Sunday, 8 September 2013

The beginning of the end of free

Or rather the end of you, the user, as the main product of Internet companies. So I'm not talking about the end of the various freemium business models, where you can get some limited version of a product for free and pay for upgraded functionality, but the end of free to use products where revenue is generated from selling advertising streams targeted at the users of those products.

This business model has been the go to approach for many Internet startups and basically goes like this:

"we'll do this cool thing, preferably that encourages people who see/use it to share it with others"

"have to figure out how to keep a low cost of operation because we won't charge people to use it"

"we'll keep doing this thing, adding some new features once in a while to keep people interested, preferably new features that encourage people to share the thing with others"

"and like when we've got x number of users, we'll start selling ads, and the companies buying advertising will love us because we'll have so much data we'll be able to target people really effectively"

The problem has always been that this model doesn't scale, that it's just not sustainable as the go to business model, however much its dominance in the space makes it seem otherwise.

There's a number of reasons why I say free to use doesn't scale, and one of those is literally scale. The first to market with this business model could sell advertising based on smaller numbers. When they said "1 million users" 10+ years ago, it sounded a lot. But now 1 million users, unless it's a really great demographic (either high spending or very niche), is hardly worth mentioning. Facebook have topped 1 billion.

But 1 million active users costs a lot of money to service - so to reach a user count that sounds attractive enough to get big ticket ad buys requires significant ongoing expenditure and therefore ever bigger rounds of investment. And all the time you have to acquire ever more users to even sound like you'll make the investors a decent return - let alone actually make them that return.

Another challenge is the increased number of "need to be viral" players - it just makes for a lot of noise in people's inboxes and social feeds, generating social virii antibodies in the general population, weakening the viral potential. To overcome this requires marketing expenditure (traditionally a no go area for tech startups) and therefore increased cost to achieve a growth rate that is still slower than that of the pioneers.

Increasing concerns over online privacy are also curtailing some of the potential for online marketing, reducing its attraction for those controlling ad buys.

But an even more pressing reason is that people are starting to expect a lot from these services that they pay nothing for, and in particular right now expecting considerable ongoing expenditure to ensure users, particularly younger users, do not experience abuse or other unpleasantness via those services. Now, for the established players such expenditure is relatively easy to fold into the bottom line. But for those still trying to enter the market and reach that scale where ad payback is greater than expenditure it just raises the bar yet further.

Is the cost bar now too high for new startups who want to adopt free-to-use as their business model? Probably not. But it's definitely getting there.


Homyar B. said...

Charging a small subscription fee ensure only 'real' users will sign-up. The question is what is the right subscription fee for any service? I think its best to charge a very minute amount so that users don't have to think a lot of join the service.

Something which is really disruptive, can still follow ad based revenue model.

Richard said...

If free doesn't scale, remind me again how Facebook got 1 billion users? They certainly didn't do it by charging $4.99 or $9.99 per user per month.

1 million users is still a big number if they are paying $4.99 per month. Or if they are all in market for car insurance this month (and therefore worth £50-100 each to a publisher). Just ask MoneySupermarket.

The different models of Facebook and Moneysupermarket have one thing in common. Consumer perception of them is that they are free at point of use. What consumers don't evaluate, because it doesn't directly or obviously hit them in the wallet. In truth, both models cost the consumer, but only indirectly.

And if you start looking at other entertainment markets, then consider Candy Crush Saga and Angry Birds, both of which are free, enormously successful in their field, and have subtley different monetisation models. Have those, along with Facebook, heralded the end of "Free"? I would argue not.

So I find myself agreeing with Homyar. The ad revenue model was declared dead many years ago, and in the meantime Google, and more recently Facebook, have built two of the world's biggest companies on the back of it.