The most intersting thing about Hank Williams post on Friday of last week - Free Is Killing Us - Blame The VC, is the comment thread. Many people take Hank to task for what is a simplistic generalization that has little, if any, basis in fact. Dave McClure provides does a particularly efficient job of it
»in most online business categories, it is inherently impossible to start a small self-sustaining business and to grow it.
this is just patently false, and the statement that VCs are making it hard to compete with free is just specious, at best.
Dave goes on to pick apart Hank’s argument point by point.
What surprised me, however, is that no one picked up on what I think is the central reason we see so many free web services. Several people talked about the declining cost of building and hosting a service. Some mentioned that the marginal cost to a web service of another user is often close to zero. These arguments explain why it is possible to offer a service for free many times with no VC funding, but it does not explain why people do it.
The thing that no one talked about was the relationship between the user of a service and the provider of that service - how that has changed on the web and what it means for business models. The reason so many services on the web are offered for free is that the users of the service are not customers in the traditional sense, the are the co-creators of the service. The service provider creates the environment, the users provide the content. Craigslist is a great example of this. Without users to upload the ads and police abuse, Craigslist would be much more expensive to operate. Of course the users get the service for free (mostly), they created it. You could make the argument that Craig should be paying them - that is how the newspapers ran classifieds for years. This is true of many of the most visible free services. Who provides the content at Google or Facebook? Who edits Digg? These services are govenrnance systems that regulate user generated contrtibution. They have to be free.
This is also why so many web services have or will have media business models. I did not say advertising supported business models because most people think of that narrowly - banners on pages. I said media because that implies that we are talking about a threeway. It is not just suppliers and customers. It is suppliers, customers, and sponsors. Even that is too simplistic. Most of these businesses will be supported by a third party who either wants to reach an audience (advertising, sponsorship, etc.) but others will work because the service provider can take a byproduct of their offering and sell that. A search engine could, for instance, package anonymous aggregate attention data and sell it to market researchers, or to other service providers who could then use the data to improve their offering, perhaps by filtering or relevancy ranking some part of their service.
Hank’s complaint that small businesses on the web can no longer succeed at small scale reveals a dated conception of small business, and a limited view of the transformation we are living through. The relationship between suppliers and customers is changing. So is the relationship between scale and profitability. Craigslist is a small business (23 people) but they have scale (20mm uniques).
I am not defending VC’s here. I agree that there was a lot of money thrown at web business in the 90s in an effort to get big fast. But most of the VC’s I know have a much more nuanced view today. They recognize that their best portfolio companies are cultivating an ecosystem, one that they can nourish and influence but not one they can control. Offering some services for free is part of the bargain with the co-creators of their service.