There’s a great post on Mashable by Steven Hodson today on how the attitude users seem to have nowadays that all services must be free is hurting web businesses.

One of the most basic tenets of Web 2.0 has been this idea that everything can and should be free for everyone on the Web to use because whatever inherent costs incurred by a service can be paid for by advertising; or in some cases it would seem – by VC dollars.

A similar thought, penned earlier this year by Hank Williams — entitled Free is Killing Us, Blame the VCs — also expresses the frustration many companies have in trying to establish real businesses on the Internet. The crux of the matter: that CPM-driven, advertising dollars are just not enough for many businesses which cannot attract enough eyeballs to give it all away for nothing and sell advertising against it.

I recall sitting through Economics 101 in college and the concepts of elasticity of demand. Elasticity of demand is the relationship of price to demand — for example, if you lower the price on a car, how many more buyers are you going to get by lowering the price? The premise of many a web-based business is that the world is infinitely elastic, that is — if you lower the price to free, everyone in the world will want to become a customer, meaning you will get millions and millions of pageviews which you can then sell on a CPM basis and make your company infinitely wealthy — or at least, that some Big Internet Company will find very attractive and take off your hands.

In part — and this is why the “blame the VC” part comes into play — the gambit being made by a lot of web businesses today is that they can go ahead and jump on the “everything should be free” bandwagon because they are looking to build it big, and sell it fast. That is, if you can build up your web traffic/pageviews/etc. up fast enough, you can sell it quickly to a Yahoo/Google/Microsoft and not have to actually worry about monetization. Sometimes, this works (witness YouTube) — but more often than not, it ends in a quick flameout. Enough VCs are willing to subsidize the efforts, that users have been mislead to thinking that everything must be free. The problem is, in the end, someone has to pay for those services. At the moment, VC dollars are keeping many, dollar sucking Web startups alive, who otherwise wouldn’t be able to survive under the free model.

The problem is — there are many businesses which are inelastic in nature — that is, even if those services are free, you aren’t going to get many more customers. Frankly, there are many, many markets which just aren’t big enough — and will never be big enough–where CPM driven advertising will be a viable formula.  Even if you price your service at free, even if you have 100% of the market of online customers in that segment, you couldn’t cover your costs. I’ve heard some of the more sensible venture capitalists I know talk about this dilemma — on how they’ve passed on Web 2.0 companies because they just don’t have a big enough market, and how they could never actually reach enough people to make CPM advertising profitable.  It doesn’t seem like there has been enough thought on market sizing by many, Web 2.0 startups, to figure out they’re actually in an inelastic market where free doesn’t make sense, rather than a very broad, horizontal market where free/CPM-based ad models actually might work.

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Bubble by Benjamin Kuo