Perspectives on entrepreneurship, startups and venture capital from K9 Ventures.

The Case Against FREE

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I’ll start by admitting up front that the purpose of this post is to hopefully incite a discussion, to start a fire, and to get you, and your startup to think really hard about what your business model should be. The title for this post ‘The Case Against FREE’ is a throwback to Chris Anderson‘s cover story in Wired Magazine titled Free: Why $0.00 Is the Future of Business, but, this post isn’t really intended to be a blow-by-blow rebuttal of Chris Anderson’s position. It just makes for a juicy title for me to express my opinion on startup business models (or often the lack thereof).

At the core of my argument is a short tweet that I’ve sent out at least twice on Twitter:

Case against free tweet


To elaborate: Too many startups feel like the right price point for them to start out is “free.” What they fail to realize is that once you start offering a valuable service for free it is very difficult to later charge for that same service. And if that service happens to be the core value of what you have to offer, well, then you’ve just given it away. Yes, you can claim to use a “freemium” model in order to charge for added features or services over and above your core service, but, if you give away the most valuable part of your service, the uptake on the number of people who convert to the for-pay premium services is not going to be very high.

I’ve seen way too many companies fall into this trap. In a lot of instances, companies fell into this trap because of competition. And yes, competition is a good thing for consumers; it encourages companies to build better product, deliver better value and, in some cases, give away everything for “free.” That last part is the one that I’m going to take issue with. Competing on price isn’t always a good thing. If you want to compete, compete by innovating, compete by out-smarting, compete on quality, and on really solving the customer’s problem in a better way. If you compete by making the price of your most valuable offering zero, then all you have succeeded in doing is create a “divide by zero” problem for yourself, and, if you’re even a little bit of a geek you know that that’s a NaN.

Contrary to Chris Anderson’s view on Free, I strongly believe that the best revenue models are where money changes hands directly. You deliver real value to me, and I happily pay you some reasonable amount of $$s for that value. That has always been the fundamental basis for business and it will remain the fundamental basis for business for the foreseeable future. That core principal of where money changes hands for value delivered is an invariant that must exist in every real and sustainable business. Whether you do it by using a direct exchange or a three way exchange or any other way doesn’t matter much. If you’re not making money, then you’re not really building a sustainable business (no wonder so many startups are jokingly referred to as defacto “non-profits!”).

In my opinion, there are very few of the three way business models that work. Google is obviously one where it does work, and it works brilliantly. But not every startup is going to be able to pull that off, and especially not for every type of product offering. Advertising has always been a three party model and lots (okay, maybe “some” is a better word here) of companies make lots money using an advertising model (ala Google); but I am partial to a direct revenue model. That’s my opinion and I’m sticking to it.

Let me give an example: Plaxo. I often rail on Plaxo because I believe that they started out with a brilliant idea. Managing contacts is a huge problem and honestly no one has had a better shot of really solving that problem than Plaxo. They did a few things right: The ability for updates to be propagated across the network was great in concept. Having all my contacts backed up to the cloud, and be able to sync across multiple machines and devices was great. But, they also got a few things wrong: They were using email a little bit too liberally to where it created the perception of being a generator of spam. Most of all, the biggest mistake Plaxo made (in my opinion) was that they started to give away their core value for free. That core value that Plaxo delivered was backing up and synchronizing the data in Outlook. There were multiple occasions when Outlook crashed or the computer crashed and the only way to recover that valuable contact data was to resync with Plaxo, and boy am I thankful to them for that! But, they gave it away for free and then never really found a reasonable upsell to build a real business model for the company.

I won’t even start about what I call the “critical mass plays” — businesses that hope to monetize based on traffic and advertising. That model isn’t flawed, it’s just overly optimistic. Very few companies ever get to having enough critical mass to make it work.

The last thing you want to do is compete in a commodity market place. The mentality of ‘Free’ and the mentality of acquire users first, and figure out how to make money later (see the next post coming up soon for more on iterating the business model) is creating an environment that puts our companies in a commodity market. Are we really selling lean hogs or coffee? I thought we were in an industry where innovation matters. If innovation matters, then prove it by building a better product — one that your customers will be happy to pay you real $$s for.

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  • Any opinions on business models that have 2 separate user targets? One is the normal “joe” using the service for free and the other is the business using the platform to sell to the user. The service itself is free for the user but to get access to that user, the businesses pay. Again this brings us back to the idea of “users first – business model later”. Ala – Foursquare.

  • abhishek manocha

    Very well said, there needs to be revenue model involved. time and again that keeps me thinking. FB is $14 billion on free market, hows that? that’s valuation realistic? what we have got here, big user base, lotsa advertising, almost 100% free apps, social games, leads, corporate media linkups, that shouldnt add up to $14B, right? Something is amiss, don’t take me as nay-sayer, but dont be surprised if you see a bust. World is not that rich to pay FB $14B. Strategy take your kitty and get out.

    Clarification: I didn’t mean that FB is not going to make money. It is but not that much what people say.
    for other startups on “free” model, that’s gonna bust like anything. Again 1 FB 999 Failed startup ratio.

  • David Semeria

    Not only do I totally agree, I also have a solution:

    It’s a pity I’m 5,000 miles away from the bay area…

  • First of all, I agree with your point on money changing hand. Talk is cheap and unless customers are willing to open their wallets, you don’t have satisfied customers.

    In my current start-up, we’ve debated this issue gazillion different times and the best compromise that we’ve came up with is to state the price of the service but give the initial set of customers a long enough of a free trial period that they essentially see it as a “free” service. This preserves the “value” of what you’re providing and set the expectation that somewhere down the line, customers are expected to pay.


  • P

    Also, another reason that mmorpgs havent got a huge user base is they cost too much to make. And publishers want a return and go the conservative way – subscription fees. While that keeps them profitable, someone has to change the model, and shift the paradigm.

    If a site offered users to play the game for free, but instead pay through in-game transactions – or micro transactions – through credit, I think it would be game-changing. Also, if a new site started charging users right from the beginning, it would lose out on a whole lot of users versus users who would get engrossed playing the game for a year, and then find it acceptable to pay after a year.

  • P

    I think the problem is that while social networks and others have a huge user base, they havent been able to monetize their user base well. On the other hand, mmorpgs and virtual worlds monetize their user base well, but their user base is limited.

    Look at the figures: Facebook has 300-500M in revenue (’08-’09) from 200M+ users. WoW has 10M users, but brings in 500-1000M in revenue. The problem is that the classical online advertising model is broken. While multiplayer gaming has fixed it, it has significant barriers to entry such as plugins and software downloads.

    Google only makes so much money because of the HUGE user base. Imagine what a 50-100M user base gaming site could get in.

    Whoever solves this will rule the internet, in my opinion.

  • Abhinav

    What about the Gift Economy model? Do you think that is a viable option for a startup?

    • @Abhinav: I haven’t looked at gifting in much detail, but on first blush, I would say that if Person A is paying to give something (tangible or intangible) to Person B, then money is changing hands, and there may be a viable model there. The question then becomes whether that happens often enough.

      BTW, In case you are referring to virtual goods and social networks, Bill Gurley from Benchmark has a great post on his blog that is worth a read.

  • One of the biggest problems with freemium is the ever-competing often-conflicting priorities of “Get More Free Users” and “Increase Conversions.” Very rarely is the path to both the same, and it is extremely difficult to do both well. More often than not, you just end up with a severe lack of focus–not doing either right.

    I would like to point out that depending on the space, it’s more or less difficult to sell a differentiated product. Ask yourself the hard questions before you get started down that path. Are there several companies in the space providing something even remotely similar for free? Can you be more than 20x as good as they are? 100x? (Hint: your definition of “cooler and better” doesn’t count, you’re biased).

    Learn quickly whether the space you’re in supports your kind of premium offering. Of course, the best way to do that is to build for cheap and test the market. If getting traction feels like pushing a boulder uphill, step back, re-evaluate and reconsider.

  • I definitely see this trend on the iPhone. A lot of games do better on the iPhone (bottom-line) because they raise their prices to show that they’re a “quality” game, as opposed to a trash $0.99 game.

    Likewise, in the Rails world, most services cost money, and almost all the Rails engineers use them (GitHub, NewRelic, etc.) because they are good applications and provide real value. I agree with you that for the most part, free is unsustainable.

    I think another good point about why I think price is good is because it allows companies to bootstrap more easily. Having cash coming in the door makes it easier to build cooler and better things than your competitors that are doing it for free.

    Great post Manu!

  • Kinda funny that you made your argument via a Twitter posting.

    (Not to specifically agree or disagree with your point, but just to highlight a huge irony!)


    • @DROdio: Yes, I was noticing that irony myself 🙂 Thanks for pointing it out. My response to that is that: I think that Twitter is a great company, with a great product. I love Twitter and use it every day. It has contributed to my learning by bringing me opinions and pointers to information that I would not have found otherwise. At some point (and I think that point will be soon) Twitter too will need to find a revenue model. They’ve already talked about “verified accounts,” but I am very curious to see what happens with Twitter in the near future. Several folks have predicted that Twitter may well go the way of YouTube.

      I think the bigger point is that for every Twitter there are hundreds, and possibly thousands, of other startups that can build a similar, or sometimes even a better product, but they don’t hit the hockey-stick in user-adoption. That is the model I refer to as the “critical mass play.” Twitter hit that hockey-stick (and lets hope it continues as a hockey-stick and doesn’t plateau) and so now has the potential to try different and interesting revenue models. They were also lucky (or smart) to have gotten enough venture backing to allow them to get to this point. That’s not the case for the the other 99 or 999 startups out there.

      I’ll also add that I’m not advocating there is only one way. There is no silver-bullet. What’s the right strategy varies from company to company. I just want to get folks to at least think about it more.

  • Nice post. I wrote a comment on the Hacker News thread that I wanted to bring out here:

    I *somewhat* agree with his assessment of business models that hinge on freemium or entry-points priced at $0, but I think he (like other seed-stage investors) tend to overlook an ill-conceived strategy that I call the “platform play” common in today’s early-stage company landscape.

    Utilizing some form of the this strategy – building a multi-level rather than a singular product, i.e. a social network or blogging tool that caters to X, Y and Z demographics when it should focus on X or the intersection of XYZ demographics – is almost doomed to gain minimal viable traction. I may be wrong, but I think “quick riches” founders of startups look at the success of Google (a free business, with a targeted product from the start that later monetized) or Facebook (singular product starting with the Ivy League demographic, built around ads with an impressive $300-400 million revenue stage, minus hype) and think, “I can do the same.”

    I don’t think so. Don’t confuse the ecosystem these companies have built (contextual ads and social applications, respectively, worth hundreds of millions of dollars) with how they started. For some, free is an entry-point to using your product (perhaps content, bare features, etc) but for others, particularly e-commerce, free and “platform plays” are short sighted toward revenue and profit goals.

    Smart founders and investors see “free” as an integrated component in their company’s vision.

    • @Dave Ambrose: Thanks for your comment. Just to clarify my viewpoint:
      I like platform plays. They have the makings of a big company. They usually have a bold, change the world, type of vision. A lot of the companies I have invested in are platform plays, but they are platform plays that also have a real business model and even bring in revenue (for some). They haven’t announced their funding and so I can’t discuss them yet, but I look forward to talking about them here soon.
      I like your point that “free” should be considered as just one part of a bigger component of the company’s vision for a business model. It is a powerful approach, if used right. My call for caution is to startups who don’t think of it as part of that bigger strategy, and give away their most valuable offering, and then struggle to find a way to actually build a business.