Introducing the “Less Than Free” Business Model

Posted by Patty Youngclaus

September 28, 2012

Last Friday, as I read The Wall Street Journal article, “Apple Makes a Wrong Turn as Users Blast Map Switch,” I could not help asking myself: Is this really a major strategic error by the world’s most valuable company or is it simply an execution blunder in a highly visible case of a prisoner’s dilemma?

To answer the question, I went back and read a post from Bill Gurley, one of technology’s top dealmakers, to better understand why Apple introduced its own turn-by-turn navigation app. Then I read this paragraph:

“Here was the big punch line – because Google will give you ad splits on search if you use that version! That’s right; Google will pay you to use their mobile OS. I like to call this the ‘less than free’ business model. This is a remarkable card to play. Because of its dominance in search, Google has ad rates that blow away the competition. To compete at an equally ‘less than free’ price point, Symbian or Windows Mobile would need to subsidize.”

Double ouch!

The “less than free” business model that Gurley describes is a truly disruptive innovation.

I am big fan of game theory and its application. Bruce Bueno de Mesquita’s book, “The Predictioneer’s Game” defines game theory as a “fancy label for a pretty simple idea: that people do what they believe is in their best interest.”

So, here is the answer: it is in Apple’s best interest to introduce its own version of the turn-by-turn navigation app.

But why? Google Maps is a superior product, and it is free. Similar to a prisoner’s dilemma, Apple’s hand was forced by Google to introduce its own turn-by-turn mapping system. Otherwise, the company was at risk to be left out of the game or compromise on its own margin with the iPhone and iPad devices. How great would the iPhone5 be compared to the Android-based Galaxy S3 without a map application? What are the chances that Google would have pulled the plug on iPhone the way it disconnected NAVTEQ and Tele Atlas?

However, Apple overlooked the fact that the product execution needs to be good (in Apple’s case, great). Supporting my claim, Gurley states, “Naysayers of these assertions will likely have the same retort – quality is key. They will argue that Google’s turn-by-turn apps are inferior to their well-honed, market-leading products. With regard to Android, Google will lack the user interface or embedded software expertise necessary and will deliver a subpar product. Plus, because the Android OS will be so splintered, QA testing will be difficult and incompatibility issues will abound. In the short run, these issues will exist.”

Today, we are seeing that Apple had the right strategy, but failed in execution. However, it may not hurt the iPhone 5 sales because when a product is completely free, consumer expectations are low, and consumer patience is high.”

The good news for Apple is that their loyal customers will be patient and wait for superior subsequent versions of the mapping system app.

The key takeaway is that a free or “Less Than Free” business model can really be an industry game-changer. Let’s analyze how Facebook did it in the social media industry.

For Facebook, Zuckerberg’s brilliance was to bypass Harvard, MIT, and Stanford, all by using the free model. Gurley states, “We noted in our take on the free business model, if a disruptive competitor can offer a product or service similar to yours for free, and if they can make enough money to keep the lights on, then you likely have a problem.”

Borrowing the words from my co-founder Marc Cenedella, “The key point with Zuckerberg’s success is even more profound. Free allowed him to 'outsell' the competition. Free freed him from the wrong customer requirements. My claim is: free made the product features better by eliminating customer requirements and that's because pricing put the focus on the wrong customer.”

Harvard had Facebook before Zuckerberg came along. In the late 90s, graduates of Harvard Business School tried to sell the university their own version of Facebook. For Facebook, the university was the wrong customer. Building university requirements into a product and having a long sales cycle would never have allowed Facebook to exist. Bypassing them entirely was an ingenious move.

So, a subsidiary claim would be: pricing forces you to choose a customer. Choose well, and you have a fantastic product. Choose wrong, and you get stuck.

Have you chosen your customer carefully? Can you leverage a free or “less than free” business model to change the game on your competition? One of the most successful ways for small private companies to gain the upper hand over large incumbents is to change the rules of the game.

Alex Douzet is Co-Founder and COO of TheLadders. In this role, Alex is responsible for the company strategy, global business operations, and product development.

Topics: In the News