Wave goodbye to that free lunch

IT Strategy:Free Internet services have long been used by web companies to attract new customers, but many are now seeking to make money out of online sites, writes John Collins

Last year's sale of online video service YouTube to Google for a cool $1.65 billion (over €1.2 billion), after less than two years in operation, was a pivotal moment in the development of web-based business models.

YouTube was one of the more high profile of the emerging Web2.0 services which capitalise on the falling prices of technology and bandwidth to rapidly build a community of users for their free services.

YouTube's statistics were impressive: it was serving up 100 million videos a day, with 65,000 clips being uploaded daily and 20 million unique visitors to the site each month. But one key ingredient was missing. YouTube still hadn't figured out how to make money from its millions of users.

At first glance, giving away your product or service may seem like a fast track to bankruptcy, but even before the stellar success of YouTube, thousands of entrepreneurs were rallying to the Web 2.0 flag and trying to figure out how to make free pay.

Many commentators believe there is only one way to do so - build a community of loyal users and then punt the company to an internet giant like Google, Yahoo or Microsoft.

"Flickr [an online photo sharing service which was sold to Yahoo for a reported $40 million] shows that if you build a critical mass of customers, a bigger player will buy you out," says Dr Willie Golden, director of the Centre for Innovation and Structural Change at NUI Galway.

"As long as there is a primary market for companies like that, many more will go down the free route." Since the earliest days of internet commerce, free services have been used as a landgrab. If the service is considered of value, and particularly if it is one that consumers or businesses are used to paying for, then the viral marketing effect kicks in as users spread the word to friends and contacts. Who doesn't like to share a free lunch?

Golden, who has written extensively on internet business, points out that free services are not actually provided for free: there is simply a different revenue stream in place rather than directly charging the end user.

For example, travel reviews website TripAdvisor gets paid when visitors to its site, which carries over five million travel reviews, click through to book a flight or other service on one of its partner sites. Meanwhile Google has famously built a hugely profitable business displaying targeted advertising to users of its many free services. Other "free" models included charging a subscription for an enhanced service or small one-off payments for additional services.

"It's too simplistic to say it's just a marketing tactic," says Golden.

"For many of these companies it's a sophisticated revenue model predicated on eyeballs," says Golden.

Judy Gibbons, a venture partner with leading venture capital firm Accel Partners, has backed a number of internet-based plays who use the free model.

"What's most important is having a big audience," says Gibbons. "If you have that there are multiple opportunities to monetise it."

She says that any site with large traffic volumes will generate some revenues through advertising, but the key is to have an attractive demographic or a large amount of information on users so that relevant advertising can be displayed to users which will generate a high level of click-throughs.

Statcounter.com, an Irish company, run by husband and wife team Aodhan and Jenni Cullen, has used free services to build a global business.

It has become the 29th most popular site in the US, according to Amazon's traffic analysis subsidiary Alexa, by giving away a service for tracking visitors to websites. It has signed up 1.4 million members, 60 per cent of which are in the US, and funds the service through advertising displayed on the site as well as selling premium upgrades. Statcounter is profitable and pulled in revenues of €1.6 million in the four months to the end of April.

"It's a balancing act," admits Jenni. "We have to actively monitor our costs to make sure we have enough cash to fund the free service."

Josh Kopelman, managing director of US venture capital firm, First Round Capital, got online commentators in a flap earlier this year with a blog post about the "penny gap".

Kopelman's thesis is that it is infinitely harder to get a customer to go from paying nothing to paying a dollar a month, than it is to increase the price from $1 to $2 a month. Both Kopelman and Gibbons make the same point - you will not benefit from viral marketing if you charge for your service.

"There's a dichotomy at work here because if your application or service is compelling to end users you have the potential to grow virally," says Gibbons.

"You will have very low marketing costs and you will build a big customer base quickly. If you stick a subscription in there you forego the opportunity to build an audience, but you will generate revenues."

It's not just internet plays that are giving products away for free. Faced with mounting piracy, the world's biggest publisher of computer games, Electronic Arts (EA), began providing one of its flagship titles, FIFA 07, as a free internet download.

Within months, over five million copies of the online football game had been downloaded. EA makes money by selling add-ons, such as the ability to extend the career of a star player, for a dollar or less. The major obstacle to this micro-payment model is the availability of a suitable payment mechanism. Credit cards are the de facto standard for payments on the internet but their relatively high transaction fees make them unsuitable for micro-payments.

Alternatives such as premium SMS messages or piggybacking on an existing billing relationship have yet to gain much traction. Giving away software for free is nothing new, although rarely are premium products such as FIFA 07 distributed in this way.

Sligo company Infacta, which now employs 14 people, provides a free version of its GroupMail e-mail marketing software, which chief executive Jonathon Hill says is purposely limited in relatively few ways. The software has been downloaded three million times in the last 18 months and 70,000 users have paid from €100-€400 to upgrade it. That's a conversion rate of just over 2 per cent, but Hill says it's been enough to ensure the company has been profitable for all but one of the years since it was founded in 1996.

Infacta's latest service, a free tool for generating online surveys called PollDaddy, is a more mainstream play which is now serving up 14 million polls a month. The surveys can be embedded in the users own website or on services like MySpace, Blogger and Typepad.

"It's a landgrab at the moment," says Hill. "Web services are very cost effective to run so you get a lot of bang for your buck."

The key for the new breed of internet services is trying to lock in their users. For example, if someone has invested days in building a Bebo profile page, surely they won't migrate to a competing service? Golden is not so sure and believes that for teens and students, with time on their hands, fashion is a huge influencer.

"Fashion trends change and move and the waves between them are shortening," says Golden. "The question for Bebo is do their users grow out of it or does what they have invested keep them there?"