Why Do So Many People Freak Out When They See 'Free' As Part Of A Business Model?

from the divide-by-zero dept

A bunch of folks have been sending in a blog post by entrepreneur Hank Williams apparently attacking the concept of "free" and blaming venture capitalists, saying that they're overfunding a bunch of startups allowing them to give away stuff for free and distort the natural market. There's a lot of things that are incorrect in his analysis. Let's go through a few of them. He kicks it off by suggesting that it's "inherently impossible to start a small self-sustaining business," though there are numerous small online business owners who would disagree with him. It's not inherently impossible at all. In fact, I'd say it's rather common.

He then claims "in the digital world, advertising, the only real revenue stream, cannot support a small digital business." This appears to be wrong on two counts. First, there are numerous small online businesses that are supported by advertising revenue. But, more importantly, the idea that advertising is "the only real revenue stream" is inherently wrong. Advertising certainly is one revenue stream -- and an important one at that -- but there are many business models where you can make money by leveraging "free" to make scarce goods more valuable. Advertising is one such business model (using "free" content to make someone's scarce attention more valuable), but it's hardly the only one.

Williams then yanks out the old line that "it is very hard to charge when your competition is free." That, of course, is ridiculous. It's the same thing as saying you can't compete. In a competitive market, prices will get pushed down to marginal cost, no matter what (driving out all profit), so businesses that survive innovate, in order to get an advantage above the marginal cost in order to profit. That doesn't change if the marginal cost is $0 or $10,000. The trick is merely in knowing what scarcity you can sell that can't easily be copied. If you're trying to sell something that is easily copied, then you're selling the wrong thing. You have no competitive advantage. That's not anyone's fault but the business owner. In fact, the only fault I'd pin on VC's is if they pushed their portfolio companies to go against these basic economics.

Finally, he says that a bunch of these companies embracing "free" need to die and then "with less "free" floating around, a more regular supply and demand dynamic can take hold." But that, too, is incorrect. The supply and demand curve includes a price of $0, and when the supply is infinite, the supply curve is flat at the $0 line. So, the proper supply and demand dynamic has taken hold: and it says the price should be free.

This isn't to pick on Williams, as others have made similar arguments in the past, and I'm always interested in understanding why people are so confused by this. In the end, I can only assume that it's a "divide by zero" problem. For most of history, it's been shown that people naturally have trouble understanding the concept of zero. We may think we do, but as soon as a zero enters an equation, people tend to freak out and assume a model is broken. Yet, if we trust the model and realize it's not broken -- good things start to happen. Many businesses have learned that they can embrace "free" not because of a bunch of VC funding, but because that's the natural economic state of the market, and it allows them to make many, many other things more valuable. The real business trick is in making sure those things that are made valuable are what you're selling.

Filed Under: economics, free, venture capital, zero

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  1. identicon
    Omar, 6 Apr 2008 @ 2:56am

    Mike: STOP sending out messages like this it's dangerous.

    Firstly: you're right in everything you say.
    Secondly: STOP sending out messages like this!

    The world is full of dumb people - just let them be.
    The more people that understand the 'free' model can be a fantastic way of getting zillions of viewers for your product and charge for a more premium for a slightly better version (and thereby making your profits there!) - the more trouble it is for those of us who DO understand this model!
    More trouble because: then if other people do the same.. then we have to re-innovate and re-invent ourselves and think of more clever and fiendish ways of making money.

    I don't think anyone has pointed the *biggest* and *most* successful free product giveaway model - one that has made billions of $'s: Microsoft!!

    This company, who you may not have heard of, gave away just about ALL their products and charged 30% of the market (for the SAME product that they gave away).
    This company employs some of the cleverest people in the world - yes somehow it's easy peasy to get hold of bootleg copy of their software, install and away you go!

    The same I would argue about Sony Playstation: get your Playstation chipped and *just* copy the damn games!!
    Well... this my personal, unfounded on any factual basis, theory.

    (Mind you: Nintendo have reinvented this model with their latest consoles over the past 2 years: where it's much harder to chip and then play games.)

    So: please stop spreading this message: in fact, just delete your post and let the world be.

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