Nov 10 2009

How to Compete with FREE

Published by at 5:34 am under book review,economics,marketing

Chris Anderson’s new book, Free: The Past and Future of a Radical Price, will scare you. And it should. If you’re in the business of selling anything, you need to think about how you might be able to give it away. Because if you don’t, someone else will.

Anderson is the editor in chief at Wired magazine and previously the author of The Long Tail, which is still required reading if your work is affected by the Internet. With Free, Anderson illuminates a radical business trend that is reshaping industries right now: what used to be a marketing gimmick (Free gift*, *with purchase), is now a business model.

While the idea of using FREE is not a new one, it has historically been used as a promotional device and as a hook (e.g., product samples). Even now, most people think “there’s no such as thing as a free lunch.” But, as storage costs fall, processing power decreases in cost, and bandwidth grows, it’s safe for businesses to “round down” to zero and effectively give away their core services. Google is the prime example of an entire company built around FREE—its engineers figure out how to give stuff away free, and then their MBAs try to build ads around it (maybe, if they can).

When something is free, the psychological response is different, because people don’t need to make a decision about whether they are giving up something they value in order to get it. So, the expectation equation is different, and they can be happy—even delighted—with something that would be unacceptable if they had paid for it. Anderson quotes research by Dan Ariely (and, as an aside, if you haven’t read “Predictably Irrational,” you are worse for it), the MIT behavioral economist that has studied the effect of free pricing.

The two primary monetization models for FREE are:

Third party sponsorship: most commonly advertising (e.g., banners, search ads, etc.), but there are new arrangements is paid by the phone company. Since conference calls encourage people to use the telephone, the phone company is willing to sponsor this service. Exercise: if your customers weren’t paying you, who would instead?

Freemium: There is a free version of the service and upgraded versions with a cost. In this case, the 5% that pay subsidize the 95% that use the free version. But with bandwidth, storage, or processing-intensive functions, that’s enough. Skype is a good example. 95% of users make Skype-to-Skype calls, and that’s it. 5% pay for the ability to make calls to telephones, have voicemail in their account, etc. But that’s enough to stay profitable and valued at $2.7BN.

Ancillary Services: There is a core product that is free, but associated services are paid on an as-needed basis. E.g., Linux: Give away the software; sell support services.

The danger, from a business perspective is that competitors can undercut your core business by giving away their products or services for free. Anything that uses the three core inputs (data storage, computer processing, or bandwidth) is at risk.

It’s scary, but the solution is clear: you must be willing to take a hard look at where you are vulnerable to these forces. And you must be willing to cannibalize your own business or risk a competitor doing so. Maybe it means creating a downscale version of your service. Maybe it means looking at partnerships or other revenue streams.

The White Horse emerging media practice is dedicated to tracking these types of trends, and finding innovative solutions to these types of future-oriented challenges. We even embrace the FREE concept by offering free custom reports and consultations on social media monitoring and digital advertising.

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