 
 

posted on Sunday, February 01, 2009 at 3:49 PM by Joe Simiriglio Jr


I don’t go with people who break their head and everything to innovate a niche which is going to make millions. Rather, it’s better to use common sense and find some thing which is on demand and Make it affordable, efficient and highly customer oriented. Best example for that would be Google.. Actually they didn’t innovate Search engine. Actually they copied just the idea of search engine and made easy and fast web tool for people without confusing too much.. 
 
Thanks 
Ram

posted on Monday, February 02, 2009 at 6:37 AM by Sriram Manoharan


People certainly do expect and look for "free" on the internet. And this may not be a bad thing...giving something away for free can increase your credibility (if your product/service/etc has value).  
 
 
 
As you increase your credibility, you increase the likelihood that you will sell something (if that's what he's giving away for free, I'm sure that what he's selling is phenomenal!!) and people will tell others about you.  
 
 
 
(At least, that's what I'm basing my marketing model on...) 
 
 
 
:)

posted on Monday, February 02, 2009 at 8:02 AM by Deidre Hughey


It's interesting to me that 10 years after the tech boom that we still think that companies can succeed not making money. Personally, I would say it's okay to give away somethings if it's part of a business model to generate traffic for your paid products.  
 
Twitter is an excellent example. They are having some issues figuring out how to make money with their tool. I would think that they would have been better off with a plan in mind as to how to use the tool to build a viable business.  
 
Free is a great price for consumers but it makes sustainable business difficult. 
 
Jeremy 
Refocusing Technology

posted on Monday, February 02, 2009 at 10:19 AM by Jeremy


"The article was good, but not a bit repetitive in places" 
-> 
"The article was good, but *g*ot a bit repetitive in places" 
?

posted on Monday, February 02, 2009 at 4:47 PM by Andy Brice


Your point that even Facebook, Twitter, etc. hasn't figured it out is the key. 
 
It's OK to dream about being as successful as they are, but surely your business plan doesn't depend on it! And even if it does, being that popular is clearly not enough. 
 
The purpose of a business is to make money. It's OK to leverage free stuff -- in fact it can be genius -- so long as there's a clear path to profitability. 
 
Not necessarily a likely path, just a clear and rational and possible one. 

posted on Monday, February 02, 2009 at 5:37 PM by Jason Cohen


Hi Dharmesh... very much 'on the money' with your comments. I especially agree with point #2. It is important to have a clear perspective on what exactly your variable cost is and what is the premium:standard:free ratio that your model can afford. This ratio has always existed and is applicable to all businesses. This is the ratio that stores and airlines and hotels and commodity traders and Dutch flower exchanges -- all have to manage in order to optimize on their revenue/profit goals. As much as we like to believe that the digital economy is some alien planet with its own unique laws, the fact is that the laws of economics are immutable, whether you are dealing in atoms or bytes. Somebody must pay! 
 
Another perspective on this subject - <http://blog.countspin.com/2009/01/one-mans-fee-is-another-mans-free/>

posted on Tuesday, February 03, 2009 at 2:58 AM by JG


The idea should be that of leveraging free services to sell paid ones which are different but somehow related. Like in opensource software: you get the software for free, you pay the subscription for support services.

posted on Tuesday, February 03, 2009 at 7:56 AM by Alberto Zigoni


Most of today's free web services are subsidized -not by a few paying customers, but- by optimistic (delusional?) venture capital and corporate investors.

posted on Tuesday, February 03, 2009 at 3:07 PM by Seph Skerritt


I'm right with you on your comments. In the market that my new company is in we work mostly B2B, not directly with the consumer. With that and given the niche area we operate in, giving anything away can actually work against you. In fact, when we considered giving away a version of our software, the idea was actually beaten down severely in our first round of marketing analysis by actual potential users who made it very clear that without charging for the product it had a big perception of value problem. 
 
I suspect direct to consumer products can have the same issue, but that the price point might be more competitive in forcing the price near free. All I can say is that for me, charging the right price for the product/service is the way to go if you product actually has an ROI. If it does not, then move on to something that does. 
 
--Josh 
Our latest offering:JobsPro

posted on Wednesday, February 04, 2009 at 12:02 PM by Josh


I like what you have to say on the subject, Dharmesh. Most of all I'm excited that business models involving something other than advertising are starting to take hold again!

posted on Thursday, February 05, 2009 at 11:39 PM by Dan Abdinoor


Interesting post. I feel that free is often the gateway to paid. If you offer something for free and people see the value in it, they will be happy to pay for additional value. This may not be the best strategy in all services/products. For instance, in the graphic design industry there is a lot of negative feedback on doing spec work for clients.

posted on Friday, February 06, 2009 at 8:15 AM by Sean Hecking


Dharmesh, 
 
Great article. Of all the points, the one I wholeheartedly agree is #8 - "Today's Web entrepreneurs have to not just invent products that people love, but also those that they will pay for.” 
 
If you are not solving a problem that people are willing to pay for, you don't stand a chance to make money - this has been time tested for years but our long term memories have been blurred by the success of a few - the YouTubes of the world - those who did not make a penny but managed to sell themselves out for billions. But for every one Youtube, there is probably at least a hundred failures of companies that did not create value. 
 
The current economy is even less forgiving - your value proposition needs to be absolutely in the critical path of customers - one that lets them survive in the current economic climate. 
 
I have always considered free products as lead generation or brand awareness tools - not something you would bet your business on. I have always looked at Twitter grader and the website grader this way - leads into the real product that Hubspot charges for.

posted on Monday, February 09, 2009 at 9:27 PM by Gopal Shenoy


Haven't visited in a while (my bad) but, this link caught my attention in Google Reader.  
 
In the small business software market I think SMB's have grown accustomed to the "Search - Find - Try - Buy" model. Search for a service, find it, get to try it at no cost and then if they like it buy it. To convert website visitors effectively, "try" captures the lead and you have to have a compelling, hassle-free, value proposition for a business to try. Free trials, Free limited service offerings and Free service offers close the deal and give you an upsell opportunity.  
 
Getting the users contact info (e-mail usually) requires something free because getting a buyer to take a credit card out of their wallet when they are browsing is just hard. 
 
Nate Gilmore 
http://www.shipwire.com 
 
Please try our FREE trial :-) 
 
couldn't help myself

posted on Thursday, March 12, 2009 at 8:37 PM by Order Fulfillment


I started to voice my concern over the culture of free in social media back in January (see: Sustainability of Social: The Financials) and still wonder why more people aren't talking about it openly. It will be interesting to see if there is any reflection on the lack reasonable business models when cool services start shaking out.

posted on Monday, June 15, 2009 at 6:32 PM by Mike Langford


Hi! 
A very good article on 'Free' system! 
But the other side of the coin is that many of us go through thousands of such 'free' stuffs before we narrow down precisely upon the thing which we were looking for since ages!And maybe end up happily buying the product or the service, or still discovering something that we missed through out the liftime!!!  

posted on Friday, June 26, 2009 at 12:55 PM by Dr Deepa Patil


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