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June 24, 2005

Nerd CEO – The Three Rules of Free

Today’s three rules are for those who want to be in the business of establishing a new category by providing free goods or services via the Internet.  This is an exponential-curve hit business.  The vast majority who try it will fail. The success of the few is spectacular.

Used to be we offered “free” stuff to people who sent  a self-addressed stamped envelope (S.A.S.E).  Today we send free stuff to our customers and prospects via our Internet connection and theirs, usually at no incremental cost to either of us.

Blogs are an example of this distribution.  You are reading this post via TypePad’s Internet connection and a connection you are paying for.  There is no incremental cost to me for an extra reader (someday TypePad says it may charge for bandwidth consumed but it doesn’t today) and it is likely there is no incremental cost to you to read another blog since you probably pay a fixed monthly rate for your Internet connection.  If it weren’t for the Internet, I’d have to either charge you or ask you to send S.A.S.E.s (or publish in print media as I once did).

The virtually friction-free Internet has largely taken incremental cost out of the information distribution equation.  And, of course, “information” includes entertainment, software, and even some services.  Services?  Sure.  When Skype provides their free computer-to-computer phone calling service, they are simply enabling you and whomever you’re talking with to exchange information – your digitized voices -  at no incremental cost via the Internet.

Yahoo rose to Internet stardom at the start of the first Internet bubble by providing free-to-the-consumer search service.  Their position as the leading provider of this service allowed them to monetize the service via advertising.

Coincident with the rise of the Internet, Adobe succeeded in creating a market for its document creation capability by giving away the Acrobat reader via Internet distribution.

Napster succeeded for a while by giving its software and other people’s music via Internet distribution.  Also Kazaa.

Skype is attempting to monetize its position by selling ancillary calling services.  They may succeed because they are the leading provider of a “free” service.

So all you have to do is give stuff away until you attract enough takers – eyeballs – and then go public, right?  Not!  The twin lessons of Internet Bubble One are that the free strategy CAN work spectacularly because of friction-free distribution via the Internet AND that the free strategy USUALLY fails.

The winners have three things in common:

  1. They lead their category;
  2. There is almost no incremental cost to them of providing another unit of whatever it is they give away free;
  3. They change the way their users do something which is significant to the users.

The losers fail one or more of these three tests.

Wednesday I blogged about calculating the value of “free” promotions used to acquire prospects.  That is a linear bread-and-butter business where many players can succeed and where neither success nor failure is spectacular.

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