ZapThink Startup Clinic: How to Make Money By Giving your Product Away for Free

ZapThink has spoken to hundreds of entrepreneurs at IT startups over the last decade, and occasionally executives tell us they are giving away their product or service for free, sometimes (but not always) as open source. Our response? We ask what their business model is. If their reply is that “free” is their business model, that clues us into what they’re really doing. ZapThink has a word that describes companies that confuse free with a business model. That word is hobby.

A business model, after all, is nothing more than how a company plans to make money. The old dot.com era joke that we’ll give away our product but make it up on volume doesn’t wash in today’s more sober times. You have to make money somehow! However, giving away your product or service for free can be a successful strategy, as long as you truly have a rational business model to back it up.

A core part of ZapThink’s advisory to startups is help with their business models, and those companies with open source strategies or other approaches that include giving away their products or services need more help than most. In this ZapFlash, we’ll give you seven different ways to make money with free products or services. If you don’t work at a startup, then put yourself into the shoes of the customer. Here are the various ways you end up paying for free software. After all, there ain’t no such thing as a free lunch!

Seven Free-Based Business Models

1. 1. Consulting/Professional Services

The most common business model for open source vendors in particular is the professional services model. Download our software for free, but hire us for projects that involve our software. Or for that matter, hire us for any project we’re qualified to handle, even if it doesn’t involve our software, as long as you hire us for something!

While the professional services model is straightforward and well-proven, it presents challenges as well. The consulting business is very different from a product business, because it’s utilization-based. You have so many consultants on staff, and their time is your inventory. You need to sell as many hours of their available time as possible. Leave people on the bench and your inventory spoils. Reach full utilization and you can’t sell any more unless you bring more people on board, which makes it that much more difficult to sell their time once the current project wraps up.

For startups this utilization challenge is doubly complex, because your consultants are likely the same folks who are working on your product development. If the consulting work is good, then yes, you’re bringing in revenue, but the product development suffers. If all hands are working on the product, then they aren’t billing their time.

1. 1. Support

The support-based business model is also quite common in the open source world. Set up support tiers, say with silver being 24-hour email response, gold being 8-hour email or phone response, and platinum being 30-minute response and the right to talk directly to the top techies. The great thing about support revenue is it goes on forever, as long as customers find your product valuable.

For sophisticated, enterprise-class products a support model can make a lot of sense, because customers really need such support and are willing to pay for it. But there’s a problem with the support model too: the perception that if the software were good enough, customers wouldn’t have to buy support, or at least, wouldn’t have to pay so much for it. Your customers may think that too much emphasis on paying for support indicates a product that is too poor to stand on its own. The problem is, customers are correct far too often in this regard, as the market is littered with crappy open source products that were little more than starting points for expensive support contracts.

1. 1. Up-sell

Give away the “basic” or “community” version of your product, but if a customer wants the “full” or “enterprise” version, they have to pay for it as they would any other licensed product. The up-sell approach actually works better with closed source than open source products, because some open source licenses make it difficult or impossible to up-sell your customers to a product that shares any of the code with the free version. But if you’re not trying to be open source, the up-sell can be a straightforward way of bringing in revenue.

The challenges the up-sell model presents include the perception that the free version is of poor quality, even when it isn’t. Of course, if the free version is truly fabulous, then why would anybody upgrade to the paid version? So you have to differentiate the versions clearly and show how the free version is really quite good for something, while the paid version is even better. Furthermore, the up-sell takes time. Customers have to get comfortable with the free version before they’ll upgrade, so don’t expect to sell much right away.

1. 1. Cross-sell

Offer a mix of products, some of which are free and some of which aren’t, in the hopes that people will like the free ones so much they’ll buy some of the paid ones. The cross-sell model is straightforward and proven, but of limited applicability, as your product offering must lend itself to cross-sales. If you really only have one product then the cross-sell approach doesn’t work, or in other cases, what you really want to do is up-sell instead of cross-sell. But if your product line consists of several products and you’re comfortable giving away some of them, the cross-sell approach can be a great way to build buzz and bring in tire-kickers you can convert to paying customers.

1. 1. Eyeballs

“Eyeballs” is a wacky dot.com term for advertising-based business models, typically for Web-based service offerings. Build a Web-based product that is free to your audience, grow that audience, and then sell ads on the Web site.

The advertising-based business model is a numbers game. You need to build an audience, because your audience is actually your product, not the content on the Web site. Remember, your customers are the advertisers, and they’re buying the eyeballs of your audience. The only reason you have content on your site is to attract those eyeballs. After all, that’s why TV networks cancel good programs with low ratings, but keep stupid ones with higher ratings. Ratings mean eyeballs, and that’s what your customers want. It’s OK if the content is poor as long as people watch it anyway. (Now you know why The Bachelor and I’m a Celebrity…Get Me Out of Here! are still on the air).

The challenge with the eyeball model, therefore, is building an audience, especially since you are likely starting with an audience of zero. To make matters worse, if your value proposition for your audience has a social media component, then you have the Catch-22 problem: your audience only wants to participate if enough other people are already participating, so if you haven’t gotten to the tipping point where you have enough eyeballs to attract more eyeballs, then you have to figure out another way to build your audience in the meantime. If you’re past this tipping point, then you’re golden (like Facebook) unless your audience loses interest (like MySpace).

1. 1. Product Placement

We’re all inured to product placement these days. I recently saw Up in the Air with George Clooney, and found myself watching nothing but a 90-minute ad for American Airlines, Hilton Hotels, and Hertz Car Rental. Product placement can work in the software business as well, although usually for business-to-consumer (B2C) products more so than business-to-business (B2B). The videogame industry, for example, has leveraged product placement as a major revenue source for many years now.

The B2B equivalent to the product placement model is sponsorship. For example, ZapThink sold sponsorships for our immensely popular SOA Implementation Roadmap poster, which enables us to give away copies for free or nearly free. Sponsoring software products in the B2B space, however, is uncommon, but that doesn’t mean you shouldn’t consider it in some circumstances.

1. 1. Acquisition

We need to discuss our seventh model because we’ve seen far too many startups with this idea, even though it’s really a terrible model. Build a “business” giving away something for free in hopes somebody will acquire you before you run out of money. Investors hate this model, because it shifts all the risk to them. Just how much runway do you need to get to the exit, and what happens if no suitor comes calling in time? Bad news all around.

The reason this model is on this list at all is because it does work occasionally, so if you have a truly amazing product and some luck, you can end up with a large pot of money at the end. So think of this as the “buying lottery tickets” business model. Yes, sometimes people strike it big, but nobody thinks buying lottery tickets is a good business plan!

The ZapThink Take

The best free-based business models, of course, typically combine two or more of these approaches. Which ones are right for you, or whether giving away your product for free is even a good idea, depends on who your customers are, who your audience is (since with free, these two constituencies are often different), and how much runway you have.

If your investors are looking for you to be in the black right away, or if they are waiting for you to show solid revenue before they invest, then a free-based business model may be too risky. But if you have the right products, the right model, and investors that support your efforts, you can achieve a profitable exit by giving away your product for free. Want to learn more or need help with your business model?