Entrepreneurs: Could ‘free’ be your new path to profitability?

The psychological chasm between a “near zero” and “zero” cost is why Google doesn’t appear as a charge on your credit card. It is also why Facebook, Twitter, LinkedIn, Gmail and Skype are primarily free. In today’s Web 3.0 economy, someone does pay, but it’s probably not you. So how do you pay for these services? What’s the return on investment for the service provider? Tech mavens have found a way to charge you in alternative currency—your time and engagement.

By Kartik Ram

Published: Wed 18 Aug 2010, 9:58 PM

Last updated: Thu 2 Apr 2015, 10:10 AM

“Free” is a paradigm shift in which almost all the newly created value goes to consumers, not producers. It was popularised by Chris Anderson of Wired Magazine in his bestselling book by the same title.

Free is feasible as the marginal cost of many digital products, or the cost of delivering one additional copy, is approaching zero. The fixed cost of producing the first copy, however, may be sky high. All those servers on the computing cloud, as cheap as they might be per terabyte, require large initial investments. The articles still have to be written, the songs recorded, the movies made.

The beauty of Free, of course, is that there’s no resistance to purchase. Once you’ve given content away on the Web, you can get people to pay. Use Free to get an audience, and thereafter segment your user base so you have a free version and a premium one.

However, getting people to read a book, even if it’s free can be harder than getting people to sample media clips. In a world where most of what people read today is free to consume, you can at least provide a level pricing field. Online advertisers can subsidise content by paying for eyeballs or, in some cases, for detailed information on potential consumers.

Gaining popularity is the “Freemium” strategy, in which services like Skype offer peer-to-peer services for free, but charge for calls to phone numbers, allowing a small fraction of users to subsidise the rest. Wall Street Journal has created a Freemium hybrid by utilising free articles to encourage visitors to upgrade to a paid subscription.

The crucial business question is how you cover upfront fixed costs. As many airline bankruptcies demonstrate, it can be extremely hard to survive in a business with high overhead, low marginal costs and relatively low barriers to entry. As long as serving one new customer costs next to nothing, the competition to attract as many customers as possible will drive prices toward zero.

This difference between cheap and free is what venture capitalist Josh Kopelman calls the “penny gap.” People think demand is elastic and that volume falls in a straight line as price rises, but the truth is that zero is one market and any other price is another. In many cases, that’s the difference between a great market and none at all. It is false to assume that zero cost equals zero value. Nonetheless, it is equally false to argue that value implies profitability.

Faced with collapsing business models, today’s journalists-in-denial rail against Chris Anderson’s message. Free content cannot be the future, they say, because content is valuable. Fixed costs must be covered. They have bills to pay. The problem, they argue, is that they’re giving their work away.

Does this mean that Free will retreat in a down economy? Highly unlikely. The psychological and economic case for it remains irrefutable—the marginal cost of anything on the computing cloud falls by 50 per cent every year, making pricing a race to the bottom. Free has as much power over the consumer psyche as ever. But it does not mean that Free is a standalone strategy. It needs to co-exist with premium products and paid subscriptions.

Today’s entrepreneurs have to not only market products that people love, but also those that can be monetised. Free is a stunningly effective Trojan horse for gaining a critical mass of free users and driving up valuations. However, it may not be enough to pay the bills.

What about the oldest trick in the entrepreneur’s book: actually charging people for goods and services? There’s nothing wrong with that. However, real innovation will flourish when entrepreneurs break through, not just with new products, but new business models.

Kartik Ram is a Dubai-based digital media entrepreneur

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