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Business Models based on “free”

A point of departure for discovery driven planning is the selection of a unit of business, which implies a particular business model.  In a recent edition of Wired magazine, editor Chris Anderson created a useful taxonomy of a powerful new kind of business model, in which some aspects of the offering are free to the end user (although someone in the economic ecosystem is making money).  The different models he lists are:

The freemium.  In this model, basic versions of products (such as software) are given away for free, while premiums and upgrades are offered for a price.  The reason that works is that the cost of providing the basic version is pretty low, and the profits made on the upgraded version are substantial.  A clever version of this is currently offered by Classmates.com, a social networking site that provides information about people you attended school with.  I’ve been bombarded recently with come-ons from that site, suggesting that I find out who signed my ‘guest book’.  But to find out this interesting information—you guessed it—you have to subscribe and take out a ‘premium’ membership.  I find that irritating.  And no, I haven’t bought.

Advertising.  This is probably the best known of the ‘free’ models and has formed the basis for many traditional industries, from newspapers to television.  Where advertising dollars go now, however, has been subject to radical change which in turn has dramatically shifted the economic underpinnings of many industries, while creating great wealth for others.  The core idea is that advertisers will pay to get your attention, regardless of the ‘free’ offerings you actually came to consume. 

Cross-subsidies.  These are the traditional loss-leaders well known to retailers.  The idea here is that you give away one product (or portion of a product) in the pursuit of charging higher prices on others.  So money-losing sale offers in the supermarket, low-priced CD’s at Wal-Mart or toasters at the bank are all provided to get you to actually buy the more expensive offers.  The key assumptions to watch for here are that customers actually are open to cross-purchasing.  Not always true.  When Wal-Mart went into Germany, for instance, they discovered (much to their dismay) that German shoppers are happy to engage in ‘basket splitting’ – meaning they will go to multiple stores and scoop up the low priced items only, rather than buying everything from one place.  Wal Mart eventually had to make a rather humiliating exit from that market.  Ironically, business books fall into this category too.  Very few people make a lot of money on business book sales—instead, the real money comes from speaking and consulting work.

Zero marginal cost.  Software distributed over the web and digital music would fall into this category.  While there is a cost to create the initial offer, the cost of distributing it broadly is very low.  Sometimes, the free good is actually a come-on for another item.  For instance, while it may be impossible for a singer to limit the distribution of songs in digital form, they may actually make their money on concert sales (a variant on the cross-subsidy idea). 

Labor Exchange.  In this model, marketers offer you something for free in exchange for your providing information or assistance to them.  Anderson uses the example of Google providing ‘free’ directory assistance because they can use the calls to improve their voice-recognition technology, potentially opening the way to a huge market down the road. 

Gift economy.  In this model, things are given away for free out of altruism or because people simply enjoy doing the work required to create the goods.  The classic examples here would be open-source software and Wikipedia entries.  People voluntarily create and consume the free good.

While there is still room in the economy for premium-priced real goods, the ‘free’ based business models are becoming a force to be reckoned with. 

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