Ning, a popular online provider of social network platforms, recently moved to discontinue its free service and focus only on paying customers.  This has raised questions about the future of free online applications in general. Ning may offer a service that is sufficiently valuable and reputable at this point that they can survive with a paid-only model, but “free” isn’t going anywhere anytime soon.  On the contrary, there are more and more free (and free versions) of online applications being offered every day.

Why is online software free?

Not to get too MBA here, but competition drives prices towards marginal cost (cost for each additional customer).  And marginal cost for most online apps is pretty close to $0. That’s why email is free.  When almost anyone can set up a server and software in their basement and offer email to millions of people, it’s very hard to charge much for the service.  And as technology is improving, and software becomes easier and faster to create, this reduces barriers to entry and increases competition for even sophisticated applications. So, then, how do you make money with online software?  There are several ways.

A Proven Model: Free + Paid

A model that has proven successful is offering multiple service levels.  They beauty of online software is that creating different versions of your service is easy.  You can have a free version that entices people to begin using your application, as well as versions that offer additional (or more customized) features that customers would be willing to pay for.  It’s called “price discrimination“, and it’s how businesses try to extract as much revenue as possible from customers with different price sensitivities (i.e. coach vs. business class vs. first class).

Some free application providers offer their software entirely for free, but charge for support and maintenance (which has higher marginal cost).  Most open source software is supported by a community of developers and service providers that profit by offering complimentary applications, support, and consulting.

Advertising Revenue

At the dawn of the internet age, most internet startups counted on advertising to support their business models once their funding was exhausted … only to be woefully disappointed.  Well, today online advertising is a valid and thriving revenue source.  And it’s not just about banner ads anymore.  There are increasingly creative ways of using the internet medium to engage and interact with consumers — including video, social media, contests, etc.  In fact, online advertising is proving to be even more valuable than TV ads.  Just ask Pepsi, who sat out the Superbowl this year and instead invested their ad dollars into a social media campaign.

“Free” as a Marketing Tool

While some businesses may look at free software as lost revenue, perhaps they should look at it instead as lead generation.  Most advertising folks say that giving away free stuff is one of the biggest bangs for your advertising dollar.  And because, as we discussed, the marginal cost for online software is nil, it’s a cheap but powerful way to attract potential customers for your paid service.  Once you have the attention of the free customers, you can sell them on upgrades and additional services.

Conclusion

Only time will tell if Ning made a good move by switching off its free offering entirely.  Given their largely business/organization oriented customer base, it may work for them.  Or it may be detrimental considering there are many free alternatives.  With or without a free version, online service providers will survive in the long run by offering sufficient value to customers that they are willing to pay for its use, and/or sufficient traffic that advertisers are willing to pay to access.

When you compete against free, you must focus of providing value and maintaining loyalty, as well as pursuing other creative revenue streams.

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