Free models don’t work in difficult times, investors say

Free models don’t work in difficult times, investors say
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First Published: Tue, Mar 10 2009. 01 15 AM IST

Feeling the heat: Harish Gandhi, executive director, Canaan Partners. Hemant Mishra / Mint
Feeling the heat: Harish Gandhi, executive director, Canaan Partners. Hemant Mishra / Mint
Updated: Tue, Mar 10 2009. 11 02 AM IST
Bangalore: Free’ — the magic word, which creates a buzz among customers for a new product or service, seems to have lost its charm for investors as the economy slows.
Feeling the heat: Harish Gandhi, executive director, Canaan Partners. Hemant Mishra / Mint
Venture capital, or VC, firms say though a great way to attract customers initially, free models are difficult to monetize later and cannot generate substantial revenues on their own for the firm.
“These are difficult times and companies, in general, are having huge difficulties in raising funds. Most companies which had a free model and were funded earlier have not really proven out…investors’ confidence is down,” said Tripat Preet Singh, senior associate, Nea-IndoUS Venture.
In VC business, free models usually refer to the revenue model of firms (mostly in consumer Internet space) wherein, they offer free products or services to customers. They mostly generate revenues through ads on their websites or mobile phones by selling content and tie-ups with other firms or syndication. Also, they make money through “freemium model” under which they charge for premium services taken up by the customer.
“I do not see ads generating revenues enough to substantiate a firm. Internet penetration is low in India. Also, more brands need to take up this mode of advertising,” said Rajesh Srivathsa, managing partner, Ojas Venture Partners. “I don’t see this happening in the next two-three years.”
When it comes to making money through online ads, firms do it broadly in four ways: Pay per click—advertisers pay their host only when their ad is clicked; pay per impression—an advertiser pays the host for every “view” an ad receives; lead generation—refers to the creation or generation of prospective consumer interest or inquiry into an advertiser’s products or services; and deal across properties—a firm advertising on, say, a TV channel can ask for the ads to be flashed on the website as well.
“There are no hard and fast rules for online advertisement rates. They depend entirely on the deals and negotiations by the concerned parties. It could be Rs10 per click to Rs50….it’s difficult to generalize,” said Diptarup Chakraborti, principal research analyst at Gartner Inc.’s Mumbai office.
Experts say though most free model firms offer freemium models, the conversion rate of users to customers generally remains less than 10%. It can go up, investors say, provided the offering is of superb quality and there is a huge need for it in the market.
“An entrepreneur has to ensure what he is offering—it’s a vitamin or a painkiller. If it’s a vitamin, customers will not pay for it. If it’s a painkiller, they will pay,” said Singh.
Entrepreneurs, on the other hand, are also feeling the heat. A local search engine firm has been looking at raising capital for the last few months and is still nowhere near to getting it. “VC firms are asking for a well carved out revenue plan and do not count advertisements on our site (as) a strong revenue stream,” said the founder, requesting anonymity.
Investors are also encouraging firms to accelerate conversion of users into customers. One such firm is Chandigarh-based WiZiQ, an online educational platform provider, which is looking at raising $3 million (Rs15.54 crore) from investors. The start-up offers free platforms and charges a $50 fee annually for providing a premium service. “The investors are giving us advice on how to grow fast and start monetizing more,” said Harman Singh, founder and CEO, WiZiQ. He says free models are more of a necessity for start-ups as customer acquisition in the Internet space is extremely expensive and costs $4-5 per customer, which he is now doing for 20 cents.
Investors say though they are trying to get out of the free model by asking firms to have a realistic path to revenues and profitability, not many entrepreneurs have moved out of it. Promoters continue to feel that higher number of users would eventually mean higher business, they say. “Investors do not want to bet on the idea of monetizing later. They are looking for revenues from Day 1,” says Deepak Srinath, co-founder, Viedea Capital Advisors Pvt. Ltd, a Bangalore-based investment banker.
The current liquidity crunch and investors’ aspiration to fund firms whose revenue path is clearly worked out will further make raising capital difficult for free model companies. “Earlier, a few such companies got funded but not in this market,” says T.C. Meenakshisundaram, founder and managing director, IDG Ventures India.
Meanwhile, there are investors who feel freemium models still stand tall provided the cost of production of a product or service is low.
“Essentially, free works only if the cost of production or service is negligible (for) e.g., software or Internet offerings,” said Harish Gandhi, executive director, Canaan Partners.
Even in those businesses there is a cost of marketing, customer support, among others, but a free model could be a consideration, he said. At least one free model-based firm approaches Canaan every week.
A firm should think through its path to profit before offering something free, is Gandhi’s advice to start-ups.
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First Published: Tue, Mar 10 2009. 01 15 AM IST
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