Perhaps from my post on Friday, Free is Killing Us. Blame The VCs, one might have gotten the impression that I am against all free. I am not. I am just against irrational free. I am against artificial abundance.
To be clear, I do believe there are lots of services for which the appropriate business model is free. Facebook is a great example of this and there are lots of others. The problem is that there is not enough “attention” to make most advertising-based businesses successful. 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 given that 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 because 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 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, this does not translate for most businesses. Advertising without intent and without narrow context, is a *very* inefficient way to generate revenue. If you could only, at best, generate a few cents a month from your average user, you have to have *a lot* of users. And so most companies will not generate sufficient 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 that they can IPO or even sell to Google et al. at a decent multiple. 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”
It has been suggested that the freemium model is an effective non-advertising based strategy for leveraging free. And to be sure, the idea of free with an up sell of an additional paid service 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 the music space where we have a generation of kids that have absolutely no compunction about stealing every last bit of their music. 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 demostrate the success of the freemium model were 37 Signals and SmugMug. I am sure there are more counter examples than these, but it is interesting that in the more than a hundred responses I read, these were the only two examples cited. While it is far from scientific, for me this reinforces my notion that freemium is not as successful as I wish it were. I would strongly 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, even without revenue, is the idea that, even if you cannot sufficiently monetize a property, that the acquirer will be able to. A great example of a business that could only be sustained by an acquirer is YouTube. The problem of course is that there are very few other companies that could have acquired YouTube, because their massive bandwidth costs probably still exceeds their revenue. 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 – many of them VC funded. Few will survive even though quite a few 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, indicated that they are going to try to charge people for their service using a freemium model. I hope they succeed because I think they have a very cool product. But I fear that the current market psychology is such that not enough people will be willing to pay to support them — at least in the consumer space.
VCs Overfunding Markets is Not New, But the Psychology Is
Some have correctly argued that VCs have always overfunded successful niches after the primary opportunity has been exhausted. And this is true. The difference is that when dozens of *free* products are released in a given niche, not only is the supply and demand curve effected, as it always has been, but the psychology of the market is effected. 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 is 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 in that there are other entities that are also responsible for this artificial abundance. Google, most directly comes to mind in that they make essentially no money on their non-search services like email, documents, etc. They can use their enormous search cash cow to support other businesses that make no economic sense except at Google.
If Google’s behavior 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 their core monopoly product, 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 do effect markets and competition negatively. Many suggested, in response to my last piece, that this was not the case.
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 indeed venture capital. And while I don’t think the genie can fully be put back in the bottle, I do think that a little natural scarcity, driven by a shakeout, would provide a healthy impetus to the development of real customer payment models.