Hive Blog

The dot-com bubble busting at the onset of the 21st century is an example of poor online business models going bust. It is no secret that we are living in a bubble economy, in fact, the younger generation have not known life without bubbles, and big ones at that. Bubbles are good and fun, until they burst. The dot-com bubble began in the late 90s with that bubble bursting in 2000. It was then that Silicon Valley saw a much higher need for mops – that bubble left a lot of water to soak up. Are we headed for another dot-com crash? Unfortunately, I think the answer is yes.

Just the other day I was looking to print up some new business cards. I was told about a site where I could get them for free. I thought I’d check the site out since what I am looking for in terms of business cards is very straightforward; simple but elegant will do. By the time I had selected the perfect “free” business cards, I realized that I could have gone to my local Staples Copy and Print Centre only to have purchased pretty much the same business cards for what it would cost me to order them online for “free”!

Was this false advertising? No. Will I name them? Not even going to bother. I will say that free does have a few catches. Do I want to be limited to their very strict layout which doesn’t quite fit my definition of elegance? No, add $. Do I want to have their advertising on the back of my card? No, add $. Do I want a heavier weight card? No, I’ll save $ there too. Do I want the more expensive finish? No, I can save $ there too. Do I want to add fridge magnets? How about a business card holder? Business card calendar? Appointment form on the back? Coffee mugs? Hats and T-shirts? $ $ $ No, no, no! Okay, now I just have to pay for the shipping and handling, after all, you can’t expect them to print and ship for free, can you? Next question, would I like to have the business cards sent quickly for an added expense or use the slow shipping and wait about a month for my free cards? Suddenly, these free business cards end up costing a nice dinner for two.

All I can say is, at least they are honest. Honest!? Yes. They promised free and they didn’t say it would be the way I want it to be. Plus, it’s painfully obvious how they make money. They offer a free product and up-sell the customizations they precociously predict customers will want.

Once someone is a customer, it’s much easier to convert them into a paying one even if they are free.

Someone in life has surely said to you, “There’s no such thing as a free lunch”. Likely you’ve also heard the saying, “The most expensive things are often free”. There’s a simple reason for these sayings, they are completely true!

In business, free is always a loss leader. Always! There might be a few independently wealthy people doing something free out of sheer goodwill, but most wealthy people I know don’t stay wealthy by giving things away for free. Loss leaders are meant to entice customers into buying something else that does generate money for the business. Worse, these free loss leaders can end up having unintended consequences that make the receiver of the free product regret they ever touched it.

Online businesses that offer free services often do so by using advertising to support their business. Plenty of Fish is one such business. Google relies rather heavily on this as well. While they may not have their own products for sale, they rely on promoting other peoples’ goods who pay for the service indirectly. How these businesses make money is slightly obvious. Receiving advertising dollars isn’t always the most lucrative business in the world (unless you can keep your expenses very low or your target audience of such high value that advertising to this audience is of high value).

Other online businesses use the up-sell approach, just like my business card scenario. These can even be softer up-sell approaches where what the company is giving away is meant to generate leads and interest in their authentic regular business.

Another set of businesses give away a product and offer support on their free product. Proceed with caution! This is where free can become expensive. You can be certain the free product will need support. The free product is likely designed not to be the friendliest, most workable or worthwhile product it could be without that business’s help. These businesses wouldn’t be in business long if they were so inspired to pump out perfect products. Those poor MayTag repairmen should switch their business model.

Then there are the businesses who offer something for free with the chance hope they’ll be able to figure out how to make money one day. Even worse than this are the businesses that knew all along; they just didn’t tell those who bought into the free product first.

Companies like Digg and Twitter are scrambling to figure out how to make money. Digg decided to run a promotion to help their readers figure out their business model. Guess what was figured out in the end? The most obvious answer is, of course, advertising. Certain spots on Digg are of high value so Digg can milk that puppy! I wonder if Digg’s owners didn’t know that model all along (duh), but wanted to appear to their readers to be altruistic while they were growing like scum on pond.

This could have been a clever ploy by Digg all along. Adding in advertising one day without fanfare on their site could have made a huge base of their readers revolt against them. Many web surfers expect that everything on the Internet should be free – it’s the Internet after all! Is it any wonder why the Internet is filled with loss leaders? Don’t these evil companies know they should be paying to provide free services?

Instead, by running a contest Digg was able to say, “Hey, it’s not our idea! We couldn’t keep going by offering a free service so we ran this contest and the answer was born by the readers of Digg!” A brilliant move! Too bad Digg isn’t profitable just yet even with advertising. Their expenses are still outstripping their advertising revenues. Although, perhaps Digg thought they would be bought out long before they ever had to make any real money.

Sure, some products are born out of pure passion and start off small only to take off like wildfire. These uncommon and albeit, exceptional products, end up becoming outrageously successful, leaving the owners with a paradox of how to extract money from what they were originally doing for free. Nothing lasts forever and free is no exception. Free simply can’t keep being free forever. But don’t be fooled, many businesses do know how they intend to make money, even if those plans aren’t very good.

So why do so many online companies have free products, yet don’t appear to be using them as loss leaders (not even with advertising)? Many of these businesses are trying to promote their product as the next “revolution” for the social web. If they can just get enough eyeballs using their product they will be able to figure out later how to make money from it. Sound familiar? Dot-com anyone?

During the real estate boom, before the housing bubble burst, this could be seen as a reasonable strategy. Simply having enough eyeballs would virtually guarantee some bigger business would come along and buy the business out. YouTube was a huge financial expense, but after being sold, the owners made out like Billy the Kid.

That’s not the reality of the market today. Digg and Twitter have been in talks about selling out. They either don’t make money or they don’t make enough money to be profitable. While they’ve had some good negotiations, I don’t see dry ink on paper just yet.

Even business giants like Google are cutting back and streamlining their business. Taking on more expenses in these times is like punching a few more holes in a leaky ship. Eventually those water pumps will be overrun. Even Google knows this!

Building a business on the hope of being bought out is a poor strategy (or a brilliant one if you are one of the few that do get bought out). It’s a big gamble. Most will fail. My advice, figure out how to turn your free business offering into a loss leader to be self supporting during these trying financial times.

The Titanic was a beautifully magnificent ship, but would you have chosen to take a ride on it if you knew you would literally sink in oceanic history for one such voyage?

I think I need a new mop.

I was sent an article in the New York Times about Markus Frind, profiling his success in creating a free dating website Plenty of Fish.

Markus took the formula “find a service which every competitor is charging money for use and give the service away for free and display advertising to pay for the service” and made it work in a big way for Plenty of Fish. The site boasts over 1.7 billion page views and 70 million visitors per month. That’s pretty good for an operation whose entire staff count can fit in a broom closet.

If you don’t know by now how the big fish makes his money, it’s really quite simple: advertising while keeping expenses low. He can get away with advertising on his site since all the other competitors charge money for the same service.  Users of Plenty of Fish tolerate the ads because they are offered a service they would  have to pay real money for elsewhere.

In fact, I would say the users tolerate a lot more than just advertising. They tolerate a poor layout, bad asthetics, confusing linkage and a few features that don’t quite work as well as they could.

I’m not trying to hammer Markus for these defects. I’d go so far as to say that he’d be the first to acknowledge them.

In fact, he has little incentive to fix these issues. The advertising is cleverly inserted into the site everywhere. In fact, it’s hard to distinguish where an ad begins and where the site continues. That’s bonus for Markus since users are more likely to click his advertising links by accident, thinking they are part of the site, especially when you factor in that knowing where to click is confusing at times. Not that I should need to spell this out, but increased click through rates equals increased revenues from advertising.

Markus has to keep his costs down, so spending money on making the website pretty and perfect cut into his profits. Make no mistake, Markus is a true businessman and he’s there to make money. Since the users will tolerate lower standards (and free dating does often require lowering standards), why should he raise them only to raise their expectations?

Further, glitches like distorted thumbnails cause people to click through to the real profiles, increasing page views and presenting more advertising. Why would he ever want to fix that issue? He would surely rather his fishies swim quickly than drown slowly.

Somehow, I don’t peg Markus as a dumb guy, in fact from what I read he seems refreshingly smart and remarkably candid which makes me discount the accusations that he is a liar when it comes to his revenues. Besides, you can confirm his stats yourself. If you haven’t installed Alexa toolbar, go do it now. On Firefox, it installs itself in the status bar which is wasted space anyway.

It’s not in any dating site’s interest to actually find most people a match. Yes, they do have incentives to find some matches for the referral factor, e.g. “my friend tried the Plenty of Frogs site and found her prince charming, you should give it a try too!” It’s good to have a few testimonials but bad if the site is so effective that everyone hooks up quickly. Besides, there is plenty of advice from youtube users on how to increase your dating chances, so don’t blame Markus entirely.

The success of such a free site comes as a double edged sword for Markus. The Plenty of Fish founder is discussing how he is letting millions of dollars in paid dating revenue slip through his fingers.

This is where his own perverse incentives will come back to bite him and his users like a Purana. Given that he has a good business mind, I doubt he will fail, but I think it’s important to understand incentives and the human animal to avoid the pitfalls.

What else drives up the ad hit rate for Plenty of Fish? For one, failure to find a good fish. Most users who are finding success won’t have much incentive to try other paid sites. The barrier to entry for new users on Plenty of Fish is pretty low and standards are kept down.

With the announcement that Match.com is abandoning paid dating in favour of free dating, Markus will face new competition and he acknowledges the likelihood of others to follow. A good deal of his advertising revenue comes from other online dating sites. If he improves the quality of his site,  advertising hit rates will drop. If he fails to improve on quality, competitors could be eating some tasty catfish. Although being the biggest does offer some protection, there is nothing preventing users from creating joint profiles using other free services. After all, there are plenty of fish in the sea.

If Markus promotes his own service from Plenty of Fish, he will lose advertising revenue. The more he promotes his site, the more revenue he loses. Additionally, advertisers might become less willing to advertise with him once he has a competing paid site promoted on his own site. This may not be an issue if he makes more money off his paid site than he loses in a free site.

Markus may face revolt from his user base who will be plenty aware of his incentive not to deliver the best free site in hopes of promoting his paid service and these users may end up swimming upstream to other competing free services.

If Markus sees a competitive advantage for a feature, he can add it to Plenty of Fish right now. He can do so and kill off his competition. He can improve Plenty of Fish to compete against other free sites. With a paid site, he will have to debate adding the feature or improving his free service to kill competition or risk leaving the competition alive to fight another day in favour of keeping the improvements in his paid site.

Markus likely has money in the bank and maybe his best bet would be to lose his advertising revenue and promote his own site exclusively for a short term loss with a long term gain. This is a big risk strategy though; once advertising is gone from his site, his users won’t tolerate it coming back, so he has to make sure that his own advertising is as annoying as the advertising his users already tolerate.

Finally, Markus may suffer a  lifestyle change. He is used to a small staff. Running a big staff is far different than running a small staff. If he goes down this path, I recommend he find someone who has experience to run such a team and allow himself to concentrate on what he does best: business.