Free – the Perfect Business Model?

A wise person once told me that if something wasn’t worth paying for, you didn’t have a business model to build on.  I don’t think he was really choosing a side, but instead he was telling me to focus on value building, as value leads to revenues. This brings me to the discussion I keep seeing around the free vs. paid content debate.

Does free = fail? Or is free a key part of any marketing strategy?

The topic of “free” is in fashion now due to Chris Anderson’s (editor of Wired) book Free: The Future of a Radical Price that just hit the shelves. Malcom Gladwell, of “Tipping Point” fame has chimed in, in the New Yorker, and the Techdirt teams have their own debate about the value of YouTube, the bandwidth black hole, as a free service, here.

What is the Purpose of Free?

While I do believe that free doesn’t guarantee you success, it has some very attractive properties worth looking at. Powell’s Books has an excellent summary here of Anderson’s book pointing out the six key categories of free that he identifies. From the Powell’s Books’ summary:

• Freemium: Free Web software and services, and some content, to users of the basic version. (Think Flickr and the $25-a-year Flickr Pro.)
• Advertising: Free content, services, and software to an audience that advertisers will pay to reach.
• Cross-subsidies: Give away any product that entices customers to pay for something else. Example: It’s a free second-gen Wii But only if you buy the deluxe version of Rock Band.
• Zero marginal cost: Anything that can be distributed without an appreciable cost to anyone, like online music.
• Labor exchange: Performing tasks to gain access to free sites and services.
• Gift economy: From Freecycle (free secondhand goods) to Wikipedia, money isn’t the only motivator.”

On one level, these points seem like common sense and represent tried and true marketing tactics for struggling musicians, artists, videographers, affiliate marketers, and business people in general. Who here hasn’t heard of the phrases “prove yourself”, “build some credit”, or “develop an audience” mentioned over and over again? Nothing is really free, as business types often give free advice, create comps, or do some pro-bono work in order to land a deal, develop a relationship, or generate fans.  What’s key about the six categories above is that Anderson lays out a foundation and framework for leveraging free for business.

A Free Model

To put matters into perspective, I’ll add another layer of discussion based on Malcom Gladwell’s piece. In his New Yorker article, Gladwell digs into Anderson’s YouTube analysis that it costs $0.25 cents to stream 1 hour of video to a user this year. In his book Gladwell sites a Credit Suisse estimate that YouTube will lose close to $500 million this year for that “free” service.

My view is that the YouTube “free experiment” deserves much more credit than what Gladwell has given. I’ll propose a simple model to get the brain juices flowing:

If the average YouTube clip is 1 minute, and it takes seven views to make a habit, or seven minutes of video, the streaming cost for acquiring that customer is 7/60*$0.25 = ~$0.03. So how many opportunities can you name where you could acquire a customer at $0.03 for an “eyeball” acquisition and seven  minutes of attention?

If that user spends 70 minutes in a month on YouTube, then it costs <$0.30 for that user for that month and the equivalent of 70 potential impressions. IF, and only IF, the goal was revenue by advertising, a CPM of $10 over those 70 impressions would represent $0.70 gross.  By leveraging YouTube’s brand equity as the Internet’s default video provider, its “free service” could easily be modified into an ad platform without degrading the user experience. Even in my simple model YouTube might break even.

Leveraging Free

As it turns out, YouTube is on track to do just that according to the Financial Times.

So YouTube appears far from the $500 million in losses that Gladwell cites, but then what?  The free video service provides a cross-subsidy to the main Google cash cow, search, while providing the largest searchable video inventory and yet another mechanism to connect with and develop relationships with armies of advertisers.

In this case, the YouTube free service has not only shown value to uploaders, viewers, advertisers on a direct basis, but has also helped solidify Google’s place in video while providing value to Google’s existing advertising base and shareholders.

So is Free the Perfect Business Model?

I would say “no”. Despite YouTube’s apparent profitability, its position as an industry standard really does skew the equation. However I’d add that “free” should be a key tactic in your marketing arsenal that, if leveraged correctly, can have several real revenue and strategic upsides when truly applied with a revenue motive.