Free is No Substitute for a Business Model

Esther Dyson, former chairwoman of ICANN and now Editor at Large at CNET, was interviewed at the Open Business site about business models for Internet startups.

The point of the interview is that “free” is not a substitute for a business model. However, giving stuff away for free in order to draw enough attention to build a loyal community is a good model.

At one point in the interview, Ether suggests thinking about your business model in two phases. She suggests that you need one model to start developing a loyal user base or community. But, she says, you have to have another strategy for making money that comes later on, in phase two:

OB: OpenBusiness is about investigating an apparent trend on the internet. More and more businesses are throwing themselves ‘open’ in many different ways — for instance, offering free services and content. At times, however, they seem to have no real business models. Yet the social bookmarking service, which requires no payment at all, has been bought by Yahoo! It creates value through the sharing of bookmarks — in a sense an exchange for information — but it’s entirely free of charge and there are no advertisements. It’s all very open, but where is the business model?

Esther: Well, it’s true more and more businesses are being built around openness. I think you need to pay attention to timing. You can use one strategy to get into the market, and then you adopt another once you are established. Few of these strategies are actually new, many of them rely on quite well established business strategies.

I see a lot of startups that are good at the first phase. Then they run into a brick wall when it comes to the second phase. In fact, the free and open model becomes a mental block. Once you start giving stuff away — content or software or services or whatever — whether you realize it or not, a mentality of giving everything away for free takes over. You start thinking, “We can’t charge for that, the community would never stand for it, yada yada yada.”

Smart entrepreneurs are thinking about and searching for ways to make money right from the get-go, even if they are not planning to implement the money-making phase of the model for 12 or 18 months. I think it is important to stay mentally focused on making money right from the start. It prevents you from getting caught up in the insidious mental abyss of believing you must give everything away for free forever.

In the interview, Esther Dyson then goes on to note that the “wing and a prayer” business model (i.e., that you don’t have to worry about making money because some big player will acquire your company) does not work for most startups. She says:

… [R]ight now, a lot of companies seem to be using the ‘get attention from the blogosphere, and then sell out to Yahoo! or Google’ strategy. That’s another attention strategy, but it’s not a sustainable one for most of the market.

Attention is a concept I have used in this context for a long time. Yes, it is basically the kind of currency we usually talk about, but it comes in many different forms, and the strategies to create it and exploit it are consequently very diverse. Some times it’s about preference, or getting people to spend their time at a space you offer. Once you get attention — which may be a brand preference, a community people want to join and stay in, a recognition for your expertise, a software platform people want to use — then you need to figure out how to charge for something related — storage of photos, for example, or programming or training services, or personal appearances, or membership in the community.

I would also add that there is a lesson in the interview for corporations with intrapreneurial aspirations. Today’s Internet business models will seem incomprehensible to traditional-minded corporate executives. For instance, in the corporation I worked in, the rule was that any new business unit had to reach positive cash flow and a profitable run rate within 12 to 18 months. That can be a tall order under today’s open business models, where you don’t even start charging until later on.

Read the whole Esther Dyson interview — it’s worth it. Via Release 1.0.

Anita Campbell Anita Campbell is the Founder, CEO and Publisher of Small Business Trends and has been following trends in small businesses since 2003. She is the owner of BizSugar, a social media site for small businesses.