Lyons: Why Good Web Sites Shouldn't Be Free

Back in the last downturn, in 2001, Jason Katz realized he was in trouble. His fledgling Web site, Paltalk, was trying to make money by giving away a free service and selling advertising. But suddenly advertising was drying up. So Katz—whose site operated chat rooms in which you could not only send text messages but also talk, the way you would on a phone—did something radical: he started charging people to use a premium version of his software, which offered some extra features. Guess what? Since 2004 he's been making a profit, and he's come to believe that, contrary to the conventional wisdom, people really are willing to pay for online services. "I think some companies are scared that they will cede users to the competition if they deign to ask someone to pay for a subscription to something—but that is obviously a mistake," Katz says.

If so, it's a mistake that a lot of bigger tech companies are making. Could these guys be leaving billions of dollars on the table? Facebook, for example, has 250 million members, making it one of the biggest sites on the Internet. Facebook takes in somewhere between $300 million and $500 million a year from advertising, but it has never made a dime of profit. Twitter, another hot Internet site, has 40 million members and doesn't even try to generate revenue, let alone profits. YouTube, the video site owned by Google, sells ads but runs at a loss.

Why not charge people to use these sites? If the service is so useful, surely people would pay. Nevertheless, the prevailing wisdom in Silicon Valley today is that everything on the Internet must be free. Enslaved by this dogma, tech companies keep bending themselves into pretzels trying to invent ways to "monetize their traffic," as they say in Valley-speak. Maybe they'll charge companies that monitor Facebook and Twitter to see what customers are saying about them. Maybe they'll steer people to shopping sites and take a slice of whatever those people buy. Maybe they'll get into the hardware business, developing smartphones or other devices that come preloaded with their application. Twitter might make money by charging celebrities and companies for "verified" accounts so that readers know they really are who they say they are.

Meanwhile, the most obvious answer hangs right out there in the open: charge a fee to use the serv-ice! I'm not even close to being an avid member of Facebook, but I do consider it useful—and I would gladly pay $5 per month for the service. The really passionate members are kids in their teens and 20s. They spend hours every day on Facebook, and would be lost without it. You think they won't pay five bucks a month? Even if half of Facebook's members were to leave rather than pay, you're still looking at a huge business.

So why don't more Web sites do it? The idea, apparently, is that charging money would limit growth and be shortsighted; that there's a bigger opportunity if membership remains free and everyone in the world can join. "Facebook is a free service, and we have no plans to change that," says Elliot Schrage, head of marketing at Facebook.

Katz, the guy who runs Paltalk, has a modest proposal: he suggests that Facebook should offer his video chat-room software as an optional feature, and charge a monthly fee to use it. "I think Facebook could make a zillion dollars putting my technology into their community," he says. (Katz would get a nice slice of that, too.) Alas, he says, he's tried to get a meeting with Facebook but has had no luck.

Katz didn't have this all planned out from the start. At first Paltalk was just a kind of fancy version of instant messaging—basically text plus voice. In 2001 Katz added video, and that's where he started generating money. For zero dollars, you can trade instant messages on Paltalk with up to 10 people and see their video- streams. But if you want to visit chat rooms and see video streams from hundreds of people, you must pay $14.95 per month, or $60 for a one-year subscription. In addition to the video chat rooms, Katz has created virtual conference rooms for corporate customers, mostly small businesses. For $90 to $1,000 per month (depending on the maximum number of users), you can have a room that's all yours, 24 hours a day.

Only about 5 percent of Paltalk's 4 million active members pony up. Apply that 5 percent conversion rate to Facebook's giant user base and you're looking at 12.5 million people paying $60 a year. That's $750 million. But even on his own, Katz has been able to build a nice little business. He has 38 employees and annual revenue that's in the "tens of millions," with 85 percent coming from subscriptions, he says.

Katz still runs ads, but ad rates have plunged so much that a business that was lousy in 2001 "now is even worse," he says. The funny thing is, if Katz hadn't dared to charge fees back in 2001, he wouldn't be in business today. That's something the big guys might want to keep in mind.