How FREE can kill innovation & your startup

June 4, 2009 at 5:21 pm | Posted in Sofware Startup | 2 Comments
Tags: Entrepreneur, free software, innovation, pdx, SaaS, startup, web 2.0, web applications

A strange dynamic has taken hold on the internet.  Just as people expect sunshine and air to be free, they also expect internet based software applications to be free.  Ok, maybe not completely free… they agree someone should pay, just not them.  Damn you Google, damn you Yahoo! why did you do this to us?

With companies left and right offering full versions of their products for free,  users have been conditioned NOT to pay for anything.  This conditioning can be seen across everything from social media sites to messaging to business applications.  The problem with this as I see it is the negative impact on innovation.

Users think that they win by getting free software or services, but do they really?  If you ask me the only real winners in the free ecosystem are the investors behind well funded companies.  By locking down markets with free offerings companies can effectively prevent new entrants from emerging.  This stifles creativity and innovation.

In a meeting a few months back with a partner from Benchmark Capital, I found out that on average they see 3-5% conversion rates on FREE offerings within their investment portfolio.  For most of us this is rather daunting news.

Let’s do some quick mathematics.  Let’s say that you are getting started and you have 2 servers from Amazon Web Services (1 web server/app server and 1 db server). Your monthly cost is going to be around $200.  Let’s now assume that your multi-tenant application can handle 100 accounts on that server, simple math $2 per account cost.  Now you go out and offer your service FREE and you have some success.  Let’s say you sign up 1,000 free accounts.   You scale your costs linearly so you are now spending $2,000 a month to support those free accounts.

You get 5% to upgrade (eventually) to your paid account of say $20/month – at this rate, even with success it costs you $1,000/month just to keep the lights on. Now add to that your Google Adwords budget, your credit card processing fees and the dozen other bills you have each month and you find yourself quickly in the hole by several thousand dollars a month.

Now what happens if you get slash dotted or an article about you ends up on ReadWriteWeb?  Your monthly costs can zoom beyond your meager savings account, all without any real revenue in return or an endpoint in sight.  The end result of your short term success will be the failure of your start up because you ran out of money.

There is also another aspect of the “FREE” account that costs you time and money.  To support a layer of free accounts you have to write code to restrict or to compartmentalize your solution.  This takes your valuable development resources and shifts them from building killer technology to building layers of management so you can support the free users.

I just heard you shout…”But David, you must have a free version or no one will use your software!” I disagree my new friend.  If you look at the Salesforce.com pricing page they don’t have a free model. Neither does Netsuite. These companies are in business to make money, not give away software.  I like this model and hope to see more and more start ups follow it.   At my start up project MioWorks.com, we are holding to this model and offering a free trial to introduce users to our software.  I feel this is an acceptable compromise because it has a definite end period and you don’t have to over-provision your computing environment to support thousands of free accounts in perpetuity.

As for you users out there, don’t be shy to actually pay for something you like to use.  You don’t think twice about dropping hundreds on a camera but you won’t spend $20 a year to store and manage your photographs in an online application.

In the past year or so, Apple has shown us that users will actually pay if the paradigm is broken.   The Apple AppStore is a great example of how to break the cycle and get users to  pay for technologies.  As entrepreneurs we need to watch how this model is evolving and how we can capitalize on it to help fund our ideas and companies.

My last word of advice helps both the user and the start up.  Users, if there are vendors with products you just love but they are too expensive, then tell them.   Tell them the price point that would be of interest to you.  Tell them how to get your business.

The end result of spending money on products you like will be a wider variety of products with more and more innovation.  And who doesn’t like variety! Maybe Google.