The future of free?

Interesting recent posts by Hank Williams at Alley Insider and Charlie O’Donnell’s response at This is going to be big.

The topic is how “free” business models make having a small business online unsustainable.

This is because in the digital world, advertising, the only real revenue stream, cannot support a small digital business. If businesses were based on the idea that people paid for services then small companies could succeed at a small scale and grow. But it is very hard to charge when your competition is free. – Hank

Hank essentially blames VC’s for this, because they fund companies until they become large enough to sustain an advertising revenue driven business model. Therefore, small internet companies cannot exist because they cannot compete with the “free” companies that are VC funded.

Charlie’s response was, (and this is quickly paraphrased), that up-front fixed costs are very low, as compared to other businesses, therefore, it is fairly cheap for VC’s to eat costs while they develop profitable businesses.  Charlie uses the analogy that Henry Ford would give away his cars until he reached scale in the factory.

For the most part, I agree with Charlie. However, Hank’s argument does have some merit. I can see it being very difficult for a small online business to try to remain small. The problem with the internet is that both large and small businesses have very low fixed costs, so VC funded internet startups can provide free services while they grow large enough to achieve advertising revenue scale (Charlie elaborates further on this). Hank’s contention with this is that because these free services are subsidized by VCs as growing companies grow, they prevent small online companies from existing because there is an expectation for their services to be free as well.

My take on this is that it’s the small/niche companies’ fault for not differentiating themselves. The reason that small businesses in the non-online world can compete with large businesses is that they provide a niche and specialized service – whether it’s a specialty product, geography focus, or more personal service. Small/niche online companies can charge users for their service, but they need to be differentiated enough from large companies to warrant such a charge. I don’t think that there are many businesses that can and should provide a very segmented/differentiated product on the internet, and I think that’s due to the nature of the internet. The internet evolved to be scalable and to reach a large number of people. By it’s nature, the internet does not make it economical to do differentiated business with a small segment.

Therefore, I think Hank should not be blaming VCs for further developing the model that is most economical, but should instead consider the nature of the internet.