How To Thrive In The Free-Product Economy

Someone will probably make a product just like yours, then give it away for free. Why not beat them to the punch?

Building technology has never been cheaper than it is today. Or faster.

In the past twelve months, Ruby on Rails programmers built more than a million apps on top of Heroku, a platform that allows coders to save drastic amounts of development time. Historically, the majority of the cost of a typical app comes from maintenance, says Heroku COO Oren Teich; companies like his build layers of technology that deplete those setup and maintenance costs—not to mention experience required—to build software. "Innovation is increasing," Teich says. "This is a huge trend we're seeing day after day."

Moore's Law says computer processing power gets steadily cheaper and faster to produce. This rapid innovation has given rise to new rules for technology pricing, essentially pushing prices down on even brand-new products. On the web, this is something I call the "Law of Free Product Economics," which goes as follows:

If a product on the market can be monetized by any means other than directly selling it, a comparable version of that product will eventually be offered for free.

It's Happened Throughout History

Early newspapers cost money; we paid for the product. But news eventually found another way to make money and simultaneously increase reach: advertisements. Since then, the price one pays for a newspaper or magazine is typically a fraction of the actual cost.

The parallel goes beyond news and content: As the cyberhighways of the 1990s expanded, the most basic, universal software applications (like email) quickly became free. Today, we're witnessing an acceleration of the trend toward free in products both consumer and enterprise.

It Happens Because Of Networks

An oft-mocked cliche of Internet startups is the practice of investors funding companies to build up massive user bases without clear ways to make money. Big networks like Foursquare, Twitter, and Facebook operate for years in the red until membership reaches some tipping point, after which monetization can be "turned on."

Network effects, however, have allowed purveyors of monetizable goods to set various products free in order to entrench users and build barriers against competitors. Google is famous for this. Google Docs, Gmail, Gcal, and a host of other products keep people within Google's ecosystem; the endgame—and what pays for all the free product development—is sponsored search advertising.

Another example, hand-made goods marketplace Etsy, lets its users build free e-commerce web pages, something other sites charge money for. Etsy makes money, of course, via transaction fees when customers buy scarves and mustachioed iPhone cases, but its software product is absolutely free.

It's Happening In Enterprise

Recent innovations have spurred discussion around a concept called "consumerization of the enterprise," or the trend of stodgy, corporate software being unseated by lighter-weight, easy-to-share, cloud-based tools like Yammer. Core to this trend is the "freemium" pricing model. Essentially, software is given away for free with limited features, and customers are charged only for more advanced features or for hosting.

As competition in app building increases, entrepreneurs are releasing better versions of enterprise software—with more features—at increasingly free-er rates.

It's Happening With Various Models

At the end of the day, in order for a product to become free, there must be another means of making money through it. Even in open-source software, monetization comes via donations. The most common ways product developers make money from free wares are the following:

  • Advertising and sponsorship: Content and networks are often monetized this way, though many other products are as well. Think Twitter, Pandora, Words With Friends, and this very website. In many cases, companies will offer to remove advertising if users make up the cost themselves, but the users never have to pay anything.
  • Hosting and storage: Often with SAAS products, users never truly pay for features; instead they pay for bandwidth, disk space, or air time. Wordpress, for example, is free, but charges a few bucks a month to users who want to host their blog on Wordpress servers with a custom domain. Per-seat or per-user enterprise products like Salesforce and Mailchimp essentially make money from data storage and server time, rather than on tools.
  • Transaction processing: As with products like Etsy and PayPal, tools tend to be free in marketplace businesses—both to encourage liquidity and because transactions are easily monetized via fees. There are even examples of this in the physical realm: Square, for one, gives credit card readers away for free in order to amass users, then makes money on transactions. 
  • Services: People will pay for red-carpet treatment, and free products often feed users into monetizable service upsells. For example, open-source programmers often charge for tech support on their free apps.
  • Cross-sells and upsells of other products: Inferior products may be given away in order to warm potential customers up to more lucrative products in a model dubbed "freemium." The Law holds up with freemium because at the top of the product food chain lives the product that cannot be monetized by another means. Everything below that point becomes free in support of the paid product. (Until someone else finds a way to make the premium feature free.)
  • Shortcuts or patience-busters: This method consists of giving apps away for free, but charging people money to jump the line or cheat. Social games like FarmVille are an interesting example of this: in-app purchases become a way to circumvent patience. In fact, at the 2011 Open Mobile Summit, FarmVille’s Director of Mobile said 90 percent of the game’s revenue came from in-app purchases, according to ReadWriteWeb

 

Of course, the existence of free alternatives does not mean some paid apps or games cannot compete on quality or uniqueness or brand. But the economics of an industry change quickly in the presence of the free option, which is quickly becoming a given.

Setting Your Own Product Free

For web innovators, the Law Of Free Product Economics may sound like bad news: You may have spent agonizing months of your life building a product; it should be worth something.

The good news is, parodoxically, giving your product away for free may unlock greater profit opportunities than if you keep it behind a paywall. Wordpress, Dropbox, Evernote, Aviary, Desk.com, and countless other everyday apps all thrive off of giving their core product away for free.

At my company, Contently, our core business is a marketplace (connecting journalists with publishers); however, in the process we've built our dream software tool: a workflow system for managing freelancers and editors in a cloud-based newsroom.

A handful of other companies sell similar tools; all of them charge on a per seat basis, the typical enterprise software approach. Naturally, we like our tool a lot more than theirs, so our first instinct was to make our product even more expensive. However, we realized that meant facing the inevitable fact that someone would one day release a free version, not to mention closing a product we loved off from a large number of people we thought could use it. So we crossed our fingers, and opened our platform gratis.

People go to great lengths for free. They're willing to give you all sorts of information and feedback, and they're often willing to hear a sales pitch for your upsell. (In our case, it's payment solutions and VIP service for big media companies and agencies.). Since releasing the Contently Platform for free, the influx of Fortune 500 brands and big media companies interested in our paid solutions has been, in a word, awesome.

The bottom line is someone will probably one day ship a version your product for free. Maybe it will lack this or that feature you hold so dear, but that won't matter. The broader the appeal, the more likely someone's going to undercut your paid product with a free one.

I say beat the competition to the punch. It's going to happen anyway. And setting your product free may just earn you the most business you've ever had.

[Image: Flickr user John Catbagan]

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17 Comments

  • Andre Heathery

    The Contently Platform isn't free anymore, didn't work out, basically this article is a load of trash.

  • Phillipmarzella

    Using newspapers and TV as examples of advertiser-funded content is not exactly auspicious is it? Those companies sought ratings "number of eyeballs" so much as it drove revenue that they forgot how to deliver value. The freemium model has been around foverever, the free sample, the loss-leader, what entrepreneurs must now work on is how to value add in the long term. No easy task.

  • Alanis2inusa

    Shane, nice article! It's tough to just "give" something to the world that you've worked so hard on, and I hope your work will be rewarded one way or the other! All the best, and congrats on your success so far!

  • Shane Snow

    This quote by Albert Wenger, partner at Union Square Ventures (investors in Foursquare, Tumblr, etc) came in too late for the story, but I thought it was worth including: "Generally what I have been saying is that when possible businesses shouldn't charge for features but for value created by a network. For instance most first generation SaaS companies are charging for use of the features, whereas there are a bunch of next generation companiesthat are charging only for transactions that occur among companies using their services."

  • M. Friedman

    There is no such thing as a free lunch. What you describe is not a new business model but a very old "hope" (or speculation)  that someone else will pay for your lunch. It can even happen, once of twice, but this is not a solution. Misguided.

  • Shane Snow

    Misguided how? Curious to know what you mean. It's true that "free" is always paid for by something. Good point.

  • M. Friedman

    Misguided, b/c in the normal market economy, if you advised someone who had just discovered a competitor with a similar or better product, "go and offer your product for free now; you might win in the long run," such action would be considered as unfair business practice and/or price dumping. Why should the internet economy have different standards? Why is it OK to advocate 'free' knowing that it is not free at all, someone pays for it? Why to support a business model that assumes consumers'  ignorance or laziness as the source of one's revenue? Why to support or write about it, if it destroys value (that is certain) before it MIGHT create some value in the future, if you're lucky?

  • Jimmoffet

    None of these products are free. Facebook isn't free. You're paying for Facebook by giving away your valuable data. You're paying gmail by bearing witness to its advertisement.

    Monetizing things in other ways than direct-sales is not "price dumping". The economy has changed considerably since M. Friedman was born you know... You don't give anything away for free, the mantra is, "if you can hide the monetization from your user-population do it, because you'll have a larger base of people whose behavior you can profit from."

    I think the thing that breaks this economy, with which Uncle Milty would probably agree, is that a sponsored free product economy does not maximize value for the people we naturally think of as the consumers (when in fact we are not, actually, the consumers) and as such we're eventually going to find it to be a bad value proposition.

    Advertising-sponsored newspapers maximize value for their advertising clients, not for their readers and they only compete against other businesses who are also maximizing value for their advertisers. They are competing for our viewership, yes, but indirectly and in a way in which our perception of value is not the one being maximized. Simply trying to get something in front of as many eyeballs as possible is a distinctly different activity from trying to create something that as many people as possible will part with their hard-earned money for.

    Eventually, the market will push say, free email services toward a design that maximizes screen-time and real estate for ads, rather than  one that maximizes value for the user (because the user is not the consumer). Of course they have to maintain users, but the product will be ultimately designed to attract and maintain the largest base of users who are most attractive to the biggest client advertisers, rather than a traditional product where the target demographic is the people who are most likely to see value in the service itself. The difference seems slight, but the difference between your consumption behavior when a transaction is involved (even at a seemingly insignificant price) is wildly different from your behavior when no transaction is involved.

    Freemium and other user transaction based monetization models don't have this problem because the price signal is there and it applies to the transaction between us and the provider. In a freemium model, innovation that comes out of the transactions maximizes the value of the product, the difference between users and consumer-users is much, much narrower and major innovations for consumer-users are likely to benefit free-users over time. Advertising and sponsorship models are based on transactions between third-parties (from our perspective) with entirely different needs, so as users, we should be wary of this kind of model and the value it provides to us, especially when we're thinking about how the value proposition will inevitably be optimized with time.

    Of course none of this applies if you are an advertiser first and a consumer second, but that's not me and they can take care of themselves as far as I'm concerned. 

  • Doyle Buehler

    Great idea! If you look at it from a slightly different perspective, it really is more about society's move towards the concept of "zero", or rather towards a singularity of sorts. Similar to entropy, "Free" implies the root of business, or the zero state of business; from which you can then build revenue in any direction from this state. It really opens up a new world of possibilities with your products and services; a new perspective from "zero". #onebigidea

  • JamielCotman

    Really, all of these are web examples of B2B...well most of them anyway. Savvy entrepreneurs aren't threatened by it in anyway. 

  • Shane Snow

    B2B models often pay for free consumer products, it's true! Google offers tons of free stuff to consumers, who then click on ads paid for by businesses.