What sells when everything wants to be free? Identity, security, and utility.

Chris Anderson’s recent book, Free (referenced on his blog), paints a vivid picture of a world where information wants to be free. Anderson’s thesis — that the underlying architecture making it possible to produce digital content is getting cheaper all of the time, making the cost of individual content “too cheap to meter” — means that many things we previously thought “should” cost money are now low-cost or free. Whether this used for a marketing campaign (the “Freemium” model coined by VC Fred Wilson), or as a way of life (Google and many of its free services subsidized by highly targeted advertising), Free as a model is here to stay. So in a world ruled by Free, what sells and why would customers buy those things? Products and/or services that target identity, security, and utility provide sustained value and competitive advantage over free (and Free will eventually adopt these characteristics if it has not already).

Identity is the first building block for maintaining competitive advantage over Free. By Identity, I mean both the ability to authenticate that you are who you say you are (popularized by services such as OpenID) and the ability to authorize certain actions, products or services based on that identity. So far, various services have done a good job establishing online identity on a single site, but they’ve had challenges extending that influence beyond that site. Twitter’s oAuth and Facebook’s Connect APIs are an interesting step toward this goal, but a service that combined these “public keys” with a few “private keys” would undoubtedly be more effective in aggregating the identity model in one place and securing it.

Security is another concept that provides clear value over Free. Although Free models can offer individual privacy and security, they often feature aggregate data mining, which can allow a savvy investigator to link the digital “fingerprints” of that user across multiple sites. Adding an anonymized model to securely access public sites such as Twitter, Facebook, and other social media will allow users to establish a federated individual identity. Today, if you want to enable purchasing through Twitter, SMS, Facebook, or many other mediums you need to either have that purchasing conversation outside of those services or use a web site as a proxy. Having an “agent” or personalized API for your secure information would allow the user to purchase goods, share information, and to have an audit trail that would allow you to track the secure use of your identity information across the Internet (and offline as well).

Utility is the third idea that can provide value over a Free product. I don’t mean to argue here that Free products do not find utility, but that paid products are a signal that certain users find greater economic utility in a paid product over a free product because it saves them time and money that they otherwise would have spent elsewhere. Free products do have this effect, but I think that targeted products have a stronger effect because they are focused on the 20% of users who really find great utility rather than the 80% of users who like the product but don’t see great economic benefit from that effort. Do You Matter, by Robert Brunner and Stewart Emery, posits that great design can uncover this economic utility that fuels Super Users.

What beats Free as a model? Your product certainly doesn’t beat Free unless it offers clear economic utility to a small group of users who will subsidize the rest of the system, or provide enough revenue to run it on its own. Products that can do this offer Identity (the ability to validate that you are who you say you are), Security (the ability to protect and audit your transactions and actions), and Utility (a clear benefit from using your product that no one else offers in quite the same way to those customers. Products that succeed at this don’t necessarily avoid Free — they just also create an alternate model that gives the most passionate users a way to pay some and to get back more than they paid in terms of time, productivity, and success. iPhone/iPod touch is a great example of this model, but now the application providers building applications for that platform are able to make the same divisions in their customer base to market to the masses and to convert the true users to paying customers. And if those customers want something different, try it. As Chris Anderson notes, Free creates a model where “…company culture can shift from ‘Don’t screw up’ to ‘Fail fast.”

What should your business model be: Free, “Freemium”, or Paid Content?

How can you make money off of a free product?
Chris Anderson writes in “Giving it All Away” in today’s WSJ that the classic example is the two-sided model, where a small number of paying customers (AdSense buyers or TV ad buyers, for example) subsidize the vast majority of users (Google or TV) and that is a self-fulfilling feedback loop. More eyeballs == more potential buyers == the highest CPM (if, of course, some of these customers buy the product). Anderson posits that new business models, such as “Freemium” (most users free, some users pay for increased functionality), have exploded in popularity as the marginal cost of giving you more digital bits heads to zero. This is very similar to the Microsoft model of providing you with different models of the same OS, unlocked by different serial numbers. The basic cost to write and build the software is the same no matter who buys it. It’s the revenue end that’s tricky.

John Gourville’s classic article on the resistance sellers face from buyers gives us a few directional ideas on what to expect. The realistic possibilities (absent a very complicated model like Airline pricing where practically everyone pays a different price) for many new and current businesses are free (most likely ad-supported); “freemium”, where the few paying customers support the many non-paying customers; and paid content, where the information is not available unless you pay. Which model should you choose?

Free — where nobody pays, or do they?
Free* is the title of the newest Jim’s Big Ego album. This Boston based group is following in the tradition of the tip jar by providing a version of the new album that you can download for nothing. If you like it, buy the physical album, or simply contribute to the band. Radiohead tried this gimmick last year, and eventually ended it because, presumably, there was no reason to download something from Radiohead that you could get anywhere. Gourville’s premise — based on the research showing that buyers want something three times better than what they have, and that sellers overvalue what they are selling by up to a factor of three — is that something new has to be nine times better than what went before to get. What’s nine times better than free? If you are a world-famous band like Radiohead, it’s probably good enough publicity to give away an album when you are handling the distribution yourself instead of using a record label. But maybe not for your business.

“Freemium” — where the needs of the few trump the needs of the many
Freemium“, or the practice of giving away a version of your product or service for free, is a digital version of the “loss leader” practiced by many brick and mortar stores. Get enough people talking about your product, the theory goes, and eventually enough of them will buy and make up the difference. Your overall average price may be lower, but you have a larger potential pool of customers. LinkedIn and Flickr are excellent examples of this business model, and by segmenting the customer base, savvy marketers can find highly profitable niches (for LinkedIn, it’s turned out to be recruiters; for Flickr, some professional photographers looking for additional exposure — no pun intended). This model, however, hasn’t worked out so well for Twitter, which is wildly popular yet seeking a business model; and Facebook, which should be an ad machine but curiously produces low CPM rates. I’m cautiously optimistic on this model, because the really active, paying users will create the equivalent of the classic two-sided model. The iTunes store shows that if you can price your app correctly, you can be very very successful because the volume of users is so large.

Paid Content — the Holy Grail, but no one really wants it
The Wall Street Journal was the poster child for paid content on the web. The Journal trumpted its paid subscriber base and boasted that it was one of the only sites on the web actually making money through paying customers. Yet a funny thing happen last year: the Journal opened up its pages. Why give the milk away when you can get the cow for free? Obviously the beancounters at the Journal decide that they could make more than the estimated $75m/yearly revenue through ads. So why didn’t the WSJ continue its walled garden?

Tight Niches equal Profit Potential
The Journal opened its walls because there were free substitutes available. From Google News to the Daily Huffington Post to your local newspaper, you can read the news in lots of places. One example of a highly targeted niche is PayBefore, an online resource for the prepaid card industry. This site offers news, opinion, and information to “the prepaid and stored value card industry”, which is essentially a trade magazine online. But no one else is covering this particular trade — hence the profit potential.

So, what now? Which model makes the most sense for my business?
Ask yourself a few easy questions:

  • What am I doing to create, communicate, and deliver unique value?
  • Is my offering 9x (or 10x) better than the substitute people might otherwise choose?
  • Why would users come back over and over again, and tell their friends?.

If the answer to all three of these questions is yes, then you’ve probably got a niche that could be served well by a Paid Content offering. Yet you should ask yourself — how could I increase my reach by broadening the potential appeal — and create a free offering that will seed future customers and provide a feedback loop for growth.

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