Wednesday, September 21, 2011

Free is a trap, not a business strategy

Bing, Microsoft's two-year old search engine, is losing nearly a $1 billion a quarter, with no sign of letting up.
Microsoft (MSFT, Fortune 500) has lost $5.5 billion on Bing since the search service launched in June 2009, but the company's search losses actually pre-date that. In fact, the software giant has never made money in its online services division. Since Microsoft began breaking out that unit's finances in 2007, the company has lost a total of $9 billion.
Sure Bing is bleeding red ink, but at least they're gaining lots of valuable market share, right?

Even the good news with Bing isn't so great. Microsoft proudly proclaims that it has gained search market share against Google (GOOG, Fortune 500) in each of the past 27 months. While that's true, it is not gaining search share from Google.
Bing currently maintains a 14.7% share of the search market, up from 8.4% when Bing launched, according to online data tracker comScore (SCOR). Google currently commands 64.8% of the market -- down just two-tenths of a percentage point from the 65% it held when Bing debuted.
More than half the share that Bing has gained has actually come from third-place Yahoo (YHOO, Fortune 500). The rest has come from search cellar-dwellers and AOL (AOL).
There's usually no such thing as "bad" market share growth, but Yahoo's search is powered by Bing. That means more than half of Microsoft's share growth has come from cannibalizing its search partner.


Dot.coms, start ups, Microsoft and Google are teaching us lessons that we should all unlearn. "Sophisticated" business mavens will tell you that you can make money by losing money. In some instances, that's true. But you can never make money by giving away your primary money making service or product for free.

Dot.coms and start ups are always losing money in order to gain market share declaring that once they have sufficient market share that they'll alter their business strategy and start to make money. Not going to happen. How many start ups have we seen gain market share and then fail once they tried to turn that market share into cash? The lucky ones get acquired by big companies that have an even less coherent business plan than they do. Market share does not automatically translate into profit share.

One of the poster children for the advocates of free is Amazon, which lost tons of money while it was establishing itself and its market share. But Amazon never lost money on its primary services - selling goods and merchandise. Those prices always remained competitive. Amazon lost money because it was building a huge infrastructure of software and delivery services that made it nearly competitor proof. If Amazon had gained its customer base by giving away its merchandise, those self-same customers would have melted away the moment Amazon raised its prices.

Microsoft? They have too damn much money. People say X-Box is a huge success. Success? Microsoft went 5 billion dollars in the hole with that project. X-Box is profitable now but who knows how many years of profit it will take for them to break even. And even when they finally go into the net black, their return on investment will always be paltry. They probably could have made more money by simply sticking that 5 billion dollars in treasury bonds.

Google? You'll notice that Google never gives its search services away for anything less than a profit. Google plays around with all sorts of services and sets up all kinds of "moats" around their search business. But they never give away their primary product for free.

One of the things I've always admired about Apple is that they never (to my recollection) lose money on a product. It's well known that Apple gives away content and services in order to sell hardware. First iTunes, then the App Store and now iCloud fall into that category. Of those three, only iCloud falls into the realm of unpaid for services. iTunes makes a profit as does the App store. Not much of a profit as far as Apple is concerned but far more profit that any other loss leader that I'm aware of.

Unlearn the lesson that you can make money from free. If you can't sell your loss leader for cost, then you're probably doing something wrong.

How Netflix Lost its Glamor and its Way 
A shrewder group of executives would have realized that streaming would become the future and never have provided it to DVD renters for free in the first place. If a thing has value, and it costs you money to obtain and deliver, you charge for it. Good CEOs know that. Customers who wanted streaming content would have a choice: pay for streaming or forego it. Instead, Netflix gave away something of value, acclimated the customers to an entitlement, then abruptly shocked them with the real costs. Compare that to Apple TV where, if you want something of value, good content without commercials, you pay for it.
Never give anything of value away for free. You'll find it almost impossible to sell it for a profit ever again.

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