Free can create value
There has been some discussion in the blog world about how to create value when you give something away. Josh Kopelman correctly points out that the hardest thing about offering a free service is getting users who pay you zero to make the leap to paying you something. It was on Fred Wilson's blog where I first heard the term 'freemium', describing a service which is offered for free with the option for some users to upgrade to a premium, paying service. I'm skeptical of high rates of conversion to premium, so free services need other sources of revenue. Everyone expects that a free service will be supported by advertising. And, that's not a bad way to make some money. But, I would be worried that advertising on its own won't scale to be enough revenue to build a big business.
What is most interesting for me is when a free service can attract enough users that are qualified in some fashion and can be handed off to other services who will pay a bounty for a lead or a sale. This allows the users to decide when they are interested in some new service. When they are interestecd, they click. The click should be worth something. It's even more interesting when this click is tracked through to a sale which pays a nice bounty back to the original site. This pay for performance model goes beyond just plugging in Google ads to your site. You need to negotiate partnership deals with suitable partners. But, your free customers can be worth more in this way than as viewers or clickers of ads or buyers of a premium service.
Like Josh, I am real interested in market segments that can be collapsed with a free model, and particularly those where you can get paid bounties when your users raise their hand to indicate an interest in a related service.