Since my last article, I have been meaning to write more in depth on the idea of giving away web services for FREE, and the mistakes some companies make in their approach to this model.

The online culture has always trended towards the FREE. Low manufacturing and distribution costs for digital goods and services cause the consumer to demand low (or preferably no) prices, and an abundance of low cost (or preferably free) labor through open source software and outsourcing reinforce those low costs. Unfortunately, this has created a business culture which is foreign to practically everyone, where classic business rules seem not to apply.

The FREE model is not being executed correctly.

Most FREE services look at traffic as their eventual monetization strategy. They offer their service for FREE, to make their adoption and conversion rates as high as possible, and plan to monetize their networks by adding advertising and subscription models once they reach critical mass. While this strategy is working well for a company like YouTube, which is now able to monetize their huge traffic with in-video ads, it is a failing strategy for most companies going down this road. It is the culture online right now that fame precedes fortune. Many entrepreneurs dream of having their name behind an instantly recognizable service, and assume that once they have the traffic and users, monetization will come naturally.

It is the culture online right now that fame precedes fortune.

It is a mistake to look at the eventual monetization of YouTube videos, and to ignore Adwords. Google acquired YouTube in 2006, and by allowing Adwords advertisers to publish ads on YouTube videos, Google is able to gain massive secondary revenue beyond the advertising revenue YouTube earns through the placements themselves. These new ad units have created an entirely new channel for Google, and as YouTube videos move from the browser to the mobile phone and television set, this ad channel will draw more advertising dollars through Adwords. Simply placing ads or a subscription model onto your massive traffic network isn’t a great strategy without a secondary revenue model.

How the FREE model should work

If you’re planning to offer your service for FREE, you’d better come up with a secondary way of making money. Your fantastic free service has the ability to grow very fast, and you should have a secondary business ready to use this free traffic for referrals and to monetize it. This model is used very well by mobile phone companies, who give away FREE cell phones, and make money through the service plans. As the company who created a great free service, you can use the attention of your customers to cross-sell them into one of your paid services, to sell B2B services, etc.

How does Twitter make money?

In my opinion, Twitter doesn’t have to make money. Obvious, the company who created Twitter, stands to gain quite a lot as the creators of an iconic service even without monetizing the service itself. It would be a mistake if Obvious were to currently focus all of their attention on how to monetize Twitter directly through advertisements, a business Pro version or subscription model, or through data plans to bring Twitter onto mobile phones. While these are each possibilities, Obvious stands to benefit more by adding new money making services next to Twitter, or by leveraging the infrastructure needed to run Twitter to sell B2B services. There are numerous secondary businesses which Obvious would be at a huge advantage to launch, building on the success of Twitter.

The current state of FREE is killing business development online

Hank Williams, blogger at Why Does Everything Suck? argues today that the FREE model, funded by VC investments, is killing the ability for online business to grow and develop normally. The “grow now, monetize later” strategy allows VC funded companies to give away for free, what a normal small business startup would charge for. Without a secondary model for earning money, these VC funded companies are often unable to monetize their services, and eventually enter the deadpool.