How to compete with free products

(Stanford BUS-21)
Martin Westhead
Mastering Marketing
Competing with Free
How to make money
by giving things away

COMPETING WITH FREE
“There’s no business model ever struck off by the hand
and grain of man that can compete with free. It can’t
be done. If I have a Pizza Hut and I’m selling pizzas at
$1.50. Somebody puts up a pizza hut next to me and
gives them away, who do you think will get the
business?”
- Jack Valentini,
Motion Picture Association of America

Competing with Free
 Concepts
- Winner takes all
- Envelopment
- Find the scarcity
 Case Studies
- Microsoft vs. Piracy
- Microsoft vs. Netscape
- Microsoft vs. Linux
- Yahoo vs. Google

Winner-takes-all
 Free markets can be
intensely competitive
 Network effects
- Success -> more success
 Examples
- Windows at the turn of the
century
- Xbox and PS
- Betamax vs. VHS standards
battle
- DVDs

To win the battle
 Require differentiation or cost advantage
 Plus three other factors:
1. Preexisting relationships with market side(s)
2. Reputation for winning
3. Deep pockets
 First-movers can have an advantage
 But so can late-movers
- Learn from mistakes of others
 Move fast, but not too fast
- Don’t grow user base faster than you can scale
- Manage cash carefully

Envelopment
 Rival platform with same
users offers your
functionality
- Bundled as part of a bigger
offer
- Blurs market boundaries
=> convergence
 Examples
- Netscape vs Internet
Explorer
- Real Player vs Windows
Media Player

Defenses against
envelopment
 Change business model
- Real changed subsidy market
- Charged consumers and provided content “Rhapsody”
 Find a “bigger brother”
- Real partnered with broadband TV, cellphone co.
 Sue
- Anti-trust law still open in this area
- Real sued Microsoft for $760M
- Time-Warner (Netscape) similar awards

Find the scarcity
 Do something different
 Go up market
- $4 latte vs. free coffee at work
 Move past the commodity to find the scarcity
- Software is free -> sell support
- Phone calls are free sell the distant labor and talent
(Indian outsourcing)
 Skills are being turned into a commodity
- Travel agents, stock brokers, realtors
- Move upstream

Piracy at home
 1975, Bill Gates, Open Letter to Hobbyists
..most of you steal your software. Hardware must be paid for,
but software is something to share. Who cares if the people
who worked on it get paid?
 As the PC grew up, people started to pay
 Law suits, PR, license codes
- kept piracy in check
- …in the developed world

Piracy in the developing
world
 …ran riot
 Officially Microsoft took a hard line
 In practice, realistic
- Real prevention expensive & painful for real users
- 1998 Gates:
- 3M computers sold in China – but they don’t pay for software
- One day they will
- If they are going to steal it we want them to steal ours
 2009 Microsoft earned $1.25B in China

MICROSOFT VS NETSCAPE
http://en.wikipedia.org/wiki/Browser_wars

 1995 Netscape: over 80% browser market
 Companies licensed Netscape to produce
branded Browsers
- IE 1.0 licensed by Microsoft from Netscape
- Windows 95 Plus Pack only
- 3 months later Microsoft launched IE 2.0
- Free to everyone
 1997 Oct - IE 4.0 – turned the tide

How to compete with free products

Why did Microsoft win
 Deep pockets
- Netscape’s total revenue never exceeded the interest
income of MS cash-on-hand.
- Once ramped up they could innovate faster
 Microsoft owned the desktop
- 90% of machines ran windows
- Consolidated the browser into the OS
- Standard envelopment strategy
- "cut off Netscape's air supply” (Steve McGeady Intel)

Linux
 Linus Torvalds
- Linux a simplified variation of UNIX
- Linux was the poster child for this new software
 Initially developed by enthusiasts
 Today represents a $30B market
- And its still free

The Penguin
Attacks
 Initially Linux mostly competing with Unix
 Eventually its success started to register in Redmond
 Chris Anderson described the reaction by referencing
the classing 5 stages of grief
1. Denial
2. Anger
3. Bargaining
4. Depression
5. Acceptance

Stage 1:
Denial
 Mostly for UNIX users
 MS couldn’t understand: who would go for free?
- Headaches and costs of an unpolished solution
 The problem
- Quality of a community supported Open Source product
increases rapidly
 Oct 1998 the leaked “Haloween Memo”
- OS a “direct revenue and platform threat to MS”
- “free exchange of ideas…longterm mindshare threat”
 Public executive dismisalls
- “Complex future projects…are things that Robin Hood and is
merry band…aren’t well attuned to do”

Stage 2:
Anger
 In 1999the gloves came off
 Linux is free?...like a puppy.
 Five Linux myths
- Technical deficiencies
- High cost of administration
- Licensing cost is only a small part of the decision
 Considered FUD – more effective strategy needed
http://web.archive.org/web/19991013044932/http://microsoft.com/ntserver/nts/news/msnw/LinuxM
yths.asp

Stage 3:
Barganing
 Linux World 2002
 By this time IBM had a whole Linux division
“We realized that we have to take the emotion out of it”
 At Linux World Microsoft T-Shirts:”Lets Talk”
 Proof of higher cost of ownership needed
- So they commissioned an independent study IDC
- Found MS was indeed cheaper (though not for webserving)
- Counter study commissioned by IBM
 Transparency: MS shared source program
- A few government buyers went through the process but no real
impact

Stage 4:
Depression
 Microsoft hired Bill Hilf
- Ran IBM Linux
 Microsoft didn’t understand Open Source
- Considered purely a threat
- Fear of GPL contamination
 Open Source lab
- Treated like a Biohazard
- No funding
- “The loneliest man in Redmond”

Stage 5:
Acceptance
 Today the Open Source lab is thriving
 Microsoft adopted the new reality
- Interoperate with free
 Today there is a place for all three models
- Free
- Free + paid support
- Paid
 By revenue MS dwarfs free models
 By users its much closers
- If you include mobile and consider Android as Linux
- Then Linux has 2x the number of users that Microsoft does

1 Gb of free storage
 April 1st 2004 Google announced Gmail
- With 1 Gb of storage
 Yahoo had been expecting this for years
- Yahoo dominant email provider
- 10 Mb storage for free
- 25+ Mb paid
- Business was profitable and brought traffic to Yahoo
 Much easier for newcomer to offer more storage
- They had no users
- Yahoo had a massive install base – how would they
behave?

Yahoo responds
 May 15th Rosenweig, Yahoo COO pulled the trigger:
- Purchased tens of millions of $ of servers
- Free storage 10Mb to 100 Mb soon go higher
- Premium users would get a refund
- By the end of the year they matched Google 1 Gb
- 2007 announced unlimited storage
- Limited rate of increase – drive as far as you like, not as fast
- 2013 reduced to 1 Tb for marketing reasons
 Gmail gradually increased storage
- now 15 Gb shared with Google Drive
 Yahoo was surprised by user behavior
- Didn’t leave in droves
- Email behavior didn’t change radically

How to compete with free products

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