The myth of free and other weird pricing issues

In the last few years, there has been a noisy group of people arguing that many things should be free as in beer. Later today, my colleague R ‘Ray’ Wang, partner at Altimeter Group will be offering his Tuesday post on the subject of ‘free’ software. It’s ironic as I’ve had one in mind on the same and related topics for several days. I don’t know what he will say but here is my take. It all started when I saw this post Free as in What, Exactly.

Two recent posts crossed my blog reader on the challenge of value versus cost. Now that so many content creators are taking approaches similar to free software via unconferences and creative commons licenses, we need to remember that “free” in these case does not mean without value and does not have to mean without cost.

The writer then goes on to to try tease out what innovators in the marketing space (yes there are some) are trying to do in their quest to establish fair value. Referring to Chris Brogan, a marketer I know moderately well and admire, and Amanda Palmer, an artist I don’t know at all, the author says:

Amanda and Chris are both in a difficult position, trying to demonstrate consistently the value of something intangible and make their living from it. Both demonstrate that stepping into new territory – experimenting with new revenue models, new ways of sharing value with communities, and new ways of interacting with audience(s) around intangibles like art and knowledge – isn’t some magic path that enables you to avoid all the thorny questions about value. If anything, Chris and Amanda are leaping headfirst into the storm, trying out new ways of sharing value and determining cost, and in the process hitting these issues head on.

I’m not sure Chris is saying anything particularly new. Instead, he is doing what all aspiring business people do: attempting to figure out value. He recognizes there are costs involved but doesn’t distinguish between costs that have no financial element and those that do. In the same way he doesn’t distinguish value that has no financial element and those that do. He also doesn’t make the essential distinction that there is no relationship between cost and value unless cost outweighs (often perceived) value.� He alludes to each but never quite nails what’s really happening. Even so, along the way he makes some excellent points. For example, he is learning that:

Free Makes It Harder to Charge Money Later – There’s a great post in Entrepreneur magazine pitting Chris Anderson (Free) against Jason Fried (37 Signals), and I agreed with what Fried had to say on the matter. Free can cause wild growth, but is that the real goal?

There’s a great deal of truth in that. Which also goes to show that the set price of something that has value is often perceived as the upper limit. If that price is ‘free’ then how do you move that to something of monetary value? There is similar truth in the idea that setting initial prices too low will lead to resentment later on when they have to be raised. But equally if prices are too high then you get the same problem only brought into sharper and more immediate relief. Last weekend, Ben Metcalfe wrote that:

I’m surprised at just how expensive some of the darlings of the Web2.0 SaaS era work out to be when used at scale.

Like a crack dealer, giving you the first hit free, most of them offer a “free” plan that is clearly designed to be severely limited the moment things begin to work out for you and your business takes off. There’s nothing new with this way of doing business, but have you seen just how much your hits costs once you get addicted?…

Invoicing service Freshbooks has a free and slightly limited option for individuals but a company of three would need to use the 3-staff plan @ $39/month ($468/year) but I notice that once we take on a fourth person we would need to skip to the 10-staff plan @ a jaw-dropping $89/month ($1068/year).

Here Ben is not really talking about ‘free’ but about price differentials and price break points. It is arguable whether ‘more’ of something is worth proportionally ‘more’ or ‘less’ the more you scale. This is something that software companies battle with all the time. Once you reach a certain point in a customer situation, the incremental cost of adding one more user is negligible. Freshbooks recognizes this: at the 10 user level, the individual cost to the user is $8.90 per month instead of the $13 per month at the 3-user level. A hefty discount. Except that Ben quite rightly sees this as a waste of 6 users’ cost. Adding one user means Ben’s actual cost is now $22.25 per month. In other words, Freshbooks pricing model is not aligned to Ben’s current value perception model.

I’m sure when Freshbooks started out, they never thought that would be the case. It is mostly in use by single user or 2-3 person businesses. The issue never came up. As the service matures, prices haven’t changed but neither have price points. It is only natural that as a service matures it will appeal to larger groups of people and therefore needs adjustment to reflect what’s going on. Higher initial price or more price point breaks?

In the past, software vendors tended to treat additional users the same way they would the first user. But as deployments scale to include everyone rather than the 10-20% they might have reached in the past, what once seemed reasonable now seems ludicrous. This is exacerbated where the service implies a connectedness, as do many of the SaaS systems compared to the unconnectedness of say 100 Microsoft Office licenses. You end up in the bizarre position where the high value of reaching everyone is unjustifiable as a cost to the company. Here’s an example.

I recall an exercise I did the other year. Say for argument the starting price was $10/user/month. Seems OK until you realize we were talking about potentially reaching 100,000 users. There was no way the client could shell out $1 million per month. It would have soaked up a large chunk of the IT budget. But does that in turn mean the last (say) 90K users should get the service for free? Not at all. But maybe $5 a year. In this simplified example, we’re still talking $570K per annum but then there is huge value to be received by everyone. Could the price have been higher? This is where the price/value conundrum gets very sticky. I would argue that in the particular circumstances, Nielsen’s 90/9/1 rule should be applied in arriving at a price but perhaps modified for metered usage if the equation changed to say 89/9/2.

The fans of ‘free’ software on the sell side argue that attracting huge numbers of people mean that you can enjoy a following income via services of one kind or another. That may be true in the fullness of time but so far that’s not really proven to be the case. One way to assess that is through stock valuations. Some say that Twitter, which is free but which is growing at a phenomenal rate is ‘worth’ $1 billion. A few years back, Sun Microsystems paid just over $1 billion for the free to acquire MySQL database which had twice as many downloads as Twitter claims users AND a monetized business model. In other words, each MySQL download was deemed worth $10 while each Twitter user is deemed worth $20. I can’t see the sense in that. I’m sure others will tell me otherwise.

Later this week I will be speaking with a company that offers a ‘free’ open source accounting solution. It has 100,000 users. I’ll find out if they’re making any appreciable revenue. What I do know is the owner of the business is in the luxurious position of being able to fund ‘free.’ In other words, he is his own venture financier. Free or an investment? And where does ‘free’ start and stop?

All of which leads to a question: if something is free as in beer to acquire, how would you ascribe value in monetary terms? Would it come from services you are prepared to pay for or would you avoid free and simply play safe with a commercial service? Would it make any difference if you knew that 100,000 or 100 million others were using the service? It’s not an easy question to answer but as EditGrid has found, without sufficient scale free will kill you anyway.

As an aside – some while back, Chris was kind enough to drive Francine McKenna and I to Logan airport from somewhere out in the back of beyond in New England. It was a long drive and both of us were grateful. Value was exchanged through the information Francine and I could pass on to Chris about the markets in which we play. Times move on. I wonder if Chris would be able to sacrifice the same time today for the same perceived value?

Tagged as: Chris Brogan, editgrid, free, FreshBooks, MySQL, Open source