Giving Away The E-Store

By Karl Taro Greenfeld

Yaron Zilberman, 33, and Guy Blachman, 28, have made all the right moves. They have M.B.A.s from top business schools, $8 million in venture capital and a snazzy Trump Place apartment and office suite on Manhattan's West Side. They also have Gooey, an innovative Web application that allows visitors to any website to chat with other Gooey users at the same site. Zilberman and Blachman will tell you it's a killer app, one that will turn the whole Internet into a billion-voice AOL chat room. So how much is Hypernix, their company, charging for this product?

Nothing. Like hundreds of high-tech and Internet companies, Hypernix has embraced the business of free. You name the product, and someone out there wants you to have it gratis. There are at least five companies giving away PCs, five offering Internet access, a couple promising long-distance calls at zero cents a minute, three passing out voice-mail boxes, one seeking the privilege of doing your faxing and another that wants to give you postage. You want e-mail? Pick from a dozen companies that would love to be your no-cost provider. Once you're online with your free PC, you may want to trade stocks--American Express Brokerage will provide free trading for accounts over $100,000. Amex won't do your taxes, but H.D. Vest, another financial planner, has just volunteered. Other software needs? Linux is a free operating system, and Sun Microsystems' StarOffice is a complimentary office suite.

Why the proliferation of businesses that are literally giving away the store? "We're moving from an economy where people pay directly for services to an attention-based economy," says Joe Krause, senior vice president of content at Excite@Home. "What's valuable for businesses is not necessarily the money being directly paid but rather the consumer's attention." Most of these businesses--like Free-PC, which offers a free computer in exchange for a constant ad presence on your desktop, and NetZero, an Internet provider--are relying on advertisers and marketers to provide their income. They subscribe to the old Net mantra: Get Big Fast. Gather enough eyeballs, aggregate enough consumer-shopping habits and click-through tendencies, and sellers will pay a premium to get at your customers.

One might rightly ask: How much does all this free stuff cost? In the case of PCs, some firms, like InterSquid and PeoplePC, provide quality computers that come with multiyear contracts requiring the user to sign for dial-up Internet access at somewhat pricey rates--a deal many consumers might regret when high-speed Internet access becomes widely available. AltaVista, a free Internet service provider, runs a narrow, scrolling banner across your screen that requires you to click through--interact with the ad--every hour.

Although free everything seems like another Internet innovation, it's actually a century-old strategy. King Gillette gave away his safety razor and made a fortune selling the blades. Perhaps you remember something called broadcast television, which was preceded, in the 1920s, by broadcast radio. RCA created the NBC network to sell radios.

These classic business models are being embraced by an Internet industry that can't dispense money fast enough. "With $60 billion in uninvested capital in the hands of venture capitalists, every gimmick ever thought of will be funded," says Ann Winblad, partner with Hummer Winblad, one of the best-known venture-capital firms. "We have seen free everything walk through our office. Still waiting for Free House."

The Net has always been conducive to giving away high-tech gewgaws. Browsers like Netscape's Navigator and Microsoft's Explorer have long been free. And in 1997 RealNetworks became a new media power by handing out its media player to build market share. Then Sabir Bhatia, co-founder of free e-mail provider Hotmail, sold his company in 1997 to Microsoft for $400 million, or $44 per user. "What hit people when Microsoft bought Hotmail was how much they paid per user," says Diane Greene, ceo of VMware, a Palo Alto, Calif., software firm. "All of a sudden, eyeballs were worth a lot of money."

Entrepreneurs of the pro bono model worship Hotmail--even though the company never made a profit. They overlook the fact that what made Hotmail hot was one of the stickiest applications out there--once you have an e-mail address, you tend to keep visiting the site--and a one-year ramp up to 5 million users. Start-up founders fantasize about that 400 mil. "Now there are so many companies, and you ask them what their revenue model is and they say, 'I don't know. We just want to get big fast and get acquired, like Hotmail," says Bhatia. "That's scary when entrepreneurs don't think through how they are going to make money."

Zilberman vows that Gooey will be profitable--he's just not sure when. He says Gooey needs a minimum of 3 million users within a year. Today he's got about 300,000. "Nobody has ever done our business model successfully," he concedes as he heads into Hypernix's next round of fund raising. "But we are talking about really high-quality reach media."

That's another word for targeted advertising. The two-way nature of the Net makes it possible for advertisers to know a lot about you (sometimes without your knowing it--see box) so they can deliver more effective ads. Web entrepreneurs are counting on advertisers paying a higher cpm (cost per thousand) for this rifle-shot data than they do for the old shotgun approach. "We charge more than average because each advertiser can see how their ad is performing with each demographic and can then focus their campaign," says Steve Chadima, founder of Free-PC. Forrester Research estimates that Internet advertising will grow from $2.8 billion in 1999 to $22 billion in 2004. But with click-through rates hovering at under 1%, those ad dollars will support only a handful of the many businesses that are making a go of the giveaway. "It'll be a dogfight," says Chan Suh, CEO of Net advertising operation Agency.com "People who think that advertising makes up for the lack of a biz model and execution are going to fall by the wayside."

The Gooey guys have no doubts about their model. But neither does their competitor, Third Voice, another free client that allows users to post on websites. These two Internet software firms will be battling it out for eyeballs, advertisers and traffic. One thing you can bet on, however: no price wars.

--With reporting by Susan Kuchinskas/San Francisco and Julie Rawe/New York City

With reporting by Susan Kuchinskas/San Francisco and Julie Rawe/New York City