"Free" is Not a Business Model: Tech During Trying Times	Visited: 617 Not rated Rate: Select 1 - Terrible 2 - Poor 3 - Average 4 - Good 5 - Outstanding
by Joel Smernoff October 06, 2008

As President of Paltalk, I am often approached by tech entrepreneurs and execs with ideas to become the next big dot com giant. After sitting through hundreds of these presentations, it struck me that many weren’t really “dot coms” but really “dot orgs” in disguise.  Let me explain

Time and time again, these ambitious tech visionaries mentioned that their promising companies would be “free to start”  so they can “aggregate eyeballs” and then they would “eventually add advertising to make it work.” Folks, “free” is not a business model!

This is no longer 1998, when you were rewarded for “getting big fast” and then going public or selling off your collected eyeballs to a larger strategic buyer.  Granted we saw a flash of this again in ’06-’07 when services like Del.icio.us, StumbleUpon and others went for high valuations without meaningful revenue streams, but that moment has passed and we are back to having to generate real revenues to survive these challenging economic times.

So if a successful online business can’t be free and survive over the long term or in difficult funding environments, what else is there? How is there money to be made?

Of course the old standby has been to turn to advertising, but most entrepreneurs don’t understand just how hard it is to make it a viable revenue stream.  The ad business is one of scale, and without a massive audience, it is difficult to bring in meaningful levels of revenue.  Not to mention that the costs of doing this successfully are huge, as a company has to either bring in a sales force (expensive and time consuming) or work with go-between services like Google Adsense or vertical ad networks (lower eCPMs and squeezed margins).

So what does that leave?  For us at Paltalk.com, we have successfully turned to a “freemium” model to generate most of our top line.  We give away a vast majority of our features to our more than four million active group chat users, but hold back some of the best bells and whistles to upsell to our power users.  This has proven to be very successful for us and has enabled us to be profitable for the past four years.

 It only takes a small conversion rate of a few percent of the free users to work well, but the real trick is determining which features can be tariffed.  If you don’t offer enough free content, your site won’t provide enough utility to garner an audience.  If you don’t select the right feature(s) to charge for, nobody will subscribe.  So what’s the answer?

There really is no magic bullet other than trying to find a balance – working with your users and optimizing on what is most valuable to them, discovering what they will pay for and what pricing is reasonable.  We focus a lot of Paltalk’s resources on this issue and have worked very hard over the past nine years to maximize this channel for us.  Put in the time and attention and you can make this work.

Other companies are doing this successfully as well.  Premium services can be as simple and as useful as Plaxo’s contacts tools, as interesting as the Wall Street Journal, or as esoteric as hyper localized wind and wave forecasts for surfers and kiteboarders (all of which I personally value and pay for).  

Then, other than working hard to successfully optimize and deploy a “freemium” model, the biggest challenge will be overcoming the consumer’s current expectation that everything on the net should be free.  I think this mentality will slowly change over time as many free sites hit the end of their funding runways during these difficult financial times, and companies have no other choice but to charge users for some level of content. 

So for all struggling internet companies out there, as you’re faced with an unstable economy I would advise you – it’s better to get started now and reap the benefits, and leave the dot orgs to the charities. Remember, free is not a business model!