You are an incumbent on the market, making decent profits from your product & services, then out of nowhere your new competitors roll out products that are very similar to yours but with one key difference: it's FREE! What now? ignore it, hoping that your customers won't find out or hope that your competitors will run out of operating cash and drop out of the market? Or do something about it!
In the digital era where technologies are widely available, the cost of building a company has gone down dramatically. This is especially true for online product and services. For instance, with amazon's AWS, you no longer have to make the initial investment in building your own server room. With the introduction of Google Docs from Google you no longer have to purchase the full set of Microsoft office. Furthermore, it is much easier to borrow capital nowadays when compared to before. Venture capitals and angel investors are much more active and prevalent. As result, the way of making money got creative. Most important of all, making money can wait.
How should you deal with this challenge? Yes, one approach is to ignore it. But ignoring it doesn't mean to do nothing about it. You should study the market, the customers, and the competitors. To revisit your company's positioning on the market, to review core values of your company. If your competitors are throwing out products that are 90% similar to yours but the 10% that your company delivers make all the difference, and you are confident that your competitors are unable to deliver the last 10%, then you might not have to take action yet. In another scenario, the cost of switching is extremely high in the short to mid term that there is no way your customers are going to switch. In this case you can also hold your response. However, in this scenario you may get hurt when it comes to acquiring new customers.
If you choose to respond by rolling out your own free product and services. Below are a few strategies to react to your competitors.
Free product & services + Charge for premium users
Does your product and services have to be consumed as a whole, or could it be broken down and be delivered separately. Most often they can be broken down. For instance, Skype offers free computer to computer calls and charges for computer to phone calls. For Google you can use gmail for free as an individual. However, you can also pay for a business account and get your own domain name. On Linkedin you can register as a member to use the basic functions on Linkedin. However, if you want to use its Sales Navigator function to capture leads, then you need to pay for it. Roll out a free version for the entry level users and charge for the more advance functions.
Free product & services + Charge for access to the member pool
Roll out your product and services for free to capture the none paying users. Then charge the 3rd parties for the access to these users. This is a strategy adopted by many social medias and content orientated platforms to generate revenue.
Offer products & services that are extremely cheap + bundle it with a profitable part
To offer products that are very cheap. So cheap that the selling price is almost the same as your cost. After attracting the customers to purchase your initial product, sell the bundled product and services that they can't go without with. For instance, printing manufacturers like HP and Canon use this type of strategy. They sell you a printer at a dirt-cheap price, and profit from the ink that comes with it. Some elevator company sell the elevators for a very cheap price and profit from the routine maintenance that you can't go without with.
Offer products & services that are extremely cheap + Cross sell other products
To offer products that are very cheap and cross sell other product line. For instance many cheap airline companies uses this strategy. The ticket fare is extremely cheap compare to the tradition airlines. However, they charge for everything else that you would like to enjoy. Additional fees for the luggage, refreshments, in-flight entertainment, in flight communications...etc.
Often when the incumbent chooses to respond with a free or close to free product of their own as a counter attack, they get a fair chance of obtaining their market share. However, often incumbent choose not to roll out their free product & services. Why? because they are often too comfortable enjoying the profit that they are making from their current business model. Take a classic example, Microsoft have enjoyed their near monopoly product "Office" for many years. A highly scalable product that is highly profitable. Then comes along the Google Docs and Oralcle's Open office to the market. Microsoft is reluctant to embrace a free product strategy. As result, many price sensitive users such as college students and public entities flock to the free products. By the time Microsoft rolls out its free product "Microsoft Live". A big chunk of users have already gone to Google and Oracle. Therefore, it is extremely important for incumbent to not overly enjoy their current status and to recognize the potential threat and to react at the right timing with the right strategy.