Free vs Paid Business Models webcast: More audience questions answered

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During our Free vs. Paid Business Models webcast, we had a lot of questions from the audience—more than our guests had time to answer. Nicolas Pujol generously took a few more minutes of his time to answer these followups.


How do you show ROI in terms of customer loyalty/good will in a FOSS (free or open) model? How do you convince your board, coworkers, and management to believe and hold to the open source model during the tough times?

ROI brings up the question of valuing free and paid users. A group of economists (Gupta, Mela and Vidal-Sanz) studied the topic and wrote a paper on it. Their point was that conventional accounting would say that free users have no value, for they contribute no direct revenue. We know however that a large user base, even if non-paying, can be monetized in several ways. The first step is to design a business so that free and paid users don’t clash. Existing commercial products need to operate in a world where free users don’t cannibalize current sales. Once done, you can value free users in a simple way: divide sales by total users and you get some revenue per user. Of course, companies can have multiple product lines with different user bases. It becomes a more granular and more difficult exercise. Also, groups of free users generally have nonlinear properties. When a group is small, it has no effective force. In other words, open source doesn’t work well on small, niche offers. It’s when the group becomes large that magic happens. This magic, in economics, is called the network effect.

As for tough times, consider that the most valuable brands today (Google and Apple) make extensive use of free products--81% of Apple’s applications for the iPhone are free. Google’s entire business is founded on a free service, with many components under an open source license. Recessions tend to make customers more price sensitive, so open source solutions become even more (not less) attractive. The central problem is that during recessions, customers freeze most new projects. So the key is to gain implementation during good times and use the tough ones to stay in business. Overall, open source has a net advantage when resource allocation tightens.

What are the three most significant free business models that have worked, and what are a couple of the most notable business models that have not worked on a free business model?

Generally, product design and relevance overwhelm the business model being used. So success or failure isn’t so much a factor of how it’s sold rather than consumers’ reaction. This said, it should be the goal of a company to make a free product as good as possible and not cripple it in excess. The free product should create an architecture of participation so that others can augment it. In software, it is the idea of application programming interfaces (APIs), and being a platform. The main risk for a free product is to not gain traction. Once you have traction, things become easier on the commercial side. But before that, it can look like the crossing of the desert. We see, once again, the nonlinearity in value. Think of the input-output as a sigmoid. Few free users, you get nothing. A few more free users you still get nothing. Then if you hit enough volume, you get a lot from it. Pure commercial models have this dynamic too, but you can make a living off 100 paying customers. You can’t make a living off 100 free users. It’s a volume game, and it can be difficult.

Trademarks are very powerful and have great value in the world of open source. I know that Automattic has given those rights to the WordPress Foundation. What factors should similar companies or projects consider before making that decision?

Open source is an act of balance: what to share and what to keep. You find similarities with concepts such as the Yin and Yang, and like in nature too much of anything isn’t good. Reciprocally, too little of anything isn’t good either.

In closed source models, a lot of intellectual property that a business develops is found in copyrights. In open source, licenses like the GPL make copyrights less potent (with exceptions such as dual licenses). The question becomes, what assets does the company still have if it gives away its trademarks? Automattic thought about this, and retains a close relationship with the WordPress Foundation. This means trademarks haven’t disappeared but are one level removed from the for-profit entity, and governed by a license. In general terms, a company needs to understand why it wants to create a foundation, and which specific assets (trademarks and other) it decides to transfer or retain. It is a cost-benefit exercise that involves the two currencies of money and mind share, as well as long term goals.

How can an entrepreneur get the start-up money from investors if they believe the open-source way will not be capitalizing on the needs of customers?

If an investor doesn’t understand open source or doesn’t think there is a business to be made, listen to their argument. If you still believe in the idea, bootstrap your business and give it a try. You may find the project has no traction. That’s OK—it’s the nature of entrepreneurship and you won’t regret not having given it a shot. You may find that it does have traction and not need outside capital at all if you quickly break even. Venture capital money is like consuming several energy drinks at once. Consider whether it’s what you need at this point in time.

Do you have any insight on the open cloud, what an open cloud business model might look like, or where the open cloud is headed?

The OSI and Google have done a commendable job on approving open source licenses and the draft of open cloud principles. The lack of barriers to entry and exit are important. It’s the baseline to avoid customers being jailed into a technology. In practice though, there will always be some barrier in migrating. End users will have to be re-trained, and programmers will need to get comfortable with new programming languages and interfaces – even when data can flow seamlessly from one system to another.

On software as a product—in my opinion, mass software is not a product. If I follow you correctly, then the business is not about the software itself?

Most companies would like their software to be adopted by a large amount of users. Even if you seek artisanship, it’s a good thing when many people love your work. Now, if you give that piece of software away then there is a philosophical argument to be made: what business are you in? It can be that you sell related products, such as a premium version. In this case you are still in the software business. But if you make money on tools for a given piece of software, are you in the tools business? It can also be that what you sell is advertising. This does beg the question, is this a web or software business, if the latter is just a way to sell ads? Isn’t it a media firm? Many companies document this in their annual reports by listing two groups of competitors. I explain this in The Mind Share Market.

Any feedback or suggestions for how to start or develop a free and open business model? For example, what would you say are steps 1-2-3?

There is, of course, no magic formula. Each entrepreneur will give you her own steps that worked for her business. As a rule of thumb, free products start with traction (not to repeat myself, no traction, no business). Some decide to monetize early, while others defer that to the very end to gain as much adoption as possible in the shortest amount of time. At that point, they find rounds of investment, or they release more commercial offerings and ramp revenues. Or they sell the company at a profit for shareholders. The last two scenarios are an indication that things have gone well.

How can we help society through free business models and open source but also make a profit?

Mythologist Joseph Campbell wrote that since the beginning of mankind, all societies have been filled with sorrow and injustice, and that instead of fighting the system we must learn to live in it. He’s partially right. The theoretical answer is that free business models should reduce or eliminate scarcity for all basic goods. But in practice these models can be forced onto neither sellers nor buyers in the name of helping society. Both need to see the economic and personal gain out of it. Systems that work (and last over the years) start with human nature and try to create social good as a side effect. Long story short: Make your passion your profession. As a business, pursue profits. Serve customers as best you can. Win over the competition ethically and legally. And if you do this using open source or a zero price, it so happens that you’ll make certain works available to everyone. This will solve other problems.

Could you discuss or share the various business models that align with or could be layered on top of free and open business models? Do you foresee modified or complimentary models as an emerging trend in the future?

Free and open business models can be ingredients for anything. In certain cases, an open source license requires you to make a derivative work available under the same terms. But in many other cases, any business can use open source in its IT department. It can be clothes, potatoes, jewelry; it doesn’t matter in the context of a consumer of IT. As ways to monetize free products, most (if not all) new models will end up in one of the three main categories of platform, freemium, or tying. All for-profit models revolve around two variables. Do you monetize the same or different users? Are the free and paid products inextricably tied, or not? At a high level it all boils down to this.

How can open source software help hardware companies expand their markets and compete with non-open-source? Is Linaro a good example?

When Linux came around, hardware vendors thought of it as the opportunity to reduce customers’ total cost of ownership. There used to be a popular tagline in the hardware industry that said “open source helps sell more hardware." The notion of free-as-in-gratis was stronger than that of sharing. Since then the turf has moved towards ways to out-innovate by leveraging developer communities. From that standpoint, open source is a strong tool for hardware vendors. But at the same time, the world is migrating to web services, and the customer is moving from being the IT shop to the SaaS vendor. Open source software and hardware manufacturers must both adapt to this.

How can we bridge the gap in the open source industry with culture compared to the classic software development?

The gap has shrunk considerably over the past decade. Classic software development has become more open. Proprietary products become available as alpha and beta releases more than they used to, and interoperability is improving—largely driven by customer demand.

On the other hand, the open source industry has matured and come up with processes such as QA that ensure products are consistently tested without excessive reliance on the community. Both are happening naturally as each camp realizes what it takes to better serve customers.

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Ruth Suehle is the community leadership manager for Red Hat's Open Source and Standards team. She's co-author of Raspberry Pi Hacks (O'Reilly, December 2013) and a senior editor at GeekMom, a site for those who find their joy in both geekery and parenting.

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