The economics of “Free” as in: you do not have to pay to use it – part 1

Posted on January 3, 2011


There are many aspects on this topic, so there will be more articles to follow over times.

Going through PostgreSQL the other day, learning that it is a community driven development process, where nobody gets paid from any commercial source triggered an old thought I did not put down yet here.

The balance

Economics are about money and a lot of things around that. In this article we focus on either the money you save, or the money you earn.

To build an environment like PostgreSQL, which is in some ways comparable to high end Database Servers like MS SQL Server and Oracle, but then for free has to have some pay-off. For companies to invest money, time and resources in contributing to this environment has to have some other pay off.

Money and time

By NOT buying a solution like SQL Server or Oracle, you save money. To BUILD your own database solution costs time.

If you have no money and enough time, the logical choice is to build your own solution. If you then share that solution, others might come in and start contribute – without you having to pay their salary. Hence the simplified model of “open source software that is made available for free”.

There is another part:

Sales and cost per sale

If you build a commercial solution, it will cost you time and money to sell that solution to the market. You invest a lot, before you start to earn: in advertisement space being bought, sales people being paid, time being lost, rent being paid. On average the time you start having a Return On Investment is about 18 months. In other words:

Each client costs money, before they bring money

This is a very hard rule and very easy to forget if you only look at the companies and businesses that thrived and succeeded. You need to invest. A lot. Nothing comes for free. Even when it is software downloadable from some online source.

From my own experience, using Google Adwords and offering my own free service called “DocumentShare”, each customer that stuck had cost me about 20 euros on advertisement. Not taken into account the cost of time invested in building the software itself due to revenue not made on other projects.

I might as well had started a program of “bring in a new user and earn 5 euros when he stays and uses the software” to each of my users as that would have probably been much more cost-effective.

By making a product – which has no cost on materials and can be copied limitless – available for free you do a similar thing: you “give money to your customers” to save money on advertisement.

If your product is successful, it will establish a group of users which will know and understand and advocate your brand by stimulating others to use it. So instead of investing 20 euros per conversion (= a new customer) you simply use peer to peer advertisement and a low threshold for customers to become yours.

If your strategy (product, placement, quality, support, visibility and usability) is successful, you also save a lot of money on the overhead that is brought in by marketing / sales.

The return on investment on “Free” products

There are many ways to make a profitable business out of “free” products. (“free” instead of free as in – it cost money to produce it and it should generate revenue via other means).

  1. Via services connected to the product – what was how the guys from MySQL made their money. You need people to build stuff with what you created. And – how surprising – your people (since they createt the product in the first place) are first class experts.
  2. By selling your expertise – Either by solving problems for others using your products or giving training or seminars or whatever you have
  3. By selling the data you collected – Which can be very relevant Marketing Research information that your (potential) clients would never find anywhere else with that reliability for the price you can offer it to them. Which can be via an API usable for others to get access to very specific information
  4. By selling access to your audience – Be it advertisement, direct mails or plugging products to specific subgroups in your audience, offering a much higher effect on advertisement money otherwise spent elsewhere.
  5. By the new markets that emerge – In some cases, like the Internet itself, entire new industries emerged. From 1994 and back, a “web agency” was close to impossible to find as the industry did not exist. A “programmer” worked at a bank or a insurance agency but hardly as a freelancer or three man company, building entire e-commerce systems for a client somewhere in the world from the bedroom.
  6. By not spending the money yourself – Especially when you move to enterprise-type of solutions, you will find price tags of 200.000 euro and more. When you feel that you can build a similar solution for half the price that does EXACTLY what you need but better and faster, the money is earned by not spending it. This is how many home-brew solutions come into the world. Sometimes released to the world for free – as there is nothing to lose anyway – leading to industry-shifting solutions like Linux, PostgreSQL, Apache and MySQL.

Why “Free” can be a better strategy

In marketing, the time you need to reach a specific target is one of the most important factors. Offering products for free, or almost for free can speed up the process of reaching those customers and make them yours. This is vital for the following reasons:

  1. Your competitor is there too – so if you are too slow, you lose a potential client or even a potential market
  2. You invest before you earn – each day of your existence costs money and the bigger your enterprise is, the more money you spend. So the longer it takes before your investment starts returning money, the greater your debts become and the bigger the chance that you end up with a failure.
  3. More clients (or users in the case of the web) means more traction – The larger your customer base is the more you can get done. So the longer it takes to get that client base, the longer it takes before you really can start doing stuff. You can get more things done either by:
    1. Earning more money by adding supplementary products – for fair prices, leading to more sales over larger groups of people you would have reached with other strategies
    2. Starting pre-sales on stuff you are working on now – leading to a better indication of potential success than marketing research, gut feeling or experiences from the past
    3. Getting access to places and people you would otherwise have never gotten – for instance: your free product is so good, cool and/or successful that you build up the same levels of trust to companies as the “old ones” did by advertisement, repeating sales visits using less time and less investments. This leading to sales of other products or services you have to offer.

As said: “Free” does not mean “giving everything away and expecting nothing in return”. It is much more like “sharing the stuff that you are not afraid to lose, to reach a bigger audience and be able to do more in return”.

Why people contribute “for free” to a “Free” product or service

People contribute because there is some reward in return. (With software) this reward can be:

  1. To be recognized as a “special” somebody – because you are the first, because you understand and use and even can milk the social consequences of being the first, somebody special, some kind of super star
  2. Because they were helped before and their contribution will help others – like some kind of “payback” but also a warranty that the system that helped them benefit will stay alive and even grow in size and usefulness for them
  3. Because the return on investment is greater than the investment itself – If the payback on their investment is fast or almost immediate and grows in value and the result helps them benefit in other fields (like building more robust software or being enabled to also do “that thing” that was not there before their contribution)

Why it fails

A “free” product is very much dependent on its community. The community is what makes the value to and for all involved. When looking at software products which are Open Source, or looking at social communities we and our friends live on – when the community starts to fall apart, the product itself is soon to fall down into abandonment by the many.

The fall of a community does not have to be the end of the product. It will bring that product into a very hard place: where the fame and stardom has withered and most stars either become drug addicts, commit suicide, go crazy or disappear into obscurity.

The long tail

Only the few that stay true to their original goal will get through that period and might even find the space to innovate and re-invent themselves.

Posted in: Free