Jan 31, 2009

How can a “business model” exist “out of nothing” ?

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Chris Anderson wrote a great piece called “The Economics of Giving It Away” in which he talks about how, in a battered economy, free goods and services online are more attractive than ever.

So how can a “business model” exist “out of nothing”?

Digital goods can be produced (by crowd sourcing) and distributed (through the internet) at virtually no marginal cost; and so, by the laws of economics, price has gone the same way, to $0.00. For the Google Generation, the Internet is the land of the free and the Google Generation has built a country-sized economy online, where the default price is zero.

This is not to say companies can’t make money from nothing.

How???  The minority of customers, who do pay, subsidize the majority who do not. Sometimes those are two different sets of customers: a few advertisers pay for content so many consumers can receive cheap or free content. The concept isn't new, but now that same model is powering everything from photo sharing to online bingo. The last decade has seen the extension of this "two-sided market" model reach far beyond the media, and today it is the revenue engine for all of the biggest Web companies.

In other cases, the same digital economics have spurred entirely new business models, where a free version is financially supported by a paid premium version.

This model is used by us at STKI. STKI uses the idea of free, as a form of marketing, allowing the product to be used by the maximum number of people, while converting just a small fraction to paying customers. It's an inversion of the old free sample promotion: Rather than giving away one “virtual content” to sell 99, as our competitors do, we give away 99 virtual contents to sell one real personal service.

With products or personal service, samples must be doled out sparingly -- there are real costs to be paid.

With bits, the free versions are too cheap to meter and can be spread far and wide. That's why so many businesses (expensive!) are turning into software or virtual (cheap!), which is why my travel agent is a glorified search engine.

But this year, for the first time since 2001, the overall tide of investment and advertising won't rise. What does that do to Free as an economic model?

From a consumer perspective, it should only help.

After all, when you have no money, $0.00 is a very good price.

Expect the shift toward open source software (which is free) and Web-based productivity tools such as Google Docs (also free) to accelerate.

The new family of computers today is "net books," which sell for as little as $250 and either ship with free versions of Linux or super-cheap old versions of Windows. The people who buy them use online free office equivalents, play free online games, listen to free music, watch free video, and have killed their landlines in favor of internet phone services.

It's a consumer's paradise: The Web has become the biggest store in history and everything is 100% off.

What about those companies trying to build a business on the Web?

In the old days (before September 2008) the model was pretty simple.

1. Have a great idea.

2. Raise money to bring it to market, ideally free to reach the largest possible market.

 3. If it proves popular, raise more money to scale it up.

4. Repeat until you're bought by a bigger company.

Now steps 2 through 4 are no longer available.

So Web startups have to do the unthinkable: come up with a business model that brings in real money while they're still young.

This is, of course, nothing new in the world of business. But it is a bit of a shock in the Web world, where "attention" and "reputation" are the currencies most in demand.

The standard business model for Web companies that don't actually have a business model was advertising. Theoretically a popular service will have lots of users, and a few ads on the side that will pay the bills. But because of the low click-through rates, the price of online ads is falling exponentially and becoming non viable.

What about actually charging people for your goods and services? This is where the real innovation will flourish in a down economy. It's now time for entrepreneurs to innovate, not just with new products, but new business models.

Successful web sites will have millions of people trying the free version, and a sizable fraction of them ready and willing to pay for premium service versions.

Microsoft’s BizSpark program:  Offered in Israel through  Lgilab : A venture fund dedicated to seed internet startups in Israel : In order to contact them: http://www.microsoft.com/BizSpark/   ;  ouriel@lgilab.com   and  http://www.lgilab.com 

Microsoft created Web versions of its business software and offered them free to small and young companies. If your firm is less than three years old and under $1 million in revenues, you can use Microsoft's software without charge. When those companies get bigger, Microsoft is betting that they'll keep using its software as paying customers. In the meantime, the program costs almost nothing.

But extracting a business model from free is not always easy, especially when your users have come to expect gratis.  A year ago, that hardly mattered.  The business model was built with a lucrative exit in mind, preferably in cash.

Now the exit doors are closed and cash flow is king.

Does this mean that Free will retreat in a down economy? Probably not, but it does mean that free is not enough. Web entrepreneurs have to not just invent products that people love, but also those that they will pay for.

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