No-Cost PCs May Not Be Viable Model.

The Web site for Free-PC Inc. proclaims that its business model of giving away computers in exchange for demographic information to be passed along to advertisers is "the next big thing on the Internet."

But last week's merger of the Pasadena-based firm and eMachines in Irvine has the Internet investment community wondering whether such an approach made much sense in the first place.

"I think that kind of model is really challenging," said John Morris, a founding member of the Los Angeles chapter of Tech Coast Angels. "Personally, I'm glad they're merging. It gives me hope that the concept of Free-PC is silliness and a fad that's going to pass."

Under the Free-PC model, customers fill out an extensive online form to qualify for Compaq computer. In the process, they had to divulge everything from their marital status to their hobbies and the kind of car they drive.

The information was passed along to advertisers, who used it to create ads targeting those consumers. The ads were embedded in the hard drives of the free computers and popped up every time the machine was used.

In theory, the cost of the computers and Internet access would be subsidized by advertising money.

When Free-PC announced its free computer offer in February, its Web site was inundated with almost a million requests. The company has since given away about 30,000 computers to people described as a diverse cross-section of those who filled out the online form.

But with the merger, Free-PC will no longer give away computers in this fashion. Instead, it will incorporate its advertising technology into low-cost eMachines computers, which are sold at big-box stores.

"I guess I would call the merger a graceful surrender," said Jim Gauer, general partner at Palomar Ventures. "Perhaps it is confirmation that the advertiser-base model is important to the low-end PC makers. My guess, looking at it from the outside, is that low-end PC manufacturers and sellers like eMachines also need the Free-PC type technology and advertiser revenue to make their business model work."

But officials with Free-PC and eMachines wouldn't call the merger an admission of failure. Rather, they called the deal more of an evolution.

"The reason we approached Free-PC was that we became aware that this was a very powerful opportunity," said Stephen Dukker, president and chief executive of eMachines. "I consider Free-PC a working experiment, and figured we could work together and turbo-charge a model that's already proven itself."

Details of the merger between the two privately held companies were not released. But under the agreement, Free-PC shareholders will exchange their stock for shares of eMachines.

Under the deal, which was worked out in less than two months, Dukker will remain in his current position and Donald La Vigne, chief executive of Free-PC, will become executive vice president of eMachines. Bill Gross, chairman of Free-PC and Idealab, the Pasadena-based technology incubator that spawned Free-PC, will join the board of eMachines.

"It's a coup for them that they were able to get Bill Gross to join the board at eMachines," Gauer said. "My guess is, Bill must have looked at the combination here and said (he's) willing to dedicate some of (his) time to this to make it work."

Neither Gross nor officials at Free-PC returned calls seeking comment.

Dukker said specifics on how the Free-PC advertising technology will be incorporated into eMachines computers are still being worked out. But he did indicate that advertisers would be able to make their mark on one of several different levels.

For instance, an advertiser could place a designated key on the keyboard that would link customers to its Web site. An icon could also be placed on the desktop that would provide information about the company. Or, there could be interactive media opportunities that would lead users to a variety of e-commerce sites.

Still, some investors question the appeal of the kind of demographic group that would most likely sign up for a free or extremely cut-rate computer.

"You think, 'Here's the site where I'm going to get my mother a computer, or my kids, or my nephew,"' said Morris. "If you peel back the onion on this, it's unlikely that these sites are going to attract serious advertisers, anyway."

Currently, Free-PC's advertisers include MSNBC, Citibank, software manufacturer Symantec Corp. and sister Idealab creation eToys.

Free-PC isn't alone in trying this business model, and some investors are becoming wary of similar proposals that come across their desks.

"I never thought that competing on price by itself is a real long-term, sustainable advantage," said Tony Hung, vice president of Dyna-Fund Ventures. "What you need to look at for a company that is giving away free things is whether they can get up to scale fast. I can't afford to fund losses for a very long time."

But while giving away computers in exchange for demographic information may have proven too burdensome, other variations on the model are getting investor interest.

One success has come from yet another Idealab baby, NetZero, which gives away free Internet access in exchange for consumers agreeing to have ads pop up on their screens while they're online.

Since its launch in October 1998, NetZero has racked up 2 million subscribers, although some question how many of those people registered are regular Internet users.

"Net Zero is interesting because they're on the cusp of the fact that the Internet service provider space is kind of bifurcating," Hung said. "With broadband coming, you're going to have to have a free dial-up ISP piece of the market and a higher-cost broadband piece of the market. Customers are going to have to gravitate to one or the other. NetZero is firmly entrenched in the free space, and the big question is whether the ad market is mature enough for them to stay there."

But with the Free-PC merger, hesitancy remains about committing to this kind of business model, especially since Gross is viewed as such a visionary in the e-commerce community.

"Investors are going to say, 'We won't play in this space,"' Gauer said. "Some of the new plans aren't going to get financed, the notion being that if anybody could make this work, it would've been the Idealab guys."