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How to Monetize Free Products
A few business models that have worked at scale for free internet products
This week, I’ll be touching on a few business models that work for monetizing free internet products (i.e., that don’t involve charging the customer) which allow them to remain free for users.
Obviously, advertising tends to be the go-to approach, but there are a number of other business models which are less common but can work well depending on the type of business, which is what I’ll go into.
Payment for Order Flow
Not much needs to be said about advertising. It’s often the de-facto the business model for free products and supports trillions of dollars of market cap in search, social media and content.
Some products that leverage advertising as a key business model include:
Google Search (~$150B/yr in ad revenue)
Facebook + Instagram (~$100B/yr in ad revenue)
YouTube (~$20B/yr in ad revenue)
Twitter (~4B/yr in ad revenue)
Spotify (~$1B/yr in ad revenue)
Media companies (NYTimes, Buzzfeed, most Podcasts, etc)
Advertising is also an important component for multiple platform and marketplace businesses such as Alibaba, Amazon, Roku, Etsy and others which are able to earn additional revenue and often makes the difference between them being unprofitable and being profitable.
One call-out on advertising is that of native advertising or sponsorships, which has been increasingly used by media companies including Buzfeed and even Newsletters. The idea here is to make a post, like any other post on that platform, which feels very native to that media platform, but has been paid for or sponsored by a partner. This can work extremely well, with:
Buzzfeed generates over ~$200M from their ads business, which is almost all from sponsored posts and content, rather than say banners or similar ads inserted into regular posts.
NotBoring on course to make 7 figures a year primarily from ~1x/week sponsored posts which feel very native with the organic content in the newsletter.
For additional reading on advertising, I recommend some of my previous pieces including:
Affiliate (including lead generation)
Affiliate marketing, which is in some sense a more outcome-based form of advertising works especially well for content-based businesses.
The idea behind affiliate marketing is for businesses (or individuals) who have attention of a customer base to promote products or services to that base, and receive a fee (usually a percentage of the transaction) per customer who either submits their lead (lead generation) or purchases the product or service.
Affiliate marketing is a ~$12B/yr industry. Typically, individuals and smaller businesses leverage an affiliate network which has essentially aggregated a bunch of companies that are willing to pay for successful affiliate purchases. Some of the large affiliate programs are: Amazon Associates, Rakuten, CJ affiliate as below.
While many believe affiliate as a business model works best for individual creators (i.e., IG influencers, indie websites) or smaller content businesses, there are examples of businesses which have been able to get to decent levels of scale using affiliate marketing as a revenue source:
NerdWallet, which is a free content-based business which helps users with their financial decisions, generates its revenue by matching its ~20M+ consumers with products from its financial services partners, from whom they earn fees (typically revenue per lead or per funded loan or per action). Most of their revenue comes from affiliate fees from credit cards, loans and insurance/banking, and they make ~$250M in revenue per year.
Wirecutter, which is a product review website which helped consumers make purchase decisions with detailed buying guides across categories, also relied on affiliate fees as their main source of revenue prior to acquisition by the NYTimes. In their first five years of existence, Wirecutter made ~$150M in affiliate fees from their partners. Similarly, Buzzfeed is driving ~$250M/yr from their affiliate sales.
Kuaishou, a short-form video and live-streaming app in China, is one of the numerous apps in China riding the content x creator x commerce wave, and monetizes essentially via a cut of the affiliate marketing revenue generated by influencers who generate transactions via videos and live-streams on the platform. Kuaishou did ~$30B in ecommerce GMV in 2020, on which it earned $4-5B in commissions.
There are some companies that have kept their products free and relied on the gratitude of their users in some sense by using tipping as a key revenue stream.
To be clear, tipping as a revenue stream implies that users don’t have to pay for some content or service, but can pay if they would like. If a user has to tip to access some additional content or service, that isn’t tipping but rather a standard paywall / transaction.
While tipping is most common as a way for consumers to help support or be patrons for influencers or creators, there are a few companies that have leaned into tipping themselves.
Earnin is the most obvious example, which allows users to access money they’ve already earned before receiving their paycheck. Users are then encouraged to tip ~10%, although they can choose to tip $0 if they wish (though over time Earnin does enforce restrictions on future usage if users don’t tip). Earnin was thought to be doing ~$8M/month in revenue just from tips, which is almost ~$100M/yr. While Earnin has been trying to diversify its business model, if it were to go public, it would likely be the very first public company that relies on a tipping-based model.
Video and Livestreaming platforms, particularly in China, such as Kuaishou and Ximalaya (breakdown) allow users to tip live streamers and take a cut of the revenue. This allows these companies to keep the content free and widely accessible, but still allow influencers and themselves to monetize. Ximalaya, for example, made ~$90M in 2020 from their cut on virtual gifts and tipping to live streamers.
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Interchange is a model used a lot in fintech as a way to monetize free products. The idea in interchange is to issue cards to users, and take a small percentage of the volume processed on every transaction on the card.
The Durbin Amendment, which I’ve written about before, allows fintech companies to partner with banks with <$10B in assets and earn higher interchange fees on the order of 0.80%-1.05% plus a $0.15-$0.20 transaction fee per transaction, and is basically the regulation which has helped fintech become what it is today.
Most companies offering a credit card take advantage of the higher interchange by partnering with a smaller bank, as below, when issuing a card.
Overall, interchange allows companies that issue card products to keep the fees or costs charged to consumers low to zero, and take a 0.8-1% cut on every transaction. A few companies that have done this well include:
Ramp and Brex on the corporate side, which charge minimal fees for their cards, and rely on interchange as a key source of revenue. While revenue numbers aren’t public, Ramp was last valued at ~$4B and Brex was last valued at over $12B.
Square, Robinhood, Chime, Apple Card and a host of other neobanks on the consumer side all use this model to make money on their card products. Typically, the cards have no annual fees, and interchange is the primary revenue driver (along with interest on outstanding credit for those that offer credit cards). For a sense of scale, Chime reportedly made $900M-$1B last year, the vast majority from interchange, and currently valued at $25B. Chime has 12M customers and Square has 7M+ card customers.
Payment for Order Flow
Another one generally seen in the financial sphere especially in the case of exchanges, is that of payment for order flow (PFOF). Another version of it, which I’ll lump together here is that of taking a spread on the transaction.
In PFOF model, the company receives a commission of sorts for directing an order to certain brokerage firms for trade execution.
In the spread model, the company executes the transaction themselves, but essentially earns a small spread (difference between bid and ask price).
In both of them, typically, the transaction can be free for the consumer, but happens at a slightly higher price than it might have otherwise, so the consumer pays a fee in some sense, but it is out of sight / mind for the consumer.
Compare this with Coinbase for example, which clearly mentions its fee separately rather than say executing the order at a higher price and taking a spread.
While payment for order flow is controversial, in general, the idea of charging a small spread if allowing for zero-fee trading is a good one, as long as companies are transparent about it being their business model. And we know this works, even at scale:
Robinhood, which in some sense pioneered the zero-fee trading model, made $719 million from PFOF and transaction rebates in 2020, and it is the primary revenue driver which supports their ~$14B valuation.
eToro uses the spread approach since PFOF is banned in Europe. It made ~$600M/yr in revenue, ~85% from trading revenues in the last 12 months, and will soon be a public company.
For more on this model and on Robinhood, I recommend the following pieces:
To summarize, companies have many options to make money while offering their products for free to customers. Depending on the type of company, certain ones work better than others, and they can be combined as well.
Advertising: works great for media, content and commerce businesses which either capture a lot of attention or a lot of targeted intent
Affiliate: works great for individual creators, platforms that many creators are on, and targeted content businesses. Also works great for vertical platforms which can help people along the journey of large transactions (and sell their leads)
Tipping: works great for individual creators or platforms that many creators use where consumers are willing to support creators
Interchange: works great for fintech businesses which issue spending products such as cards
PFOF/Spread: works great for exchanges and other similar financial businesses which allow people to buy various types of financial assets.
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