If “Free” is the New “Paid” Who Wins?

Rewind back 10 years or so, before you were really spending a lot of time online. Pretty much everything you wanted to do required you to pay. If you wanted to call across country, you had to pay the phone company or buy a prepaid card or call collect (and the other person paid). If you wanted a video game or a CD or a video tape you went to the store and bought it. If you needed software, you paid for it.

But the internet was born on the backbone of freedom of information and slowly that “free” mentality has crept into just about everything else we do. We make free phone calls with Skype, create free Spreadsheets with Google Doc's and Spreadsheets, and share photos for free with Flickr. Illegal file sharing has become so easy that we can now “steal” any game, movie, or song that we want.

So what is this resulting in? A new wave of businesses that have given up on charging consumers, and instead focused on generating advertising revenue. EA is experimenting with giving FIFA Soccer away for free, and Ruckus Network is giving away free music to college students. They insist that if they can attract enough eyeballs, they will have a sustainable business model. I am not so certain.

Being someone who has attempted a business model like this with iPrioritize, I understand the attraction and also the great risk. For the sake of argument, let's look at two businesses – the first one is attempting to charge a fee for their service and the second one is attempting to solely rely on advertising revenue.

Both pour equal resources into developing and testing the initial product. However, when the first company launches they immediately start targeting the customers that are willing to pay for their service. The second company is looking for anyone willing to sign up for a free account so they can get big numbers to show off to advertisers. The first company might not generate the traffic that the second one does, but they are immediately producing revenue as opposed to delaying any real revenue until the site is consistently in front of tens of thousands of eyeballs each day.

Maybe the revenue is even equal. But wouldn't you rather have $10,000/month in revenue from loyal subscribers than from advertisers? Even IF you are indifferent to seeing your money coming from 10 advertisers vs. 1,000 customers, you'll have higher expenses (customer service, hosting, etc) because you need that many more registered users to make the same money.

Worse yet, what happens when advertisers realize they aren't getting a return on investment on your site? Odds are they probably aren't now, and the more you bombard consumers with ads the more they will ignore them and ads will likely soon become unprofitable. Losing one advertiser that generates 15% of your revenue is much worse than losing a customer that generates 1%.

From my business experience, I've come to the realization that people will pay for quality, and that those who want everything for free you don't want as your customers. What is a company to do if they're competing against piracy? Create a business model with incentives that make it a better choice to pay than to steal (consider Apple's iTunes).

In the end of the day, consumers get worse products because businesses have a more shaky revenue model, businesses are ultimately forced to rely on the unreliable source of advertising for revenue and focus more time on creating more ad space as opposed to improving the product for the end user, and advertisers end up throwing money at a medium that doesn't generate a return on investment. So I ask, who really wins?