How to Make Billions with a Free Product

In 2016, Facebook (FB) earned over $10 billion, while seemingly giving away their product. FB’s sales averaged almost 50% growth over the last 5+ years. The current stock price tops $150/share—the market values the company in excess of $425 billion. That’s pretty heavy lifting for a company that went public just over five years ago.

In our digital boom era, Facebook can teach entrepreneurs a thing or two about how to make big bucks—with little to no cost for users.

Understanding the underlying Facebook profit philosophy

Anyone who had to sit through a few accounting courses knows there are two kinds of costs—fixed cost and variable cost.

In simple terms, fixed costs don’t change with changes in sales or production. Rent, accounting costs, etc. are examples. This is important when looking at the unit cost of a product. Assume your company (Widget, Inc.) has a fixed cost of $1 million and you produce 1 million widgets. Your fixed cost per widget is $1. If you could double your production without adding costs, your fixed cost per widget drops to $.50.

Variable costs change based on sales or production. Sales commissions are a good example. Commission expense varies by how many widgets are sold.

In the case of Facebook, the primary fixed cost is infrastructure—building a stable platform that can be used by users to engage one another. There is occasionally need for maintenance and upkeep of the infrastructure, but that cost is minimal.

Leveraging fixed vs. variable costs

Let’s move to another example as a demonstration of wisely-leveraged fixed cost growth.

Ted Turner became a billionaire building the Cable News Network (CNN). He spent millions building a worldwide news organization—while losing money.

Let me explain. In 2016, S. Derek Turner outlined, “Why CNN Doesn’t Care What You Think”:

“…During 2014, an average of 96.6 million households ‘subscribed’ to CNN, each paying an average of $7.32 per year. That equated to $710 million in revenues from cable-TV customers, 63% of all of CNN’s revenues for the year.”

This is money CNN earned regardless of the fact that most people paying for it rarely, if ever, tuned in. Turner continues:

“…CNN has lost 5% of its subscribers since 2010. But the monthly fee that the remaining cable subscribers pay for CNN has increased by nearly 25%! What a great market to be in, where you lose customers while raising prices and still manage to bring in higher revenues.”

Once CNN’s revenue covered their fixed costs, things changed quickly. With the network infrastructure complete, each additional subscription generated almost straight profit—and additional advertising revenue. At the time, cable television was growing, adding millions of new subscribers yearly.

Microsoft is similar in this regard. Two years ago, Microsoft sold their Office Home and Student 2016 program for $149.99. You could buy it and download it immediately. As soon as they recovered their fixed development costs, the next $149.99 download was almost 100% profit.

But the multi-billion-dollar Facebook take a different tack…

The Facebook “free” approach

Facebook created a FREE website that is visited by millions of people daily, generating huge advertising revenues. As they continue to add viewers, their sales revenue jumps dramatically. For example, FB revenue increased from $12.5 billion in 2014 to $27.6 billion in 2016. Their gross profit margin is spectacular—86.29%. That’s mostly advertising money.

Once they covered their fixed costs, their profits skyrocketed! In 2014 alone, they earned $2.94 billion. By 2016, that number jumped to a whopping $10.18 billion. How? With a stable platform in place, they could bring on more users every day—and the more people that engage the platform, the more people want to follow. Those higher numbers equal BIG advertising dollars.

How can you build a company that gives a product away and be worth billions?

Create a website that creates huge traffic, attracting advertisers. Once you cover your fixed costs, the (profit) sky is the limit.

However, it should be noted that not all tech companies or content platforms are created equal. To boot, generating major traffic is no easy feat in this day and age.

Case in point: Twitter started as a social media website in 2006. Following in Facebook’s footsteps, they went public in 2013. Over the last three or more years, the number of monthly active users jumped from approximately 255 million to 330+ million. Their 2016 revenue was $2.5 billion, but—and this is key—they have yet to turn a profit.

Two years ago, David Goldman (CNN) wrote, “10 years later, Twitter still isn’t close to making money”:

“Twitter has lost $2 billion since in 2011. New management, products, designs, and features haven’t done much to move the needle.”

Why?

It hasn’t been able to expand its reach the way social media rivals like Facebook have. It’s hard for Twitter addicts to accept, but Twitter just hasn’t shown itself to be popular enough.

Shares have fallen by 77% since they reached their all-time high the day after Christmas in 2013.

Rumors that Twitter is up for sale have been around, but with such a messy balance sheet, it’s unclear who might be interested in buying it. The usual suspects—hedge funds and big tech companies—have hinted that they’re just not interested.

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The moral of the story is simple: Yes, it is possible to generate billions of dollars in revenue using the Facebook “free” model, or even the recurring subscription model that CNN uses. But the trick is getting a critical mass of followers/users.

How? By making your product indispensable and ubiquitous.

One great example of this currently at play is the platform Alignable. Still a nascent brand, Alignable is an updated version of LinkedIn for small businesses with a hyper-local focus. Forums dominate the platform, as do recommendations. Unlike LinkedIn, original content is not really a thing on Alignable.

With a lot of LinkedIn overlap, though, many people might ask: Why would I go to Alignable if I already have LI?

Because it’s becoming ubiquitous. New users receive daily emails from the support team—personalized emails, by the way—that highlight their activity, applaud them for their growing network, and introduce new and innovative ways to engage. It also constantly reminds them who is hopping on board.

This regular, personalized communication is what is bringing early adopters on board. And as more join, more invitations to join are sent out. The community grows, and before long, it becomes an indispensable resource. It wouldn’t be all that surprising if Alignable becomes a spotlighted, fresh-faced, professional Facebook as 2019 dawns.

[Note: The aforementioned companies are used as examples. Investors should perform their own due diligence before investing.]

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