How To Make Money By Giving Something Away For Free

Free is well on its way to becoming a sustainable business model for companies that make money by giving something away. Beyond the gimmickry and the academic discussion, companies that are serious about testing the waters of Free often benefit from a set of rules and principles important to its successful application.

Stop us if you've heard this one before. A business is giving products away. When a surprised customer asks how the company can make money distributing free products, the answer is familiar: "We make it up in volume."

With more and more companies adopting Free as a preferred pricing strategy, some executives aren't laughing at this old joke so much as they're taking it to heart. Free is well on its way to becoming a sustainable, meat-and-potatoes business model for companies that make money by giving something away.

Software and Web-based companies were among the first to blaze the Free trail, and their successes have become legendary. Flickr's photo hosting. Blogger. Craig's List. Skype. Facebook. And more. But many think these are just the beginning of a dramatic and fundamental shift in pricing, with more traditional companies already jumping on the bandwagon.

Chris Anderson's Free: The Past and Future of a Radical Price (2009) has only served to amplify broader interest in the zero-price phenomenon. Anderson sparked a wide-ranging debate, leaving some critics to conclude that Free is merely a business fad. But the business world has shown a sustained interest in Free, sometimes going boldly where none have gone before. Verizon Wireless, for example, has partnered with HP to offer customers free HP Netbook computers, powered by Verizon software and Wi-Fi services. Meanwhile, books such as Jeff Jarvis's What Would Google Do? (2009) provide provocative glimpses into a future where Free is the norm.

It's one thing to speculate about Free as an intellectual exercise. What if you stopped charging for your products? How would competitors react? How would finance react? What would be your next move? But when the speculation ends, companies that are serious about testing the waters of Free often benefit from a set of rules and principles important to its successful application.

Why Free can't be ignored

For companies in many industries, it's tempting to write Free off as a technology industry trend or intellectual exercise not worth serious consideration. But there are a handful of potent forces that are rapidly changing the marketplace in almost every sector of the economy.

Technology is marginalizing traditional retail shopping

There is a concerted effort underway by many retailers to shift consumers' shopping habits from brick-and-mortar buildings to an online experience. Some retailers are offering products on their sites that aren't available in their stores. Others are offering services online that were previously considered to be the hallmarks of a great in-person experience – consider Levi's "digital fitting experience" for women looking for the perfect jeans.

While these companies aren't necessarily giving everything away online, this shift is creating a fundamentally different dynamic for companies that have been doing things the same way for years.

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Free cars?

Free pricing strategies have made inroads beyond the expected domain of information and technology providers, and arguably businesses with more traditional products and services may be just as likely to benefit from Free in the future. Take one of the largest, most expensive "traditional" items consumers purchase routinely – the automobile. Could cars be free? Here's a quick look at ways it could work:

Cross-subsidy model

Fuel companies give away free cars, with the agreement that the driver uses the company's fuel exclusively. The cars come loaded with software that reports fuel sources and usage to the sponsoring company, and drivers are docked with penalties if a competitor's fuel is detected. In exchange, the fuel company has monopolized sales for an entire fleet of cars, securing a steady, predictable source of revenue.

Freemium model

Auto manufacturers provide free basic cars as teasers, offering options to upgrade to premium models for a fee.

Advertising model

A beverage company gives away a limited number of free cars in exchange for product placements, with the cars serving as mobile billboards in key target markets.

Labor exchange model

Hungry for data to inform the next breakthrough in auto design, manufacturers offer free cars and collect data from the automobiles to inform R&D efforts. As part of the deal, drivers agree to be monitored for driving patterns, energy consumption and the like.

Deferred free

Instead of offering a standard three-year lease on a car, the manufacturer offers a fourth year for free.

Less than free

Manufacturers microtarget key influencers and other valuable demographics and pay them to drive the car on a mileage or usage basis.

The spread of information is generating increased competition

Consumers have more tools than ever for comparing information on products and services. Today, a consumer can walk into a store, point her phone at a product's barcode, and instantly download competitive pricing and product information to inform her purchasing decision. This spread of information on the Web means more cutthroat competition on a range of battlegrounds – especially the battleground of pricing.

Sellers are already injecting the psychology of Free into the market

Stop for a moment and think about all the things you're able to get for free today that would have cost you only a few years ago. Phone calls. Videos. Maps. Product information. Networking for careers, friends, dates and so forth. We take these things for granted today, making it hard to remember what it was like before we had them available at a moment's notice, for free. While it's tempting to say that it starts and ends with information services, it's clear that the psychology of Free refuses to be contained in the "online information" box. Consumers don't live in such a neatly partitioned world. The psychology of Free is already spreading to products and services that we always assumed would cost something.

Demographic shifts favor Free

Every year we hear new variations on the theme of how younger generations have grown up using technology that is still relatively new to older users. Digital media players. Social networking. Smartphones. While it's not a technology, Free has a place on the list as well. Younger users are more accustomed to having free access to television programs, music, videos, transportation services, health insurance and more. They expect a wider range of products and services to be free—not just TV and radio—even as those products and services are subsidized by others. The impact of this generational perspective is only just beginning to be felt in the world of pricing.

New partnership models make Free an option for hard goods products

A physical product is just the most visible link in a long value chain. And while it's the only link most consumers really care about, behind the scenes there is a long list of providers and partners who are rethinking how they can work together to offer more value to the consumer. In some cases, their survival depends on working as partners rather than adversaries.

In the consumer packaged goods industry, for example, where trade promotions rule the day, retailers and manufacturers share point-of-sale data that can open up new opportunities for everyone – not only retailers. And it's not just the current value chain that can spawn innovative new partnerships. Companies that provide aftermarket or complementary goods and services may also have a role to play. All of this can translate into real innovation on the pricing front. Because while the marginal cost of a product may never reach $0.00, free pricing strategies may be within reach through partnerships with other companies.

Increased scale is opening the door to new profit strategies

Where does scale have the biggest impact on the value chain? Who benefits the most? The manufacturer? The retailer? The distributor? Understanding scale in this dimension can change the equation for everyone involved in delivering a product to the market. It can even lead to redefining the current value chain, bringing new networks, platforms or partnerships into the fold that are willing to pay for access to another company's customer base. And that means it's not just the retailer that has an interest in innovating on pricing. In fact, it could be the manufacturer (or the retailer, or another third party with no current ties to the value chain) that stands to benefit the most, changing the partnership dynamic altogether.

Free forms

While Free can take many forms in practice, there are several proven models already in place today:

Cross-subsidies: Loss leaders generate sales for profitable products

Advertising: Advertisers gain access to a larger audience attracted by Free

Freemium: Basic free services are subsidized by others paying for premium services. Flickr, Skype, andThe New York Times all employ freemium strategies.

Labor exchange: Consumers perform value-generating tasks every time they use or access the product or service

Deferred free: Companies drive current sales on the promise of Free offerings at a later date.
Loyalty programs are a common example.

Less than free: Companies pay consumers to use their product. Today, Google is essentially paying carriers to use their mobile operating system.*

*Source: Bill Gurley's "Above the Crowd" blog, www.abovethecrowd.com

Why Free?

Free strategies target the same fundamental business goals as any other pricing strategy. There are several reasons companies have embraced Free as a strategy. Among these:

Drive adoption

There may be no faster way to introduce new products and services than by giving them away. That's one reason cable companies offer free limited trials of premium content to basic subscribers, for instance. Free can also be used to reintroduce consumers to an existing brand, as shown by Anheuser-Busch InBev, which has given away free beer as part of its "Grab some Buds" campaign to revitalize its flagship brand, Budweiser.¹

Nothing is really free. Companies that employ Free strategies are simply transferring cost and value to different parts of the value chain – or to a different time in the revenue cycle.

Build scale and market share

More customers drive more revenue opportunities – and more incentives for others to pay for access to your markets. Free can be a powerful way to build a base of users who could be converted to paying customers in the future. But pulling this lever requires extreme caution. It can erode profitability in the short term while you're waiting for other revenue streams to kick in. Whether this approach works or not hinges on the product strategy itself. Products or services that rely on the network effect to reach critical scale are well-suited to this model. That's why mobile phone operators began offering free mobile-to-mobile network calling for friends and family.

Build barriers to competition

Free can completely change the game for competitors, catching them off-guard and forcing them to rethink their strategies while you gain market share. Along the way, it opens the door to uncharted market territory. First movers who deploy a Free strategy are also at an advantage to negotiate strategic deals that further rewire industry and product category dynamics.

Disrupt the market

Information providers already know how Free holds the potential to upend an entire category. Just ask encyclopedia publishers who are still trying to make sense of a Wikipedia world, or GPS makers struggling to compete with the free functionality provided by Google Maps on mobile devices. For nontechnology businesses, Free holds the same potential, even if it's largely untapped today. Best to be prepared with offensive and defensive strategies that identify potential new sources of revenue and the key partnerships that would have to be in place to make it happen.

Create and sustain loyalty

Consumers who benefit from free products or services have a proven proclivity to stick with their providers for the long haul. For an example, look no further than the airline industry, which deployed a loyalty model that has grown into its own cottage industry – and has been replicated by companies ranging from supermarkets to pharmacies.

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Beyond information

Technology, media and telecommunications companies dominate the list of pioneers in zero pricing due to their ability to use the Internet as a virtually zero-cost distribution channel. But companies in more traditional industries are working to find ways to make Free work elsewhere. Here are examples of companies that are using Free to create business advantage in unexpected places.

Arizona Public Service Company

With renewable energy sources such as solar enjoying a surge of interest among the public, energy utilities like the Arizona Public Service Company (APS) are looking for new ways to harness this interest in the future. But without a large footprint of existing solar users, information on how consumers use it and the impact usage has on providers is scarce. So APS created a program that provides free solar panels to consumers in exchange for rich data regarding usage. The insights gleaned from this valuable information will be used to support the future expansion of solar energy products and services. It may also help consumers overcome their aversion to being early adopters.

Verizon

In the world of consumer electronics, service providers and manufacturers are often joined at the hip, opening the door to pricing innovations. One recent example comes from Verizon, working with HP and Cisco. In an attempt to take market share from cable providers, Verizon launched a promotion that put a new Compaq Mini netbook (HP) or Flip Ultra camcorder (Cisco) in the hands of users who signed up for the company's voice and high speed Internet service. When service is so closely intertwined with physical products, Free can be a powerful differentiator.

The rules of Free

Business leaders tend to have two fundamental assumptions about pricing changes of any sort. First, changes can have a significant impact on revenue, and second, they're enormously complex to pull off. These are doubly true when navigating through the transition toward Free, making it even more important to go in with the right set of assumptions – and to operate according to clearly defined rules.

Free must be part of a well-researched, comprehensive program, identifying both expected outcomes and potential unintended consequences. If your company can pull off a Free strategy, so can your biggest competitor.

Real business value isn't just about money

It's often more about making smart strategic trade-offs. When considering the move to Free, be sure to think beyond the short-term impact on the bottom line and consider what is valuable to your business, in addition to revenue. For many companies, a rich flow of information is one of the most precious resources they have today, whether this comprises consumer insights, R&D inputs or something else entirely. This information, delivered in a timely fashion, gives management the ability to consider and make strategic tradeoffs that were previously made only on the basis of intuition, experience and gut-level reactions. For others, brand value and reputation are the big concerns. Free can deliver real value in unexpected areas, but it can also potentially destroy value if not fully thought through.

Free is about driving value for your entire partner/value chain – not one-on-one transactions

While the moment at which a consumer purchases a product or service is extremely important, there is a broader value chain leading up to that moment – a network of contributors and partners that the customer rarely sees. Make sure that all the participants in the value chain take on their fair share of responsibility—and get their fair share of the benefits—from Free. Doing that requires a clear, shared sense of responsibility from everyone in the organization. One of the biggest pitfalls of promotional programs occurs when the program costs one part of the organization or value chain while benefiting another. A smart Free strategy recognizes who will benefit and spells out how those benefits need to be shared in order to induce the right behavior. Start by finding out if any of your top suppliers are exploring the possibilities of Free.

It's not a free-for-all – it's "free for those who are most valuable"

Many companies have advanced tools in place for identifying exactly which of their customers and prospects are the best candidates for Free pricing. Who's most receptive? Who would be most profitable? Not all Free customers are alike, and their needs may change over the course of the product life cycle. That's where segmentation capabilities come into play, allowing companies to tailor their Free sales and marketing strategies to deliver the maximum impact – and to predict future changes in behavior that might affect their choices today. Be sure your organization has robust segmentation capabilities before considering a program like Free. Without effective, actionable segmentation, the potential benefits from Free become a hope, not a plan.

Give away the wrong services and you could inadvertently train customers to expect more value than you can deliver. Monitoring needs to be formal, consistent and actionable. And the organization has to be ready to take quick action when the time is right.

Free cannot be the sole differentiator

Free must be part of a well-researched, comprehensive program, identifying both expected outcomes and potential unintended consequences. If your company can pull off a Free strategy, so can your biggest competitor. In fact, it can be easy for them to emulate after your first-mover advantage has faded. The long-term success of Free depends on the plan that snaps into place after it's been unleashed. Free is only the opening salvo of a longer-term battle for profitability and market share – not a "fire and forget" program. Nor can Free be done without considering other promotional activities and potential impact to the perceived value of your products or services.

Free has a life cycle

Nothing is really free. Companies that employ Free strategies are simply transferring cost and value to different parts of the value chain – or to a different time in the revenue cycle. Recognizing where products are in their life cycle, how fast those life cycles move, and how your product life cycles compare to the competition's is the required first step in evaluating any promotional activity, but it's especially important for a program as potentially disruptive as Free. As an example, your company may offer a product for free early in its life cycle to drive penetration and market share, expecting consumers to pay for it later, or to pay for a closely related product or service. Conversely, for a product set with rapid life cycles, giving away product that will fast become obsolete can offer a solution for old inventory and, often, actually extend that product's life cycle beyond original expectations.

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Free is not static

When it works, Free alters the dynamics of entire product categories and even industries, often in ways that no company can fully predict. Leaders constantly monitor changes in the marketplace and adapt quickly to keep riding the wave, rather than getting swept away in the undertow. This is particularly important when considering all the unintended or undesirable customer behaviors that a Free program could spur. Give away the wrong services and you could inadvertently train customers to expect more value than you can deliver. Monitoring needs to be formal, consistent and actionable. And the organization has to be ready to take quick action when the time is right.

If you don't do it, don't be surprised when someone else does

Technology firms and information providers have given the broader business world a window into the world of Free, generating valuable insights that can be applied to other companies, regardless of industry. Many signs point to a groundswell of interest in Free in some very unlikely places, and the new adopters of Free are beginning to take these lessons to heart.

This is not the type of change that evolves slowly, giving companies ample time to respond. The first-mover advantage that comes with Free is strong. If it happens in your industry, it will probably look more like a tsunami than a gradual rising of the tide. That's why it can pay to begin planning now – sketching out alternative scenarios, creating contingency plans, or mapping your own course to change the game with Free. Because when the music stops, you want to be sure you have a seat at the Free table.