Sooner or later, someone pays...
Free Web Services: There's No Turning Back
Betsy Schiffman, Forbes.com, 03.20.01, 1:53 PM ET
NEW YORK - A $150 dinner at a five-star restaurant will always win the taste
test against a box of Kraft macaroni and cheese made for $1 at home. The
price on any product or service should reflect its value.
Small wonder, then, that Internet companies are in a major quandary. After
years of giving away e-mail, news, digital address books, and calendaring
services, they're stuck trying to convince consumers that--oops!--they meant
to charge for that stuff. No one is suggesting that the existing free
services offered by companies like Yahoo! (nasdaq: YHOO - news - people),
MSN, and even Juno (nasdaq: JWEB - news - people) and NetZero (nasdaq:
NZRO - news - people) will be pulled. That being said, Internet companies
are scrambling to upgrade their cheapskate visitors to use for-fee services.
It's bound to be a painful, if not impossible, transition, and it could come
at the cost turning off loyal users.
While Yahoo! is down in the dumps with a crummy ad market, it has repeatedly
promised to roll out additional for-fee services. On the outset, it looks
like a panic plan that so far lacks specifics. The company has only said it
will roll out "pay-for" services in financial, entertainment, and commerce
areas. However, if Yahoo!'s attempt to initiate fees for its auction
listings serves as any kind of indicator, chances that the company will
succeed look slim.
Just a month after Yahoo! began charging for auction listing fees, the
number of listings plummeted, by some estimates about 90%. Although the
exact drop was never specified, financial analysts cut annual revenue
estimates by orders of magnitude. Credit Suisse First Boston analyst Jamie
Kiggen had previously expected Yahoo! Auctions to generate about $27 million
in annual revenue. Kiggen revised that estimate to about $5 million in 2001.
It was a discouraging indicator of the damage that was done by spoiling
loyal users with free services. Current members of the Internet population
won't be very willing to pay for services such as e-mail or Web poker that
were previously free, and they may actually move on from sites that even
attempt to charge.
"It's similar to what happened in the 1970s and 1980s: A lot of companies
shifted budgets from advertising over to sales promotions like coupons,"
says Georgetown University McDonough School of Business visiting professor
Susan Heckler. "It conditioned consumers to care less about brand and more
about discounts. I don't think you can ever repair that kind of damage."
The upshot? Consumers won't unlearn their behavior, so companies have to
wait to exploit the new batch as they mature. "Those companies shifted
budgets back to advertising and targeted younger generations," says Heckler.
"Older generations were too tough to recondition."
That doesn't leave Yahoo! or MSN in a very promising position. The only
people on the Internet they probably haven't corrupted yet are the kids who
are too young to use a PC.
Even The Wall Street Journal fell prey to the freebie bug in an effort to
drive traffic. In November 2000 the newspaper, long praised for sticking to
its guns and refusing to give its content away, began distributing "selected
headlines" to Yahoo! for users to read for free. According to Journal
spokesman Dick Tofel, it's still only a "very small percentage" of content
that's being given away in an attempt to drive more traffic to the site and
to sell more advertising.
Salon.com is trying to backpedal in the other direction. In April the
content site will roll out a new subscription service to augment revenue
from the sagging ad sales on its free Web site.
"Giving goods away for free isn't always a mistake, but companies have to
understand the implications of what they're doing. Dot-coms that built
high-volume [traffic] based on free services are likely to lose market share
if they start charging. They're trying to step back and convince people
there's a value in a service that they were giving away," Heckler says.
But it's a catch-22--had companies started charging to begin with, growth of
the overall Web would have been nipped in the bud. Now it's the individual
companies that are feeling the nip.
After postponing the IPO until next week, the company said yesterday that it is repricing shares at between $6 and $7, down from previous price of $12 and $14. Assuming the current pricing, the Agere deal is valued at about $3.9 billion, down from $6.5 billion.
It's an unspeakably foolish time to IPO, but Lucent (nyse: LU - news - people) has a strong motive. It needs the deal to go through so it can transfer some $2.5 billion in debt from its books over to Agere's books. This was supposed to prevent Lucent from getting its credit rating cut to junk status. But by now many people think Lucent will likely get its credit rating downgraded anyway.
Lucent and Agere spokespeople maintain the IPO is a strategic choice, but in this market it may be more strategic for Lucent to just accept a junk credit status. It may be inevitable anyway. "I honestly don't think Lucent can avoid getting junk bond status," says a financial analyst involved in the Agere underwriting.
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