Supply, Demand, Optimism and Entitlement

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Supply, Demand, Optimism and Entitlement Posted: 10 May 2010 10:10 AM PDT Toward the end of my week at the Web 2.0 Expo in San Francisco, I hastily wrote the above post entitled "Charge 'Em!."  I asserted that Web service providers offering their services for free are likely doing themselves a disservice and that Internet users need to get used to paying for services they value. I've thought about it some more over the next couple of days and I want to take a shot at building some business theory and context around this argument.  I warn you, I'm going to throw some freshman macroeconomics at you and probably misremember Freakonomics.  I might employ the phrase "irrational exhuberance" and, just for fun, I think I'll lob in a venture capitalist conspiracy theory. To start, I can think of 5 good reasons to offer a Web service for free: Passion, pride or generosity You develop something great and offer it free just for fun, for the respect of your peers or to make a contribution to the Internet community. As a trial You believe strongly in your service and believe that users will pay for it after trying it for free for some period.  Of course, it's tough to raise prices, particularly from free to paid, so be clear that this is the intention from the beginning. As a gateway to paid services You have relevant, compelling paid options to enhance the free service.  Our friends at Yola are a great example, adding premium templates, domain names and storage to their free site building.  And they have the revenue to show for it. To sell your audience The classic media approach.  Attract users and then sell marketers the opportunity to get their message in front of your users.  The challenge here, and it's a big one, is that you really need to figure out from the very beginning how to make those third-party messages a welcome part of your user experience. To acquire valuable data You give users a valuable service and they give you something in return, data.  Google is an obvious example.  Quantcast is another one for free Web analytics.  There's a brilliant little B2B company called Ethoca that is building a huge database of transaction data in order to anticipate fraudulent transactions.  Each of their clients contributes data to the "community" so that everyone gets smarter.  On the way to building that database, they brought on some big clients for free.  Now they have valuable data that clients, and possibly third parties, will pay a lot of money for.  The warning here is that your users need to be completely comfortable from the beginning about the contribution they are making.  And your data can't be so vague (or sensitive to your users) that it's not actionable. So, lots of good reasons to support free Web services.  Here's the problem.  These are all way more difficult than they sound and I believe most free Web services today are following a different model entirely – build a huge following now and figure out how to monetize later.  Hey, it worked for Facebook.  It will probably work for Twitter.  But these services have succeeded by getting so many millions of users that they only need to make a few pennies off of each of them to be wildly successful.  And maybe one in a thousand companies are going to amass that sort of customer base.  It reminds me of the junior drug dealers in Freakonomics who are accepting wages and risks that don't make any sense because they are fixated on the one guy who got to be the kingpin.  Or the college basketball players who never go to class because they're all convinced they are going to be NBA players. These companies are subsidizing their users – offering a service that supply and demand would set at $2.95 a month, for example, for free – with resources they are borrowing from an uncertain future.  Remember the impact of a subsidy on supply and demand?  It shifts the supply curve to the right, lowering the price and increasing quantity.  To continue to meet the demand, the service needs to continue to subsidize it themselves, find buyers for their audience or their data or wrestle the revenue from their users. It occurs to me that this is a pretty sound strategy if you're a venture capital firm with 20 or 30 of these companies in your portfolio.  You can afford to send them all long because you have a pretty good chance that one or two will scale through the roof and discover an approach to monetization.  But if your hopes ride on just one of these, it starts to feel more like a lottery ticket.  And the key when you consider a pricing strategy really ends up being time.  If you start off with a paid service or advertisers or a buyer for your data, you'll find out a whole lot sooner whether you can satisfy all the parties involved.  If you start out offering the subsidy, you could pour years into a service only to find out later that there was never really any way to shove revenue generation into the experience. I do hate that I sound like such a dowdy pragmatist.  I love the idea of believing so much in a product that you just want to hand it out on a street corner.  I do believe that great innovators will generally be recognized and rewarded somehow.  I am mostly concerned right now that all the parties involved are looking around expecting somebody else to reward them.  Users are hooked on free and figure some advertiser will subsidize them.  Advertisers don't want to insert themselves someplace that they won't be welcome and effective.  And investors are going to offer less and less funding if there don't seem to be any viable sources of revenue. As an Internet user, I don't want to rely on anyone else to subsidize me.  And I don't want to continue to jump from service to service every time the one I'm using starts to get old or disappears entirely.  (I pined for Vindigo for years.  I can name a dozen others.)  I want to pay a fair price for services that I love.  I'm not alone on this.  A friend told me the other day that he begs dailymile to charge him a service fee.  He doesn't want to take the chance they won't figure out how to monetize later and he'll have to somehow motivate himself to run 5 times a week in freezing cold weather. I know business isn't always fair.  I know the best service doesn't always win.  I know you're competing with services that can pull a deeper subsidy from somewhere.  But I strongly urge Web services and Web users alike to start considering the value of using great services and the cost of losing great services and let the market set an appropriate price.

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