Pay Up or Shut Down

Sure, Net companies can attract millions of users by offering free stuff. But who wants -- or can afford -- customers who won't pay? Welcome to the end of the Internet free-for-all.

What should you do when millions of users visit your Web site but don't feel like paying?

That's not a hypothetical question. It's the core challenge facing Internet companies that went all out to attract traffic -- only to discover that they had triumphed in a loser's game. Investors aren't dazzled anymore by vague claims that advertising revenue or cash flow from e-commerce will someday materialize. Unless there's strong evidence of revenue now -- and a clear path to profit -- it hardly matters how many people patronize sites that offer free email, free electronic greeting cards, or free Web-building tools.

Even well-known traffic champions are feeling the squeeze. Consider Egreetings Network Inc., an email-based greeting-card company that went public last December. Last year, 5 million users took advantage of Egreetings's free service, and traffic keeps growing. But so does red ink. And the company's shares have plunged more than 80%.

Companies like Egreetings are trapped by the free-for-all Internet culture that they created. Conduct your own informal poll, and listen as friends and coworkers explain that if it's on the Web, there's no reason to pay for it. People who wouldn't dream of shoplifting CDs or videos feel perfectly comfortable visiting free sites such as Napster and Scour.

Old-timers may grumble, but the basic vocabulary of commerce is changing to accommodate these new habits. And it makes it ever tougher for many Web sites to create a viable business. What can Net companies do to put the meter on -- without alienating their current users?

Some intriguing answers emerge from three recent attempts to turn popular Web sites into paying propositions. In one case, a free Internet-access company has started nudging users to "upgrade" to a more sophisticated service that costs $10 a month. In another instance, a builder of free sites thinks that it has some clever improvements on the oft-tried but seldom-successful strategy of trying to make a free service into a gateway for e-commerce. And in what is perhaps the bluntest approach of all, the German version of eBay's online-auction service abruptly switched some of its key elements from free to fee-based. Its gamble: Even if users grumbled, they wouldn't bolt.

Consider Juno Online Services Inc., which is taking a fresh look at the 2.6 million active users of its free email and Internet-access service. Almost every time those users go online, Juno woos them with ads urging them to sign up for a deluxe version of Internet access. In return for paying $10 a month, users get more dial-up phone numbers, a toll-free service number, and a reprieve from a permanent, floating ad module that is inflicted on nonpaying users. Not everyone wants this deluxe version, but lately, about 50,000 users a month have made the switch from the free service to the pay service. As of June 30 this year, the number of Juno's paying users was up to 730,000.

Getting users to switch to pay services is crucial to Juno's long-term strategy, says Charles Ardai, 31, president and CEO of the New York-based company. Paying customers are handsomely profitable on an operating basis, even considering the extra costs associated with the premium service. By contrast, the bare-bones free service, which relies on advertising revenue to cover costs, doesn't quite pay its way.

Still, Juno has to strike a delicate balance in order to make this migration happen. It must offer a workable, free service to continue attracting new users. Then it needs to offer enough extra features so that the paying alternative appears to be a good bargain. Making that two-tier strategy work isn't easy, especially for other Internet services such as online journalism and event planning. As editors and executives keep learning, either the basic service is so feeble that it isn't a magnet for newcomers -- or it's so good that hardly anyone wants to upgrade.

Juno's smartest insight is that Internet users' habits change over time -- clearing the way for natural migration to fancier service. Newcomers don't use the Internet much at first, and they don't mind Juno's floating ad module when they're online. As people spend more than 10 hours a month online, that minor distraction becomes irksome enough that they will pay to get rid of it. It's the most active new Internet users, says Ardai, who have the best chance of becoming paying customers.

Homestead.com Inc. is trying a different way of making free service pay. The Menlo Park, California-based company has helped more than 6 million people build no-cost Web sites to highlight everything from weddings to fly-fishing businesses. With such a large user base, Homestead has negotiated alliances with companies, such as Amazon.com and MarketWatch.com Inc., that want to be linked to Homestead users' own home pages as "elements." These partners are willing to share future revenue with both Homestead and its individual members.

In this year's first quarter, Homestead rang up just $1.1 million in revenue from all sources. But in May, when the company announced plans to go public, it hinted at much bigger hopes, calling such tie-ins with commercial sites "a unique opportunity for companies seeking to build their brand, attract new customers or distribute their technology.''

If Homestead's strategy works, it will represent a fresh (and smarter) way for high-traffic sites to get e-commerce revenue. So far, free sites haven't fared well with their in-house stores -- mostly because there's no obvious connection between their site's mission and the ubiquitous candy stores that suddenly show up on a corner of their sites. Visitors just don't do much online shopping in such settings.

By contrast, Homestead is betting that its patrons will choose only those elements that truly make sense for their own sites. If so, shopping traffic could be much more significant. And that would translate into more revenue for Homestead.

Of course, sometimes the best revenue strategy is the simplest: Just ask people to start paying you. That's what eBay did earlier this year, a few months after acquiring alondo.de, a leading German auction site. To build traffic, alondo allowed sellers to list items for free -- a much more generous approach than eBay's stateside habit of charging people a listing fee of $0.50 to $2. Like eBay, alondo collected a success fee of 1% to 5% if items actually sold. But if merchandise didn't change hands, German sellers could keep listing it at no charge.

That didn't square with eBay's thoughts about the right way to run an auction site. Listing fees help pay for site upgrades, seller verification, and other services, explains Steve Westly, 43, a senior VP at eBay. What's more, he contends, listing fees help weed out unappealing items, which do nothing more than take up space.

So on February 5, eBay implemented listing fees for sellers on its German site. At the time, 1.2 million items were for sale on eBay Germany. Expectations within eBay were that the policy switch would no doubt shrink the listing tally a bit -- but not dramatically.

To Westly's horror, the German listing count over the next two weeks plunged to just half of what it was -- and kept falling. At one point, the site had only 240,000 items to offer. Sellers barraged eBay with emails complaining that they didn't like the switch. An upstart German rival, ricardo.de, began boasting that it had more items than eBay Germany.

Then the situation turned around. Sellers noticed that a much higher percentage of items on eBay Germany actually sold, because the chaff was gone. So they began posting more merchandise, boosting the total number of listings to more than 400,000. All told, the German site became a bigger money-maker for eBay after the policy switch than it had been before. And ricardo, after a brief run as a high-flying stock, missed analysts' forecasts and was forced to merge with another European auction house, London-based QXL.

For eBay's Westly, the strategic lessons of the German campaign are obvious. "Everyone likes it when things are free,'' he says. "But people need to ask themselves, 'Am I looking for good service? Am I looking for trust and safety?' Doing those things right costs money. We do a lot of things that others don't do, and we've always believed that charging for that is a good thing.''

George Anders (ganders@fastcompany.com), a Fast Company senior editor, is based in Silicon Valley.

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