• by Steve Smith , Staff Writer @popeyesm, November 28, 2007

With prospectors panning for gold in everything from music to telecom, Steve Smith takes a look at the hidden costs of free

Free lunch? What's the catch?People seldom trust the offer of something for nothing. When the new music service SpiralFrog tested its ad-supported free download model with focus groups, consumers met them with suspicion. "Everyone was looking for the catch," recalls senior vice president of marketing George Hayes. And consumers, with their inherent skepticism, are quite right in questioning free. Just as at spiralfrog.com, where the music expires after 30 days without a re-visit, there always is a catch. After all, even in the promised land of low-overhead digital, somebody is going to have to pay for all of this.

People seldom trust the offer of something for nothing. When the new music service SpiralFrog tested its ad-supported free download model with focus groups, consumers met them with suspicion. "Everyone was looking for the catch," recalls senior vice president of marketing George Hayes. And consumers, with their inherent skepticism, are quite right in questioning free. Just as at spiralfrog.com, where the music expires after 30 days without a re-visit, there always is a catch. After all, even in the promised land of low-overhead digital, somebody is going to have to pay for all of this.

And it's no longer a guerilla concept (aka stealing). Where free once meant a consumer uprising - Wavy Gravy shouting, "It's a free concert from now on, man," from the stage of Woodstock after the fences around Max Yasgur's farm had come down, or Napster starting from a dorm room - there are now serious business models in place. Keep in mind that the "free" concert at Woodstock went on to gross $50 million at the box office just from the film that was made of the event, though not, of course, by design. Now there are designers.

As Chris Anderson explains (see interview, pp. 36), the free model is really about monetizing goods and services differently - give some thing away to charge elsewhere. But there may be subtler costs to a rampaging giveaway model that redefine many parts of the value and marketing chain. How does free change the way businesses are conceived and executed, for instance? How do free models shift power to consumers and to advertisers? And how does zero pricing change our notion of product quality and value? The downward pricing pressure that digital culture asserts on all goods and services is only beginning to show just how deeply disruptive it may be.

The proliferation of the free-to-consumers model has been very good at grabbing headlines and piquing consumer interest. We are all fascinated by the prospect of free.

Former SAP CEO Shai Agassi attracted $200 million in funding for a plan that would subsidize the cost of electric cars by selling drivers subscriptions for the electricity. The band Radiohead got buzz and 1.2 million Web site visitors in October by letting consumers pay what they wanted for its new digital album, In Rainbows (62 percent wanted to pay nothing). Both Pinnacle Software and Microsoft recently launched substantial but free software packages (VideoSpin and Works), and Google continues to offer increasingly sophisticated Web-based spreadsheets and word processors at no charge. This year's heavy metal Ozzfest tour boasted zero-price tickets and didn't even pay the participating bands. The plan was to make money by selling the audienceto sponsors and also on merchandise sales at the venues.

Clearly, free can work in the way it is intended by many media companies - as a way to increase reach. When mobile ad network Rhythm New Media launched fully ad-supported mobile video on the 3 UK network (even paying for consumers' data charges), it reached 25 percent penetration in six months. "I would claim there is not a service in the history of mobile with that ramp rate," says CEO Ujjal Kohli.

For the short term at least, many companies in the media sector simply are going to have to make free work, because digital culture has exalted the model. Even the music industry, a notorious litigator against consumers who pirated music, is now entertaining new models like SpiralFrog, which offers free ad-supported downloads of copyrighted Universal Music Group tracks. "They came to the realization that a couple of generations out there expect their music to be free whether they have a conscience about it or not," says SpiralFrog's Hayes.

But it is not just kids seeding BitTorrent files: Well-paid doctors are looking for journal articles via Google and going to ad-supported professional destinations like Medscape. And so, against the prospect of cannibalizing a lucrative journal business, Elsevier just put a large layer of its high-priced medical content into the free OncologySTAT site, which hopes to sell pharmaceutical ads. "This is an absolute must for us to do," says senior vice president and site publisher Monique Fayad. "The potential upside and need to learn had to overshadow the fear."

The Burn Rate of Zero

Free is a simple model for consumers but it actually introduces new business wrinkles and threats into a range of companies. The immediate downside for start-ups using the no-pay model is that there is no visible revenue stream until they nudge countless competitors out of the space, build critical mass, and then - only then - find a way to monetize the crowd. Even massive freebie successes like YouTube and Skype have only gotten one or two pieces of this equation down yet.

Fee-based VOIP companies like the deceased SunRocket and struggling Vonage leveraged digital economies to lower prices radically in telecom but not to create profit. Much like the first dot-com gold rush, the free and near-free models may invite too many start-ups making substantial bets with other people's money. "It's a big problem," says Eran Arbel, cofounder of Pudding Media, which proposes to insert ads in and around VOIP conversations to fund free calling. "The model for many companies is to burn investor money in order to hopefully monetize it in the future. It is not sustainable," he says.

Surprisingly, the high cost of scaling a no-pay audience may give larger, older companies an advantage over those nobly disruptive start-ups. An Elsevier, a Microsoft or an NBC can amortize their big investment over that many more platforms at once. In just two years, networks like ABC and NBC moved from $1.99 per-episode fees on iTunes to flowing much of the primetime shows free online. "It favors big media," says Leo Kivijarv, vice president of research at PQ Media. "They are at the forefront of generating more dollars online than the pure plays."

Ultimately, free is not free. The consumer often pays at some point and the content provider must manage artfully when the sub walls go up and down, defining what does and does not have monetary value.

Elsevier's OncologySTAT will let doctors access free journal articles only through a search engine, because the company contends that browsing full issues is an experience for which doctors should pay - even for the same content. Otherwise free, Pinnacle's VideoSpin charges users incrementally for each new advanced tool they access - pay-per-feature pricing.

Mobile media provider Kohli foresees a music model where artists release 25 songs but only charge for the two most popular and let the rest go for free. "To handle cannibalization you will need strategies to manage some content people are willing to pay for and others that are ad-supported only," he says. Free ain't easy. Or simple.

Nor will it be simple for consumers, who still need to ascribe some kind of value to things like media in order to feel invested in any single provider. Early, free social networks like Friendster and Xanga discovered that low barriers to entry also became low barriers to exit - to MySpace and Facebook.

The fierce competition among free online calling start-ups created tremendous instability for companies and consumers. "When we talk about 100-percent free, then it is not sticky," says Arbel of Pudding Media. But we are seldom talking about truly free. It will be incumbent on free media to create new definitions of value in order to ensure loyalty. Skype, for instance, is introducing mobile phones and gives people static phone numbers to keep the entry level low but the exit level higher.

The music industry saw its product demeaned and devalued by free-for-all piracy. SpiralFrog is trying to redefine value not by giving away downloads but having them expire in 30 days unless the user returns to the main site to get his dose of ad exposure. "That is the price you pay," says Hayes. "It just isn't a monetary price."

But a big unanswered challenge for these companies will be making non-monetary pricing defensible
in an environment of relentless low-cost start-up competition. Also unclear is how consumers will respond to the confusion of multiple revenue models, transitory providers, non-standard content restrictions and free-but-oh-not-really-free deals. Will free really be worth all the grief?

How Much Free Can We Afford?

Most of the free-to-consumer business models rely on (or dream about) marketing partnerships of some kind, which could extend the influence of advertising immeasurably, even uncomfortably. Suddenly a software seller (Pinnacle) or medical publisher (Elsevier) has to grow new brains and businesses for ad sales. Are we all to become media companies now?

Beyond the usual hurdles of moving a business outside of its core competency, free models raise a host of ethical and economic issues when they let advertising drive revenue. Chris Anderson admits media companies may have traditions of church-and-state walls between product and sponsor, but do telecom, airlines, software developers? Most online media buyers already understand that the hungry young start-up sites and Internet TV "networks" are the place to go for the deeper product integration that would make a major network balk.

To get their money's worth from the many niches that free business models serve, marketers will need to get closer and become more tightly targeted to consumers than ever before, perhaps to an uneasy degree. The prospects are dark.

Will mobile carriers give up personal calling information or airline travel details to marketing partners in order to subsidize their product? And how intrusive does the targeting and advertising become when advertising is the primary patron of so many industries? For instance, Pudding Media's Internet calling system monitors conversations for keywords (movies, food and so on) that will trigger promotions that surround the Web-based phone interface. Pudding's Arbel assures users that the automated system is not listening to or recording conversations. But is this a value add for consumers, or just a sign of the creepier ways that targeting and ad placement will play out in the land of free?

Every industry wants a piece of a limited marketing pie, and there may not be enough to go around, says Beth Comstock, NBC Universal's president of integrated media. "I'm getting to the point where I feel like every answer to every business development pitch is 'We're going to be advertiser-supported,'" she said at a recent conference. "It's not going to be possible."

Some in the industry counter that the same cries about a limited pie met cable TV and the Internet. But marketers will always need to meet their targets and find new money or budgets to do so. And yet, tying a range of new businesses to ad spending could introduce new and foreign wrinkles into business planning.

We don't know yet whether the marketing pie is elastic enough to support all of the proposed new needs of free models, says Peter Winkler, senior vice president and chief marketing officer of Teletrax, which tracks video content for broadcasters. "The next time we see a significant ad recession, a lot of this theory will be put to the test," he says.

Attention Deficit Disorder

The Internet may well have been the culprit: It trained consumers to expect evermore media, goods and services to go free. But at the same time, digital media helped make more explicit the implicit relationship between producer, advertiser and consumer.

We have always traded our attention to advertisers in exchange for content. But online, registration walls, browser cookies and even some early attempts to convert banner ad viewing into e-commerce credits brought that quiet relationship to the surface and even handed us more control over it.

And as the Internet's free model proliferates to new goods, the models explicitly make consumer attention a tangible commodity that they can trade in the marketplace. Companies that pursue the free model most aggressively actually tag your time with a real price. "The general value is one minute of your time for one minute of airtime credits," says Scott Kelleher, director of mobile advertising at Virgin Mobile. Virgin's novel Sugar Mama project awards free cell-phone minutes to over 450,000 registered customers in exchange for viewing and rating online promotions from brands like Pepsi and Xbox. "They took to this much more rapidly than we anticipated," says Kelleher. "They are a very savvy generation and the proposition is that their attention is of value."

In an economy of free services subsidized by marketing efforts, one's own attention, one's personal data, becomes the coin of the realm. The consumer is not only empowered to make choices but perhaps to become an active trader of his eyeballs for all sorts of content and services. The basic relationship between advertiser, producer and consumer can change as a result. "We sponsor the user," says Barry Soicher, president of AdPerk, a start-up that awards visitors free issues of Popular Science and Dwellmagazines in exchange for each minute they watch videos. As Soicher rightly observes, the model re-positions the user in the eternal media triangle, with the potential for advertisers to sponsor a user's consumption of media. "He can say I will watch this when I want and offset my media costs. That is a big shift right now."

What is shifting is not just monetization from one product to another. The no-cost approach also has the potential to reorganize the basic relationships among advertisers, producers and consumers, but no one knows yet exactly how. Anyone can become a media company here and leverage free to create the massive audiences marketers need.

Advertisers could gain greater control themselves as more industries rely on marketing partnerships to underwrite costs. And the consumer himself becomes something of a free agent, a master of his own data and attention with which to barter more explicitly on the market.

Not only will this lunch not be free, but splitting the hidden costs could be a real pain.