My last post gave some people the impression that I am against all business models that hinge on giving away products and services for free. I am not. I am just against irrational free.
To be clear, I do believe there are lots of services where free makes sense, like Facebook. The problem is that there is not enough “attention” to make most advertising-based businesses successful. And the quest for gold has turned everything into a “media” business.
People have suggested, for example, that Microsoft Works should be made free and turned into an advertising based platform. Now, maybe that’s smart for Microsoft (MSFT); they are probably generating very little money from Works. But let’s be clear. Works is not a good advertising property. The amount of attention Microsoft would be able to siphon towards advertising is essentially nil: Ads are generally invisible when used inside productivity tools.
There Isn’t Enough Money In Text And Banner Ads
The market has extrapolated from Google’s success that most anything can be supported from advertising. Google (GOOG) succeeds for two reasons. First, they understand your intent when you do a search. Or with AdSense, at a *much* lower level of success, they attempt to glean your context. This is great for Google, which operates at an Internet-wide scale, but is not very effective for most of the websites that Google places ads on.
So while Google can be hugely successful because of scale, most of us can’t. Advertising without intent and without narrow context is a very inefficient way to generate revenue. If you can only generate a few cents a month from your average user, you have to have a lot of users. So most companies won’t have a big enough audience to justify any venture capital.
But in the gold rush, many VCs are investing in things that they have no good reason to believe will ever scale to the level they can IPO or M&A. To be sure, the best VCs aren’t doing this, but there are plenty of VCs out there that are not Sequoia or Union Square.
Freemium and the Psychology of “free”
What about the freemium model? The idea of free, with an upsell, is great for some products. But far fewer things succeed with freemium than I think really should. Because unfortunately, a psychology has been created on the Internet that nothing should be paid for. This is a broad social issue that has most perniciously affected us in music, where we have a generation of kids with no compunction about stealing, They believe *everything* on the Internet should be free. Artificial abundance supports this psychology.
It was interesting in reading the disagreements with my last piece to note that the only examples people could cite to demonstrate the success of the freemium model were 37 Signals and SmugMug. I am sure there are more examples than these, but no one seems to be able to name them. I suspect that the amount of freemium revenue is dwarfed by the amount of advertising revenue by at least an order of magnitude. My thesis is that the culprit is this new “free psychology.”
Part of what drives the desire to get big quickly is that even if you can’t make money, whoever buys you can. YouTube’s a great example: Without Google, they would have quickly run up legal and bandwidth costs they couldn’t pay. But there’s only one Google, and today there are way too many me-too video companies that have no shot at a reasonable exit, because Google has already made its acquisition.
So unfortunately we have perhaps dozens of companies that aspire to be in the video business, and very few will survive, even though some bring something interesting to the table. There is no ecosystem or psychology for paying for anything in the video space. Mogulus, a live video broadcasting company,says it wants to try a freemium model. I hope they succeed, because I think they have a very cool product. But I fear that given current market psychology, not enough people will be willing to pay to support them.
VCs Overfunding Markets is Not New, But the Psychology Is
VCs have always overfunded successful niches after the primary opportunity has been exhausted. The difference is that when dozens of *free* products are released in a given niche, not only is the supply and demand curve affected, but the psychology of the market is affected. Psychologically, an abundant hyper-competitive market is very different than an abundant and totally free market. Even an abundant and totally free market is fine — if it’s economically supportable. But in most cases, it is not. Too much free has the effect of changing our value system. In short, I believe what we really have is a psychology problem on the Internet.
One More Culprit: Google
In my last piece I probably aimed my blame gun too narrowly in focusing on VCs, who aren’t the only ones creating this artificial abundance. Google, most obviously, makes essentially no money on their non-search services like email, documents, etc. They can use their enormous search cash cow to support other businesses, many of which make no economic sense except at Google.
If Google’s behaviour was likened to trade with a foreign country, the US government would consider it dumping – the practice of selling goods below cost to gain market share. It is also effectively what Microsoft was accused of in the anti-trust case, where they bundled lots of free add-ons inside Windows. I say this not to suggest that the courts should step in, but merely to demonstrate that there is plenty of economic study to suggesting that free and below cost does affect markets and competition negatively.
Can It Be Fixed?
The bottom line is free products, where the “free” is not supportable except by outside forces, is unhealthy. This is true whether the outside support comes from China, Google, Microsoft, or VCs. A little natural scarcity, driven by a shakeout, would provide a healthy impetus to the development of real customer payment models.
SAI Contributor Hank Williams is a New York-based entrepreneur. He recently launched a new blog: Why Does Everything Suck? Exploring the tech marketplace from 10,000 feet.
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