(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 winning3. 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

MICROSOFT VS PIRACY

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

Netscape 72 : Microsoft 18

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)

MICROSOFT VS LINUX

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 grief1. Denial2. Anger3. Bargaining4. Depression5. 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/LinuxMyths.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

Battle of the Internet Giants

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