Small and medium businesses (SMBs) -– companies of less than 50 employees -– are the holy grail of software. They compose 99.7% of all U.S. employers and generate 40-50% of GDP, but are notoriously resistant to technology: Only 39% think IT can help them compared to 80% of large businesses. 70% of SMBs don’t even have a website. Technology vastly enhances productivity but as analyst Steve Hilton writes, “SMBs are stuck in a productivity malaise using technology no more helpful than a bikini in a meat locker.”

SMBs are Luddites for two main reasons: lack of expertise and low confidence in ROI given upfront costs. This creates a huge opportunity. A company that can address these concerns and digitize SMBs could tap a significant portion of the trillion-dollar business IT market. How could that be done? With the best value proposition possible: free.

The idea: offer free computers to small businesses and upsell software and services. King Camp Gillette popularized this model a century ago by giving away razor handles to sell high-margin blades. Cell phone companies now give away or deeply discount phones to lock users into two-year contracts. Giving away PCs wasn’t feasible when they were $2,000, but you can now get Pentium 4s with a monitor and free shipping for under $100. When software is more expensive and higher margin than hardware, giving away the metal makes sense.

Let’s call this hypothetical new company FreeOffice. A small business owner could visit FreeOffice’s site, enter demographic and business details, and choose a computer costing $100 or less. The key is that users must submit a credit card to subscribe to a selectable list of free software trials and web services, which would be pre-installed and could be canceled at any time. A wide variety of programs and services would be relevant, not even considering industry-specific applications:

Accounting: Quicken, Quickbooks, Freshbooks
Productivity suites: Office, Google Apps
Email: Outlook, Zimbra, Blackberry
CRM: ACT, Salesforce, SugarCRM
Project management: Project, Zoho, Basecamp
Payment processing: PayPal, Visa, Verisign
Remote access: WebEx, LogMeIn, GoToMyPC
Taxes: TurboTax, TaxACT
Blogging: TypePad, Automattic
IM: AIM, Messenger, GTalk
VoIP: Skype, Vonage
Security: ESET, Norton, Symantec
Backup and sync: Mozy, Live Sync, Carbonite
Content: NY Times, Wall Street Journal
Graphics: Photoshop, Paint Shop Pro, Picnik
Business networking: LinkedIn, Spoke, Plaxo
Search marketing: Adwords, AdCenter
Internet service: SBC, Comcast, GoDaddy

FreeOffice could auction computer space to these vendors like the hood of a NASCAR racer. It could then earn commissions for every user who becomes a paying member. Because software has nearly zero marginal cost but charges $20-$500+, sometimes with regular subscriptions, commissions can be 10-75% of revenue. Only a few conversions would cover a $100 computer. For example:

To address cash flow risk, FreeOffice could initially require business users to pay for these services upfront. With volume, FreeOffice could negotiate deeper discounts on computers, higher commissions with vendors, and co-marketing with partners, who could offer free computers to their own leads.

To help technophobic business owners, FreeOffice could also offer a marketplace of low-cost tech experts who could teach computer skills, design a website, setup a back office, and manage online marketing. An online community could link FreeOffice users to share best practices, potentially hooking another white whale, a social network for businesses.

There is a similar precedent for this model: OpenTable. The company installs point-of-sale terminals in restaurants for a few hundred dollars, then charges small fees for booking diners. The terminals can capture customer info, track guest preferences, optimize table usage, and run marketing campaigns. OpenTable is only in 8,700 of America’s 935,000 restaurants but already earning $40M in revenue. It will soon earn four letters on the NASDAQ.

To my knowledge, our hypothetical company has no direct competitor. Craigslist and promotions occasionally offer free computers, but that’s hit-and-miss. FreePay offers free PCs but requires you to spam friends and sign up for irrelevant, sometimes scammy offers.

Once FreeOffice launches, competition may come from hardware companies like Dell or TigerDirect, which already have a massive user base and relationships with software vendors. However, creating this end-to-end system would be non-trivial and possibly cannibalize higher-margin sales. Vendors are probably more likely to partner than compete, especially to liquidate older or refurbished inventory.

Executed well, I believe FreeOffice has the potential to bridge the small business digital divide and become a back-office staple. What do you think?

Do you think FreeOffice is a good startup idea?(surveys)

[This is the first in a series of stories on startup ideas that don’t yet exist. Tune in next Friday for our next installment.]

Mark Goldenson advises entrepreneurs and is launching an innovative web venture in health care. To submit an idea for the Next New Biz series, email Mark at Selected ideas will receive attribution.

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