Web-based business models in 2013

WEB-BASED
BUSINESS MODELS
Slides of class #1 #2 #3 #4 – February 2013
Prof. Eduardo Larrain

Eduardo Larrain - Linkedin - Website 1

This lecture was taught at a French business school by Eduardo Larrain

Eduardo Larrain

• HEC 2005 – Strategic Management

• Founder of an Internet start-up called Kel Quartier

• Strategy consultant at Roland Berger Strategy Consultants and Atos – 40 projects


Agenda of the web-based business model lecture

1. What’s the web? …………………………………………………………………………………………………………………………………………………….……… 4

2. What’s a business model? ……………………………………………………………………………………………………………………………………….…….. 16

3. Why study Internet-based business models? ……………………………………………………………………………………………………….……..… 23

4. What are the key elements of a business model?

• Value proposition and revenue streams ………………………………………………………………………………………………………….….. 40

• Drill-down of key Entertainment markets: music, video games, book publishing ………………………………….………….. 82

• Customer channels, customer relationships, key partners, activities, resources, cost structure …….....….……….….. 115

5. What are the business models of Internet heavyweights: Facebook, Google, Zynga, Linkedin, Groupon ……….…………… 130

6. What are the most promising business models among the world’s most valuable companies: Digital 100, Twitter ..…… 173

7. Conclusion and farewell ………………………………………………………………………………………………………………………………………………… 184

8. Appendix: group project and individual test ………………………………………………………………………………………………………………..... 185


What’s the web


What’s the Web? ICT

Internet

Web
Definitions

• Web (or World Wide Web or WWW) is a global set of documents, images and other resources, logically
interrelated by hyperlinks.

Web = HTTP, HTML, CSS, JPEG,…

• Internet (or Net) is a global system of interconnected computer networks that use the standard Internet
protocol suite (TCP/IP) to serve billions of users worldwide. It is a network of networks that carries an
extensive range of information resources and services, such as the inter-linked hypertext documents of
the Web and the infrastructure to support email.

Internet = Web + mail + data transfer

e.g. FTP incl. P2P, VoIP, streaming
media, video conferencing, mobile
apps (not HTML 5 based)
• Information and Communication Technology (ICT) is the use of computers and telecommunications
equipment (IT) which also encompasses other information distribution technologies such as television and
telephones (C).

ICT = Internet + IT + C

Wikipedia


Is Internet only about Web presence?

• In the European Union, two-thirds of all businesses have a Web presence (McKinsey, 2011)

• Exhibit - Looking at top 100 French websites:
NEWS

ECOMMERCE

SOCIAL
MEDIA

BLOGS

PORN

TV

SEARCH

VIDEO

PROFESSIONAL

EVERYDAY
LIFE

LEGEND

Category

Ranking

Unique
visitors per
month

Titiou Lecoq / Diane Lisarelli, Encyclopédie de la Web Culture, January 2011


Is Internet only about Web presence?

• Exhibit - Looking at top 100 websites in UK, France, Germany, Italy, Spain, Switzerland, Brazil, US and
Australia
Number of unique users, January 2010

BBC, SuperPower: Visualising the internet, January 2010


Is Internet only a distribution channel for online retail/ecommerce?

• In retail alone, G-20 consumers researched online and then purchased offline (ROPO) more than $1.3
trillion in goods in 2010

Boston Consulting Group, The Internet Economy in the G-20, March 2011


Internet is not just a distribution channel or
just about Web presence


Is Internet an Industry?

• 75% of the economic impact of the Internet arises from traditional companies that don’t define
themselves as pure Internet players (McKinsey, 2011)
• Exhibit - Looking at top 100 USdes grandes through sociétés US
Profits des 100 plus 100 plus grandes time:
Chiffre d'affaires companies sociétés US
100%
100% Conglomerate
Conglomerate

Professional, Scientific, and Technical Services Services
Professional, Scientific, and Technical
90%
90%
Finance and Insurance
Finance and Insurance

80%
80% Information
Information

70% HealthHealth Care andAssistance
Care and Social Social Assistance
70%
Wholesale Trade Trade
Wholesale
60%
60%
Retail Trade Trade
Retail

50% Utilities
Utilities
50%
Transportation and Warehousing
Transportation and Warehousing
40%
40%
Manufacturing Telecommunication
Manufacturing Telecommunication

30%
30% Manufacturing Automotive
Manufacturing Automotive

Manufacturing
Manufacturing
20%
20%
Metal Métaux
Métaux
10%
10%
PétrolePétrole
Petroleum

Agriculture, Forestry, Fishing and Hunting
0%
0% Agriculture, Forestry, Fishing and Hunting
1955
1955 1960
1960 1965
1965 1970
1970 1975
1975 1980
1980 1985
1985 1990 1995
1990 1995 2000
2000 2006
2006
Analysis based on Fortune 500, 2007


Internet is not just an industry

Internet is touching every part of the
economy (like electricity)


Internet is a technology on which are based numerous activities across
industries

Internet-based activities

1. Web activities using Web as a support

• Ecommerce, content, online, advertising

2. Tecommunication based on IP communication

• Internet service providers

3. Software and services activities linked to the Web

• IT consulting, software development

4. Hardware manufacturers, maintenance providers of Web-specific tools

• Computers, Smartphones, hardware equipment, servers used for the Internet

McKinsey, Internet matters: The Net’s sweeping impact on growth, jobs and prosperity, May 2011


Internet accounts for 3-4% of worldwide GDP

Exhibits – Economic impact of the Internet by McKinsey and BCG

Boston Consulting Group, The Internet Economy in the G-20, March 2011


Though, the Internet economic impact goes beyond GDP generating
consumer surplus when there is not monetary reward

Real economic impact of the Internet

• Free services value are excluded from GDP:

• Emails

• Search

• Collaborative services (wikis, blogs and social networks)

• Similar to housewife activities excluded from GDP

• E.g.

• Craigslist has generated consumer value though reducing classified ad revenues of the US
newspaper industry

• Facebook has generated consumer value



Question raised at class#1
What’s the issue with mobile apps and HTML5?

• HTML5 is a new technology that allows developers to build rich web-based apps that run on any device via
a standard web browser

• Go to www.audacy.fr or www.webformy.com using your smartphone browser to get a view on what is
HTML5

• For mobile applications, choosing a technology can have a large implications on your business model…
• Native technologies (iOS, Android, RIM, Symbian, Windows) are great for:
• Using the phone features (photo,…)
• Using lots of data (offline mode)
• Security (harder to crack)
• When you need real time data
• HTML5 technology is great:
• When you want to launch fast and cheap a mobile application
• Because you are not reliant on App stores indexation
• Other technologies (Adobe AIR,… ) are great for other specific needs

• … and those of main Applications Stores: iTunes App Store, Chrome Web Store, Facebook App Center


What’s a business model


What’s a business model?

Basic definition

• A business model is a coherent way to manage and develop an economic activity.

• A business model describes the rationale of how an organization creates, delivers,
and captures value.

• A business model describes how an enterprise proposes to make money.


What’s a business model?

Very basic definition

• A business model is “show me the money”.
• It is a simple expression of the strategy of the company on how to make money
without going into too much details

• In French, we use the english word « business model » rather than translations:
• Modèle économique
• Modèle d’activité
• Modèle d’affaires
• Modèle de revenus, modèle de profit


A Business Model is not a Business Plan

What’s a Business Plan?

• A Business plan is a document that describes how a project can be implemented.

• A Business plan usually aims at selling the project because “you can’t have a funding without a Business
Plan”

• A Business plan usually includes a description of:
• The team
• The Business Model
• A Financial Analysis (e.g. financial spreadsheets)
• A Business Environment Analysis (e.g. market, competitors and competitive advantage analysis)
• An Implementation roadmap (e.g. operation plan, milestones)
• A Risk analysis (e.g. SWOT, Critical Success Factors)


A Business Model is not Strategy

What’s Strategy?

• Strategy is a plan of action and the allocation of resources necessary for carrying out these goals

• Michael Porter’s view on Strategy:

• Strategy is a plan to differentiate the company and give it a competitive advantage

• “Competitive strategy is about being different. It means deliberately choosing a different set of
activities to deliver a unique mix of value”

• Then decisions can only be deﬁned as strategic if they involve consciously doing something
“differently” from competitors and if that difference results in a sustainable advantage
• e.g. making existing methods more efficient (“operational efficiency”) are not strategic since
they can be easily copied by others


A business model describes what makes an company unique looking from the
value propositions to cost structure

Key elements of a business model

Alexander Osterwalder and Yves Pigneur, Business Model Generation, 2010


A business model is an ecosystem

Rationale beyond those key elements

Cost-side Value-side



Why study Internet-based business models

Business Internet-
Models based


Business models have been studied for 30 years

Traditional business models: trying to explain success with profit models
1. Customer Solutions 2. Product Pyramid 3. Multi-Component
Invest to know the customer, create a solution, develop the At the base are products and services that are low price and Several of the components represent a disproportionate
relationship high volume; at the top products and services that are high share of the profits
E.g. GE price and low volume E.g. business seminars at hotels, advertising (Google, Yahoo,
E.g. Air France Group: Air France for business and long haul Facebook)?
Profit zone
Profit flights, Transavia for leisure and Hop! for local flights
Profit

Basic
activity
0

Other components
Time Time

4. Switchboard 5. Time Profit 6. Block Buster profits
Multiple sellers communicating with multiple buyers. The Takes advantage of uniqueness, profit margins erode as Revenue realized is so powerful and fast that in a quick
more buyers and sellers join the great the organization competition seeks to imitate. Time profit companies must swoop the model pays for development and marketing costs
builds on itself take the lead and maintain a "two year" lead over their E.g. movies, books
E.g. eBay, Alibaba, Amazon, Monster, Seloger competitors E.g. Intel, Microsoft
Or the opposite: desintermediation (Dell) F/unité Project return
Seller Buyers

Time Project types
Adrian Slywotzky and David Morrison, The profit Zone, 1998



7. Multiplier 8. Entrepreneur Profit 9. La spécialisation
Strong customer brand Hierarchical design with multiple subsidiaries to maintain Specialist are several times more profitable than the
E.g. Disney, Google closeness with the customer generalist. Characterized by lower cost, higher quality,
E.g. Biotechnologies, Google stronger reputation, shorter selling cycles, and better price
Small teams realization E.g. Home Depot
Different offers Return

Specialists

Basic
activity
Generalists

Key asset

10. Install Base 11. Defacto Standard 12. Brand
Initial product sales or profits are slim and profit is realized The more players who buy that enter in the system, the The Company expends significant marketing investment in
on the follow-up products and services more valuable the network order to build awareness and is reinforced by customer
E.g. HP printers and Gillette Razors, Ryanair E.g. Microsoft, Oracle, Skype, Linkedin, spotify, Facebook experience. You know Brand is working when a consumer
says, "I won't change because I trust AT&T". E.g. Google
Margin Margin Price
Complementary
products Brand price

Basic product Average
market price

Market share



13. Specialty 14. Local Leadership 15. Transactional Scale
Specialty companies enjoy a higher premium for their Many businesses and their company economies are totally Transactions go up but the cost to provide the transaction
products and services until competitors start to imitate local. Risk occurs when these companies fail to recognize does not go up as quickly
E.g. Merck, 3M, Photoshop they are a local business model E.g. investment banking, real estate, transportation
E.g. Wal-Mart
Marge Local return Transaction return
5 years ago Nowadays

Leading

Leading

Common
0
Common

Local market share Transaction size

16. Value Chain 17. Cycle Profit 18. After-Sales Profit
Industries characterized by distinct and powerful cycle. The The company's profit does not direct come from the sale of
Specific activities pass through a chain of specialist offering company can not control the cycle, but it works to maximize hte product, but the after sale financing or services of the
value its position within the cycles grip. As capacity tightens the product
E.g. softwares, Intel companies lead price increases, as capacity loosens, its lag E.g. General Electric, banking
price declines E.g. Dow Chemical, Toyota
Return by unit produced

After-sales offers
Basic
offer

Capacity / Occupancy



19. New Product Profit 20. Relative Market Share Profit 21. Experience Curve Profit
As new products are introduced profit margins are high and Companies with high market share tend to be more Experience drives down the transactional cost
growth rapid. As the product mature the profit margins fall profitable. Large companies have price advantages due to
manufacturing experiences and volume economies, such as
purchasing capability and economies of scale
Diffusion Return Unit cost

Time Relative market share Cumulated experience

22. Low Cost Business Design
The company trives on reducing the cost per unit through
cumulative experience
E.g. Southwest Air, Dell, Internet as an channel distribution
(fnac.com,…)
Unit cost

Traditional

Low cost



Why study Internet-based business models?

Two reasons

i. The technological revolution increased exponentially the number of business models
types:

• Marginal cost of digital information comes closer to nothing

• Long tail enables larger segmentation of customers

• Better assets rotation can enable new businesses with low margin

ii. After 30 years, we are better at understanding complex business models


(i)The technological revolution (IT, Internet, biotechnologies, nanotechnologies,…)

Ray Kurzweil video on TED, 2005
The accelerating power of technology
14’00-19’10


Marginal cost of digital information comes closer to nothing

Basic economics

• In basic economics, price falls to the marginal cost which increases with production…
Exhibit – Market supply and demand Exhibit – Costs of one company
Price Price Marginal cost
Supply

Average cost

Demand

Quantity Quantity

• … Though with the technological revolution, marginal cost of digital information comes closer to
nothing
• Moore law: “number of transistors on a chip doubles every 18 months”


• The great power of the eBay business model is the fact that a small number of salaried employees
and outsource partners can handle a huge and growing volume of business:
• Doubling of transaction volume can be accomplished with relatively modest investments
• Software and servers do the heavy lifting

eBay Headquarters, San Jose California


Long tail enables larger segmentation of customers

Long tail

• Long tail is about selling less of more:
• They focus on offering a large number of niche products, each of which sells relatively infrequently
• Aggregate sales of niche items can be as lucrative as the traditional model whereby a small
number of bestsellers account for most revenues
• Long Tail business models require low inventory costs and strong platforms to make niche content
readily available to interested buyers
• Add-on by a student: Internet by lowering search costs and accessibility costs can even increase the size of the “Head”

Chris Anderson, The Long Tail, 2006


• Amazon sells blockbusters products but also niche hard-to-find products (online book stores bring
access to increased product variety)

• Customer customization has enabled Dell to sell a large volume of products in small numbers

Amazon warehouse, somewhere


Better assets rotation can enable new businesses with low margin

Better assets rotation

• Technological revolution increase assets productivity decreasing the amount of assets immobilized

Formula of Return on Capital Employed (ROCE)
ROCE = Net Income (R) / Equity (K)
ROCE = (R / K) * (Income / Income) * (Assets / Assets)
ROCE = (R / Income) * (Income / Assets) * (Assets / K)
ROCE = Gross Margin * Assets rotation * Financial lever



Design to cost

• Then, new business models with low margin can be designed and have the same return than more
profitable activities
• E.g. Logan, the low-cost brand new vehicule, was designed to be sold at 5 000€ (ultimately 8 000€ in
France)

Exhibit – Different business positioning with same ROCE

Gross
Margin

Assets rotation



Pyramid base: targeting tier 5 population

• Developing countries are inventing new business models in regions with very low purchasing power where
populations where traditionally excluded from any economical business modeling. E.g. Tata vehicule
costing 2 500€ even cheaper than Logan

• 4 billion people live with less than 1 500 USD per year

C. K. Prahalad, The Fortune at the Botton of the Pyramid, 2006



Mobile banking case

• Half population is unbanked worldwide leaving:
• People with no official financial service to save or to borrow:
• Unofficial lending rates range between 50% and 400% p.a, microfinance rates are 20-40%
• One day per month is lost in Morocco to pay invoices
• Enabling mass tax avoidance from States with low budgets
• Raising the cost and complexity for companies t pay their employees
• Though new mobile banking offer are emerging in developing countries. E.g. half public servant in Kenya
are paid with mobile banking
120%
Portugal Royaume-Uni
Suède
Irlande Moy. UE
110% Autriche Espagne Finlande
Danemark
Russie Allemagne Pays-Bas
100%
Pologne
Mobile penetration 2008

Belgique
90%
Roumanie
80% Chili Afrique du Sud France
Jamaïque Etats-Unis
70%
Tunisie
Algérie Colombie
60% Botswana
Moy. Afrique Canada
Mexique Brésil
Maroc
50% Guatemala
Guyane
40% Nicaragua
Arménie Chine
30% Pakistan Namibie
Sénégal
Vietnam Egypte Côte d'Ivoire
20% Kirghizstan Kenya
Lesotho
Tanzanie Inde
10% Ouganda
Djibouti

0%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Banked population 2008

Other big trends in creating new Internet-based companies

Three current trends

• Pyramid based strategy: create a business model based on people very low purchasing power

• Blue ocean strategy: look for a new ocean rethinking differentiation and low-cost and go beyond
industry boundaries

• Cloning strategy: clone successful internet sites and replicate them in other countries


(ii) We are better at understanding business models

One Business Model Canvas



1 - The proposition value

Definition and scope

• The value proposition describes the bundle of products and services that create value for a specific
customer segment

• Value proposition is marketing territory:
• It can be functional (solves a customer problem, physiological need,…), social (need to belong,
status,…), emotional, relationship…
• It is an aggregation of the benefits that a Company offers customers (solve a customer problem or
satisfies a customer need) minus sacrifices (price, technical process when buying or when recycling,
travel time,…)
• It is a unique combination of benefits and sacrifices
• It is not a list of products and services, technologies or distribution channels




Elements that can contribute to customer value creation

• Newness: some value propositions satisfy an entirely new set of needs that customers previously didn’t
perceive because there was no similar offering. E.g. mobile phones, ethical investment funds
• Performance: improving product or service performance. E.g. bringing more powerful PC, more disk
storages and better graphics
• Customisation: tailoring products and services to the specific needs of individual customers. E.g. mass
customisation
• Getting the job done: helping a customer get a certain job done. E.g. Rolls-Royce airline engines.
• Design: a product may stand out because of superior design. E.g. fashion and customer electronics
• Brand/Status: customers may find value in the simple act of using and displaying a specific brand. E.g.
Rolex
• Price: offering similar value at a lower price e.g. Bic
• Cost reduction: helping customers reduce costs
• Risk reduction: reducing risks customers incur. E.g. giving a one-year service guarantee
• Accessibility: making products and services available to customers who previously lacked access to them.
E.g. NetJets popularized the concept of fractional private jet ownership, RIP Merrill Lynch bring Wall Street
to Main Street in the 60s
• Convenience/Usability: making things more convenient or easier to use. E.g. iPod.



Defining a promise helps understanding the proposition value

Defining the promise or tagline

• The promise is not only advertising territory but it shapes all the business model

• A good promise or tagline must not only deliver a clear message but also advertise an offering truthfully
• A good way to test the effectiveness and strength of a strategy is to look at whether it contains a
strong and authentic promise or tagline

• The promise can still be simple and concise even for large international and complex companies
• Zara (Inditex) promise is “fast-fashion” which has shaped all the company operations

• What are the promise of those companies?
• Starbucks
• Ikea
• Easyjet / Ryanair
• Toyota
• Lego
• Danone
• Yves Rocher


• Starbucks promise: a “third space” of conviviality between home and work


Defining a promise helps understanding the proposition value

Company promise or tagline

• What are the promise of those companies?
• Starbucks • A “third space” of conviviality between home and work
• Ikea • Functional home furnishing, low price and design
• Easyjet / Ryanair • Simple airline flights at low price faster than the car
• Toyota • Auto reliability
• Lego • Learning though the joy of building
• Danone • Health through food and beverages to a maximum number of people
• Yves Rocher • Beauty based on plants

Denis Dauchy, 7 étapes pour un business model solide, 2010


The proposition value has to take into account all customers

Two customers

• Most of the time, the buyer is not the user of the product or service

Customer 1 Customer 2
 Distributor  Consumer
Mass-market products
or services

Services to  Company  Employees
corporations (food,
transportation,…)

 Students  Companies (management
Web-based business consulting firms, investment
models class banking,…)

 Prescriber (dentist, general  Patients, social security
Pharmaceutical drugs practitioner GP,…)



• Companies have long engaged in head-to-head competition in search of sustained, profitable
growth
• Yet in today’s overcrowded industries, competing head-on results in nothing but a bloody ”RED
OCEAN” of rival fighting over a shrinking profit pool
• This strategy is unlikely to create profitable growth in the future
• Leading companies will succeed not by battling competitors but by creating “BLUE OCEANS” of
uncontested market space ripe for growth

Eduardo Larrain - Linkedin - Website

Differentiate from competitors or innovate within the value

Red Ocean Strategy vs. Blue Ocean Strategy

• Similar to Michael Porter definition of strategy as a differentiation plan, Blue Ocean Strategy aims at
changing the proposition value to gain profitable growth
• Red oceans will continue to be an important part of a company’s strategy (a lot of tools and framework
already exists) but invest in blue oceans will create profitable growth

W. Chan Kim and Renée Mauborgne, Blue Ocean Strategy, 2005


Differentiate from competitors or innovate within the value

Four questions to challenge an industry’s strategic logic and business model

• First, capture the current state of play in the known market space in order to understand competition and
the principal factors (price, quality, design…)
• Second, reconstruct buyer value elements trading-off between differentiation and low-cost
• E.g. is the company over delivering without payback? (typical of a company caught in the Red
Ocean)



• In the 80s, Circus was a declining industry with decreasing audiences because of increasingly
attractive alternative forms of entertainment
• There were star performers but none could compete with movie stars, multiple show arenas and a
audience of families
• There was also increasing sentiment against the use of animals in circuses by animal rights groups
• Cirque du Soleil launched in 1984 and is now one of Canada’s largest cultural exports. Why?


Cirque du Soleil created a new value curve offering the best of both circus
and theater and eliminating or reducing everything else

Cirque du Soleil canvas

• By offering unprecedented utility, Cirque du Soleil has created a blue ocean and has invented a new form
of live entertainment, one that is markedly different from both traditional circus and theater
• Cirque du Soleil strategically priced its tickets against those of the theater because it attracted an adult
theater audience
• Cirque du Soleil tagline is: ”a mix of circus arts and street entertainment”



• With which industry do Southwest airlines compete?
• In what do they focus, in what they differ and what are they tagline?


Southwest airlines created a new curve offering high-speed transport with
frequent and flexible departures at prices attractive to the mass of buyers

Southwest Airlines canvas and the low-cost model

• Southwest Airlines created a blue ocean by breaking the trade-offs customers had to make between the
speed of airplanes and the economy and flexibility of car transport
• Southwest emphasizes only three factors (focus) and differentiate on four others factors from the
industry’s average profile (divergence)
• Southwest promise or tagline: “the speed of a plane at the price of a car… whenever you need it”
DIVERGENCE FOCUS



• With which industry do Logan compete?
• In what do they focus, in what they differ and what are they tagline?


Logan created a new curve offering a new car for the price of an used-car

Logan canvas

• Logan promise or tagline: “for the price of an used-vehicule, have a new car”

FOCUS DIVERGENCE
High

Low price new vehicule

Used-vehicule

Logan

Low
Price Spaciousness Garanty Resistance Design Accessories Status

• Similarly, Amazon launched Marketplace not only to compete with second-hand cultural goods
marketplace like eBay but to close the gap between new and second items


2 – Revenue stream


• Revenue stream is the cash a company generates from each customer segment

• A business model can involve two different types of Revenue streams:
• Transaction revenues resulting from one-time customer payments
• Recurring revenues resulting from ongoing payments to either deliver a Value proposition to
customers or provide post-purchase customer support



Ways to generate revenue streams

• Asset sale: selling the ownership rights to a physical product. E.g. Amazon selling a book

• Usage fee: selling the use of particular service. E.g. A telecom operator charging by the minute

• Subscription fee: selling continuous access to a service. E.g. Club Med Gym, WOW/World of Warcraft
online

• Lending/Renting/Leasing: temporary granting someone the exclusive right to use a particular asset for a
fixed period in return for a fee. E.g. Autolib

• Licensing: giving permission to use protected intellectual property in exchange of licensing fees. E.g. media
industry

• Brokerage fees: intermediation services performed on behalf of two or more parties. E.g. credit cart
providers, real estate agents

• Advertising: fees for advertising a particular product, service or brand.



Each revenue stream might have different pricing mechanisms

Pricing mechanisms



How do you set a price


Price is determined by what a buyer is willing to
pay and the competition is allowing to be
charged (not by markup on cost)

Price is determined by strategy


Reminder

Pricing strategy depending of the product life cycle

• Product introduction:
• Market skimming strategy setting up a very high
price . E.g. Electronic goods, luxury
• Or Penetration strategy: real low price even below
cost to gain market share

• Growth: decrease price because of volume

• Maturity: decrease price because of competition

• Decline: special offer because price is the main factor of
value

Chris Anderson, Free the future of a radical price, 2009
Milton Friedman, There's no such thing as a free lunch,1975


How can a product be free


Introduction to Free


• Free is giving without a cost… all included

• Free is not to be mistaken with “free” used by advertisers when it’s not really free:
• Free “buy one get one free” is just another way of saying 50 percent off when you buy two
• Free gift inside
• Free shipping

• Basic economics: there's no such thing as a free lunch
• The "free lunch“ refers to the once-common tradition of saloons in the United States providing a
"free" lunch to patrons who had purchased at least one drink. All the foods on offer were high in salt
(e.g. ham, cheese and salted crackers) so those who ate them ended up buying a lot of beer.

• You can make money on free (revenue stream) but also free can lead to fast growth:
• Before the 2000’s, Dell was known to be the first company to have reached one billion sales after
been launched in less than 10 years

Milton Friedman, There's no such thing as a free lunch,1975



The penny gap theory

• The penny gap is the difference between cheap and free

• For small payments, there is not a constant elasticity in price

• Zero is one market and any other price is another market

• Zero can attract lots of people because from the consumer’s perspective charging even a penny
makes us think about the choice




The economics of abundance (vs. scarcity)

• Digital technologies have become too cheap to meter creating a economy of abundance (e.g. information)

• Digital free theory:
• “If it’s digital, sooner or later it’s going to be free”
• “When something halves in price each year, zero is inevitable”
• “Waste is good”
• “Every abundance creates a new scarcity” (e.g. time)

• Though, externalities for the consumer still exist: technical process when buying or when recycling, travel
time,…




4 revenue streams around: first two been very old but evolving and the last two are emerging
with Internet

A. Direct Cross-Subsidies: give a free product that have high probability to make people pay for something
else

B. The “three-parties” (or two-sided markets): one customer segment subsidizes another (the most
common)

C. Freemium: premium paid version

D. Non-monetary markets: people choose to give away with no expectation of payment



A – Direct Cross-Subsidies


• This is the oldest and most familiar model where the cost of one product is shifted into the price of
another
• Free attracts customer in masses. Then cross-selling or up-selling validate the business model:
• Give a product (equipment) and sell a service (maintenance) or another product (supplies)
• Key success factor is the increase the equipment rate with products with better profitability
• It has other names: Gillette and razor blades, Equipment and Supplies, Equipment and Maintenance




How can you sell airlines tickets far under cost?
« People pay attention on ticket price not on the extra’s »




Famous examples of direct-cross subsidies

Free or far under cost Where the money comes from Companies

Printer Ink Printer manufacturer

Coffee machine Capsules Nespresso

Razor Razor blades Gillette

Real estate loan, credit card, Cross-selling because customer Retail banks
savings account is stuck with the same bank for
20/30 years
Airline ticket Hotel room, rental car, cruise Go Voyages, airline companies
and vacation package
Elevator Maintenance and security Elevator companies
upgrades
Alarms Electronic surveillance Security companies

Equipement Reagent supplies Medical biology companies

Telephone Communications Carrier



More examples of direct-cross subsidies

• Give away services, sell products (Apple Store Genius Bar Tech support)
• Or Give away products, sell services (free gifts when you open a bank account)
• Give away software, sell hardware (IBM and HP’s linux offerings)
• Or Give away hardware, sell software (video game console model)
• Give away cell phones, sell minutes of talk time (many carriers)
• Or Give away talk time, sell cell phones (many of the same carriers, with free nights and weekend
plans)
• Give away the show, sell the drinks (strip clubs)
• Or Give away the drinks, sell the show (casinos)
• Free with purchase (retailer “loss leaders” e.g. gas sold in a supermarket)
• Free samples (gift boxes)
• Free trials (magazine subscriptions)
• Free parking (malls, supermarkets)
• Free condiments (restaurants)



B – Three-parties or Two-sided markets


• A third party pays participate in a market created by a free exchange between the first two parties. Thus
one customer segment subsidizes another

• The most common of the economies built around free is the three party system

• Advertising is the most famous one where advertisers pay for media to reach consumers:




Markets with three-parties revenue stream

• Three-parties is not limited to advertising

Market First-party Third-party Second-party
Consumer examples
Search Internet user Advertisers Google, Yahoo!

Online recruitment Job seeker Recuiters Monster, cadreemploi,
keljob
Free newspapers Readers Advertisers Metro, 20 Minutes

Free softwares Readers Software publisher Adobe

Debit card Card owners Retail Banks

Ecommerce platform Sellers Buyers eBay, Amazon
marketplace
Outdoor advertising Municipalities Advertisers JC Decaux, Clear Channel




More examples of three-parties

• Give free voice calling (in the US), charge advertisers (Facebook Messenger app)
• Give away content, sell access to the audience (ad-support media)
• Give woman free admission, charge men (bars)
• Give children free admission, charge adults (museums)
• Give away listings, sell premium search (match.com)
• Sell listings, give away search (craigslist housing)
• Give away travel services, get a cut of rental car and hotel reservations (travelocity)
• Give away house listings, sell mortgages (Zillow)
• Give away content, sell information about the consumers (practice fusion)
• Give away content, sell stuff (Thinkgeek)
• Give away content, charge advertisers to be featured in it (product placement)
• Give away resume listings, charge for power search (Linkedin)



C – Freemium


• Freemium is giving a free basic version to most of people and charging for a premium version to a few
people
• Freemium or contraction of Free and Premium was invented by Fred Wilson in 2006.
• Freemium is different with direct-cross subsidiaries because the ratio of free to paid is high (e.g. 90%,
95%) when giving free sample has a low ratio
• This ratio is enabled by Internet because the cost of serving the basic version is close to zero
• Si it’s not the same thing as "premium with a free sample.“
• Freemium is one of the most common Internet-based business model even though not every product or
service can work as freemium



C – Freemium

Different kind of limitation of the basic free version

• Functionnalities
• e.g. Linkedin, Flickr, Skype, Evernote, WordPress
• Time
• e.g. legal online streaming
• Capacity
• e.g. sending large files, DropBox (cloud backup system)
• Storage
• e.g. webmails
• Others factors
• e.g.
• Spotify and Gmail invitations
• Seat limited (first customers get free seats)
• Customer type limited: free for small and young companies, universities (licence model)


C – Freemium

Why go for Freemium business model?

• Marketing:
• By definition, having a free product makes it really easy to get customers
• Even though a free user might not convert, they can invite other free users who might (referral)

• Network effects (like fax):
• A network effect is what happens when a product or service becomes more valuable the more
people use it
• A phone isn't very useful if you can't call anyone else with it. But once everyone you know has a
phone, it becomes a pretty valuable thing to have
• If you're in a market that lends itself to network effects you're going to want to have a free basic
product because if you don't someone else will and will use the network effects to crush you
• E.g. Skype has 600 million users who make calls for free over the internet and only a small
percentage of those pay to make calls to landlines

Business Insider, What Is The Freemium Business Model, 04/2011


C – Freemium

Key success factors (if not, choose another business model)

• Get lots and lots of free users:
• Freemium is a numbers game: if only 1% of your users are going to pay you, then you need to have lots and lots of
free users (millions, typically) to make that 1% enough money
• If your product is more niche, go for premium instead of freemium
• If your product is not sticky, go for advertising instead of freemium
• Have a product or service whose value to users increases with time:
• This is the biggest thing that most people
• The value of your service needs to increase the more people use it
• E.g. Spotify: where you create all your playlists and organize your music. Once you've done thatyou're much more
likely to pay up. The value of Spotify to you has gone up from being just music to music, your playlists and your
friends' playlists, so paying starts to make sense
• Keep costs low:
• Freemium works because the marginal cost of each additional user is low, so you need to keep your operating costs
correspondingly low
• Time:
• It takes a long time to be profitable because users take longer to convert as the value of the product to them
increases over time, and because you keep adding (hopefully) new free users, freemium businesses take a long time
to reach breakeven point
• As people get older, people migrate into paying customer (premium part of freemium) because they get richer

Business Insider, What Is The Freemium Business Model, 04/2011


C – Freemium

Examples of freemium

• Give away basic information, sell richer information in easier-to-use form (BoxOfficeMojo)
• Give away generic management advice, sell customized management advice (McKinsey)
• Give away Web content, sell printed content (everything from magazines to books)
• Give away online games, charge a subscription to do more in the game (penguins)
• Give away demo software, charge for the full version (most video games)
• Give away computer-to-computer calls, sell computer-to-phone calls (Skype)
• Give away free photo-sharing services, charge for additional storage space (Flickr)
• Give away basic software, sell more features (QuickTime)
• Give away ad-supported service, sell the ability to remove the ads (Ning)
• Give away "snippets" sell books (Google Books)
• Give away virtual tourism, sell virtual land (Second Life)



D – Nonmonetary markets


• People give away content with no expectation of Payment
• Gift economy is based on the principle that the action of individuals have a global impact
• People give for different reasons: to gain reputation e.g. blog writers, altruism e.g. Wikipedia
or unintentionally/passively (web content helps Google)
• Labor exchange: paying something with labor even without knowing it
• E.g. free content in exchange of Captcha solving (used by spammer in exchange of free porn
but also used by Google Street view to decipher street numbers, names and trafic signs)
• E.g. voting on Digg, Yahoo Answers or using Google 411 (phone directory in exchange of
speech sound)
• Piracy: when piracy is so powerful that content producer have accepted that, form them, doing the
activity is not a moneymaking business
• E.g. online music



• Google is getting the public to identify house numbers and signs from Street View photos as part of
its reCAPTCHA anti-spam technology and feeding the data into its online mapping service


reCAPTCHA is a free CAPTCHA service that helps to digitize books,
newspapers and old time radio shows

Answers to reCAPTCHA challenges are used to digitize textual documents
Comparison of the accuracy of standard OCR versus
Example of a CAPTCHA reCAPTCHA transcriptions

OCR: Optical Character Recognition programs


Features with poor usability can be an opportunity for revenues

CAPTCHA can also be used for advertising and generate revenues

Adyoulike


• How’s the music industry going?


Looking at the music industry

Global recorded music sales are decreasing since end of the 90’s due to digital piracy

Exhibit – Global Recorded Music Sales (bn USD, trade value)

IFPI, press report, 2012
Synchronization rights: revenues from music acquired for movies, advertisements and music videos



Music downloads still accounts for 80 per cent of digital music revenues but the market is
maturing

• Piracy has made difficult of charging a price for listening songs or albums

• Though consumers still find value in downloads from iTunes Music Store, VirginMega, FnacMusic and
others because of the sacrifices of the free music downloaded illegally (quality, security, complexity,
accessibility…)

• Even if downloads of music from iTunes Store and others still account for 80 per cent of digital music
revenues, this market is maturing and spending is flattening in all key territories



Streaming and downloads make the digital proposition value

• Consumers are finding great value in:
• Having access to millions of songs (sellouts are impossible)
• Creating and sharing playlists
• Listening to music in on all devices everywhere (accessibility = cloud storage, remember Philipp
comment on the “head” part of the long tail)
• Listening to music even offline
• Sharing his songs and getting recommendation on social networks

• Fremium streaming music services such as Spotify will be the key growth drivers over the next years as
usage and spending grow rapidly:
• Spotify Open: free but limited in number of songs and number of hours
• Spotify Unlimited: a monthly fee limited on a laptop
• Spotify Premium: a monthly fee for listening to music in on all devices and even offline
• All Spotify offers enable users to share easily on social networks such as Facebook:



Music streaming business model is already the largest market in Sweden, a country with a
robust culture of Internet piracy

• Music revenues are increasing the Swedish music industry market due to digital sales

• Streaming is even cannibalizing downloads in Sweden

• Music licensing for online videos is a growing market as more and more people watch videos that are
accompanied by music

IFPI Svenska Gruppen, press report, 07/2012



Digital recorded music is expected to overtake physical sales in 2015

PwC, Global Entertainment & Media Outlook, 2012



What about content production and consumption?
The amount of content being produced and consumed in music is believe to be growing

• 11 M song tracks (stock) in 2001, 100 M in 2010 (Gracenote/Sony db > Shazam db)
• Growth of the Gracenote database obviously includes a lot of older music that has only recently been
indexed and that is been rediscovered
– E.g. Oscar Wilde - Los Vidrios Quebrados (1967)

• The trend still looks like the amount of music available to consumers is steadily growing
• At the other side, overall sale of music (including albums, singles, digital tracks,…) exceeded 1.5 billion
transactions in 2010 (up from 845 million transactions in 2000)

Floor 64, The Sky Is Rising, 01/2012



What about musicians revenues?

• Psy with its Gangnam Style song, viewed more than 1 billion times,
would never had been a success outside South Korea without Youtube
– It generated 8 M USD from advertising (50/50 split)

• Ticket prices and merchandise have become major sources of income
for many popular rock stars like Lady Gaga, Madonna, Bruce
Springsteen and for bands like U2

• It’s not easy to duplicate the experience of a live show, so concerts
have become a source of revenue for musicians and aren’t negatively
affected by the availability of free downloadable music - in fact, free
music can encourage fans to attend live performances

• There’s actual scarcity for live music

• Other trends:
– Algorithms may be replacing humans in some parts of discovering new
talent (or at least discovering talent more cost-effectively)
– Gracenote, Shazam,… are datamining music metadata in order to serve
better music recommendations to consumers or to predict which artists
will be popular with target demographic groups



What has the Entertainment industry learned from the Music industry?

Other Entertainment industries continued to grow in the past years when the Music industry,
newspapers and consumer magazine publishing took a hit

PwC, Global Entertainment & Media Outlook 2012-2016, 2012



Some Entertainment industries have found new business models successful with the Digital
era, others no… well not yet… thus a business model challenge

• For consumers, today is an age of absolute abundance in entertainment due to the digital era and piracy
• New business models based on Digital sales are emerging in each Entertainement industry to take over
decreasing physical sales

IFPI, press report, 2012



Though not all new business models can be based on Advertising since advertising is a
huge but finite market and volatile (reliant on the economic situation )

PwC, Global Entertainment & Media Outlook 2012-2016, 2012


• Has the internet decimated the entertainment industry, or are we living in a new gold age for both
content creators and consumers?
• Entertainment spending per households as a function of income is increasing from 4.9% in 2000 to
5.6% in 2008 (US)
• The amount of content being produced in music, movies, books and video games is believe to be
growing:
• 1/4 M new books were available in 2002, 3 M in 2010
• 1.700 new movies p.a. in 1995, 7.000 in 2009
• 11 M song tracks (stock) in 2001, 100 M in 2010 (Gracenote db)
• The Entertainment industry is growing though the value chain is being totally redesigned



• How’s the video game industry going?


Looking at the video game industry

Video games sales have grown with the digital revolution and cross the barrier of gender and
age limitations

• Globally, the amount that consumers spend on video games - for hardware, software and accessories - has
grown from about $20 billion in 2000 to approximately $70 billion in 2011

• The demographics of video game players has expanded greatly beyond the traditional core of boys and
young men:
– 53% of game players are male and 47% female
– Average gamer player age is 30
– The amount of time kids are spending on video games has grown from 26 minutes per day in 1999 to 1 hour and 13
minutes in 2009 due to mobile device that has allow kids to squeeze more playing time into their busy days (Kaiser
Family Foundation survey)
• Worldwide, the population of gamers has exploded from 250 million in 2008 to 1.5 billion in 2011




Purchases of digital content are growing the video games industry

• The traditional console business model, based on the
installed based per the attach rate (number of games
per owner), led to an elitist approach to game design
since price of each game was high (40-60 USD) and
hardcore gamers wanted a return for their investment

• New video games digital segments have emerged:
– Downloads: Steam is to games as iTunes is to music
– Massively Multiplayer Online (MMO) e.g. World Of
Warcraft
– Online / Casual
– Mobile
– Social

• Digital sales (and rental delivery) now generate 40% of
the industry

ESA, Essential Facts about the computer and the video game industry, 2012



Looking at the video game download business model

• Piracy of video games has fewer benefits than music 2011 top-selling games at retail ranked by unit sales (VGChartz)
and movie piracy: Piracy is an issue for single-player
mode though the primary reason people buy games
retail is for the multiplayer modes:
– Most pirated games do not allow for multiplayer as the
game often has to connect to an official server where its
legitimacy can easily be verified by some sort of
authentication service

• Steam is to games as iTunes is to music:
– Steam is a digital distribution, digital rights management,
multiplayer and communications platform
– Steam has an estimated 70% share of the digital
distribution market for video games (competitor: EA’s
Origin)
– One PC game out of three is downloaded (average price
not much lower than retail: -7%)
– Steam is developed by Valve Corporation best known for
a number of popular entertainment franchises such as
Counter-Strike, Half-Life, Left 4 Dead



Looking at MMO business models

• Massively Multiplayer Online game are video games in which a large number of players engage
simultaneously in a persistent world

• Value of an MMO is in the size of the community per life time (retention)

• The hardcore game MMO revenue stream was invented by World of Warcraft:
– Average customer lifetime of 18 months
– Client box or download (50 USD)
– Subscription fees (15 USD/m)
– Virtual goods
– Average full cost to complete WoW for a gamer is 300 USD

• Few MMO have been able to replicate WoW model so they switch to F2P to lower entry barrier and get a
sizable community e.g. Habbo Hotel, Kart Rider, Warhammer, Everquest,…
– Free trial or free game
– Subscription optional
– Virtual goods for actions items (competition) and personalisation (expression)
• Theory of engagement: « the longer a user plays the more chances there are he buys virtual items »
– Items payable through micro-payments mainly inside the game (60%) and on an external web site

Luc Bourcier, Game in progress new business models for the videogame industry, 04/2012



Looking at the online casual business model

• Online casual games are games played online to “kill time, make a pause, relieves from stress”:

• Free-to-Play (F2P) is the main business model (also for social games and some mobile games)

• F2P is a freemium business model that can be based on:
– Try-and-buy: limited access (time, levels,…), though games must be really addictive
– Advertising with ads display on hosting sites or inside the game
– Virtual goods




Looking at the mobile video game business model

• Ten of thousands of mobile games for smartphones and tablets can be download on platforms such as the
Appel App Store, Android MarketPlaces (Google Play), Amazon, Facebook Mobile and Playstation Suite

• Distribution is bypassing carriers: 30/70 meaning the game app developer get 70% of sales revenue (vs.
45/55 in cell phone business)
– An opportunity for mobile banking?

• Mobile video game revenue stream is based on:
– Selling the app (e.g. at 0.99 cent or F2P model)
– Selling virtual goods
– A little of advertising (average of 15%):
• Offer walls
• Sponsoring




Looking at social games

• Social games are those games played primarily on social networking sites or games that can be played with
a person’s real world social graph
– E.g. CityVille, FarmVille (Zynga), EA (Sims)

• Social video game revenue stream is based on:
– F2P model with a logic of a massive audience
– Virtual goods (50%)
– Advertising (25%)
– Lead-generation offers (25%): virtual currency incentives by marketers to social gamers in exchange of signing up for
subscriptions, participating in surveys, or buying goods and services
– Since virality is a key to success, notifications, invitations, sharing, gifting and other social network tools are used
extensively to get new customers
– Social games must work with a low retention rate (first day retention rate of 30% is a “huge success”)




Looking at the e-sports business model

• Twitch launched 18 months ago borne out of Justin.tv, the largest online community to live streaming
service to enable streaming video service embedded into popular games
• Twitch provide instant broadcasting of user gameplay: 23 million unique viewers per month, viewers
watched 6 billion minutes viewed in December 2012, average session time of 1.5 hours
• Twitch is getting embedded in games such as Call Of Duty: Black Ops 2
• Twitch business model is based on sharing advertising revenue with broadcaster and in growing the e-
sports market e.g. Twitch has announced a new scholarship of $50,000 to five student gamers



What’s next for the game industry?

• “Gamification” trend meaning that video games are no longer restricted to leisure:
– Every part of our lives will eventually be turned into a game

– Potentially encourage people to change their behavior to:
• Benefit the environment

• Perform their jobs better

• Lose weight

• Buy products

• Perform almost any task imaginable

• Games are even encroaching into vocational education


Short focus at online video services

Purely online video services are not yet collecting revenues at the same scale as the
traditional TV and films industries, but the size of this audience is unquestionnably large

• Two business models:
– Based on subscriptions such as Vimeo
• 150.000 paying subscribers in 2010

– Based on advertising such as Youtube
• 400 M USD of adversitiving revenues in 2010

• Online videos are also a substantial traffic driver to social networking (e.g. Facebook)


• How’s the book publishing industry going?


Looking at the book publishing industry

Sales of e-books expected to compensate the decline of the physical books

• Consumer and educational book publishing will increase by 0.6 percent compounded annually to 116 bn
USD in 2016 from 112 bn in 2011
– E-books grow their share of global spending from 5% in 2011 up to 18% in 2016
– Print/audio consumer and educational books will continue to decline throughout the forecast period notably
paperback books (“livres de poche” in French)

• Publishers will need to provide eBooks in addition to paperbacks and the entire value process will be
changing, from aggregation right to distribution

• Piracy less likely to impact digital sales like in the music industry: demographic groups that are most often
associated with digital piracy (generally men between 20 and 39 years old) and not the same than those
associated with high-volume reading of mass market books (in general women age 40 and older)

• New intermediaries are emerging to handle eBooks:
– eBook platform (e.g. mass aggregators such as Amazon, Apple, and Google)
– Handling of payments
– Support for digital conversion
– Establishment of a digital content system

PwC, Turning the Page - The Future of eBooks, 2010



New revenues streams are emerging and changing current business models

• Apps and special eBook editions enriched with music and video
– Notably for educational and juveniles segment e.g. Byook start-up http://youtu.be/O_pBNPe3s-M
• Sales of individual chapters and sections from books
• Offer additional content such as a blog/forum dedicated to a chapter or sentence, immediate definition of
a word, links to other content (news/other authors),…
• Easier to sell updates
• Books on demand
• Easier to sell porn and erotic fiction
• Establish basic contracts with university libraries to offer free eBooks for students or offer special editions
exclusively to students for a discounted price
• Providing online reviews (non-monetary action is posting a review at Amazon website)

PwC, Turning the Page - The Future of eBooks, 2010



Non-traditional book publishing on the internet is 8X the output of traditional book
publishing

• In 2010, 4 million new titles were published with 92% of those being “non-traditional” i.e. self-publishing
and books representing the reuse of content, most of it not covered by copyright
• Non-traditional books are largely on demand titles produced by reprint houses specializing in public
domain works and by presses catering to self-publishers and micro-niche publications
• Non-traditional titles are marketed primarily on the Web

Bowker, ISBN Output 2002-2011, 2012
Non-traditional numbers are undersestimated since books with no International Standard Book Numbers (ISBN) are not included


What’s the business model of self-publishing?

The traditional business model of book publishing



What’s the business model of self-publishing?

A new business model by lulu.com



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