11/15/2010 07:03 pm ET Updated May 25, 2011

Thinking "Inside" the Box: How Freeloaders Can Make You a Load of Cash

Maybe it's the low barrier to entry. Maybe it's a downtrodden economy that's forced a displaced workforce to become more entrepreneurial. Or maybe, to update the old adage, there really is "gold in them thar clouds." Whatever it is, more and more people lately seem to be looking to the sky in search of that proverbial pot of gold.

As a former entertainment executive turned internet entrepreneur, I, too, have been looking beyond the horizon. And the question I'm asked most often (interestingly, the inquiry often comes before I even tell them what our sites does) is this: "How are you going to make money?"

When I tell them the plan isn't to charge for our service (our service being a collaborative online video editing platform, thank you for asking), the reaction is always the same:

"So you'll be giving it away?"

"Actually, yes," I reply. "For a while, anyway." What happens next never fails.

They smile, arch their eyebrows and nod their heads in a slow, synchronous bob. Not a word is spoken. But I know what they're thinking: "Well, that's certainly one heck of a way to run a business."

As it turns out, it actually is.

"Free" has long been a mantra for aspiring entrepreneurs and investors willing to cut the cost of their wares to as close to nothing as possible in exchange for traffic that can be converted downstream. And while "free" may fuel a business' growth in terms of name recognition and word-of-mouth, the concept of "free" often runs out of gas when it comes to actually filling the financial tank. "Free," it turns out, is a fickle thing. Consumers typically don't like to pay for something they've been getting for nothing. But then again, consumers can surprise you. Just ask Jason Rosenthal.

Last March, Rosenthal took the CEO reins of Ning, the popular online service that allows users to create and share their own customizable social networks. Shortly after being promoted, Rosenthal announced he was going to take a hard look at how Ning did business.

Thirty days later, Rosenthal fired a fateful shot across the "freemium" model's bow, "This process has brought real clarity to what's working and what's not, and what we need to do to make Ning a big success." And with that, Ning bid farewell to "free": If you wanted to keep your Ning account, it was going to cost you.

The ability to let consumers design their own social network, and do so for free (the core offering at the center of Ning's value proposition), had often been cited as a shining example of how to leverage a free, open online platform into massive market share with impressive customer acquisition to boot. The conventional wisdom last March, therefore, was that Rosenthal's decision to abandon the "freemium" model would cost Ning dearly. But that hasn't happened.

According to Forbes tech writer, Taylor Buley, since freeing themselves of "freemium," 35,000 of the 300,000 Ning networks have signed up for paid plans. Of course, the flip side of that equation is that 265,000 presumably balked at Rosenthal's "pay or play" ultimatum. But no matter, Buley maintains, "Ning wooed nearly 12% of its non-paying customers into opening up their wallet -- more than double its previous conversion rate. Ning's paying customer base is three times its previous size."

In hindsight, things turned out quite well for Jason Rosenthal. After five years in the marketplace, the company is on track to turn a profit early next year. But it could have just as easily gone off the tracks. What Rosenthal did was risky. At the time, his decision to discontinue non-paying sites left many in the social media space questioning the move: "What could Rosenthal possibly be thinking abandoning a business model that's at the core of Ning's success?"

I submit Jason Rosenthal was thinking inside the box.

Don't you arch your eyebrows at me. No, I don't mean "outside the box" -- I mean inside the box. The "shoebox" to be exact. Rosenthal's ploy to turn a profit for Ning is what I pithily refer to as the "shoebox effect," and it lays out something like this:

Whether we want to admit it or not, we're suckers for sentimentality. We take photographs, we shoot video, we save every drawing our kids commit to paper. And what do we do with all those photographs, video clips and assorted scribblings? We pack them away in closets, cabinets, cupboards and, yes, shoeboxes. And we forget about them.

Then one day, we stumble across that old shoebox. And when we do, we realize those photos, videos and drawings that once seemed a nuisance to keep track of are, in fact, a treasure trove; the shoebox in which they are stored is a treasure chest. So we do what any self-respecting sentimentalist would do. We replace that cheap, corrugated shoebox for a photo album (maybe one with an embossed leather cover and a nice gold trim?) that can give our memories the respect they deserve.

In case the point is lost on anyone, allow me to spell it out. Shoeboxes are free. Embossed leather photo albums with gold trim cost money. And there's a point when you gladly pay the price.

Returning to the Ning example for a moment, many maintain that Rosenthal wasn't thinking inside the box at all when he abandoned Ning's longstanding business model. To the contrary, they argue, since Ning's infrastructure makes it virtually impossible for customers to port their content out of Ning and into another platform Rosenthal was actually boxing his customers in.

And while I would concede Ning's remarkably high conversation rate can, to a certain extent, be attributed to the fact Rosenthal turned the proverbial shoebox into something more closely resembling an iron-clad locker, I would suggest something else is at play here that's contributed to Ning's remarkable retention rate: the perception of value.

There's no question Ning had their share of users who reveled in the fact they were getting something without having to pay for it. But I suspect after using the Ning platform, a sizeable percentage of those freeloaders saw real value in the service. And because a variety of price points were offered to keep their accounts current, they found one that aligned with their perceived value. Now they're gladly paying for it.

I further suspect this is precisely what Pandora, MailChimp, Flickr, LinkedIn, Evernote and Skype all are banking on. All have successfully been built on the back of the "freeloader." Ning was just the first company to prove those pesky freeloaders can actually be converted... and make you a boatload of cash in the process.

All of which is why I endure all those incredulous eyebrow arches when asked how my new internet endeavor is going to make money. In an age "cloud computing" when we're all are looking for a 'locker in the sky' to store our stuff in, the key isn't building a better mousetrap -- it's building a better shoebox.

I feel confident we have one.

Tom Grasty is a novelist, screenwriter and 15-year veteran of the entertainment, advertising and internet industries. He is also a co-founder of Stroome, a collaborative online video editing community that connects friends, family and aspiring content creators.