The idea of free software largely came up during the dot-com years when a generation of erstwhile college graduates who evidently skated through their business and economics classes decoupled products and revenues. The vast majority of companies failed, but the concept of "free" as in "free beer" products continue. And Google, which is very profitable, remains the false poster child for how this can work.
Google's False Free
Google isn't truly a "free" vendor. It serves up potential customers for a fee. The way it captures those customers is through tools like search. In fact, people (or eyeballs) are what Google sells. It has found a creative way to acquire people for free, but it isn't actually a free-product company. It is paid directly for the value it provides its core advertising customers. It is simply that search users, who are effectively part of Google's product, are being falsely branded as customers when they are actually the part of the product that Google sells to its true customers. In effect, those of us who use search are being sold by Google for a profit. If we move from Google Search to Bing, we are simply moving from Google's product to Microsoft's and are little more than interchangeable parts sold to a third party.
The competition between Google and Microsoft on search is like two vendors competing over supplies, but by using a service (search) rather than money as the exchange mechanism for those supplies. The vendor that has the most high-quality supplies and can offer them at the most affordable price wins the market, which isn't unlike any other traditional market.
Linux Generally Isn't Free Either
At scale, Linux isn't free, either. It is provided to create a technology base against which vendors can sell services and hardware. Granted, individuals can get the OS offerings without charge, but this is similar to seeding the market for vendors like Red Hat and Novell, which believe a certain percentage of these users will buy the revenue-generating services. This means these vendors aren't in the OS business at all -- they are in the services business. They simply give away (mostly) the operating systems in order to sell the related services. If people aren't attracted to the OS, however, they will never buy the services.
However, the perception of "free" leads to some endemic problems.
Profit Equals Influence
The problem with the perception of free is that, in a current-generation company that is managed by distributing profit-and-loss responsibility through the organization, the unit that has the "free" product has no influence and can't effectively compete for internal resources. Contribution, in one of these companies, equals power.
A few years back, I did some research on the changes in IBM when it went from bundling free software to charging for software. During the free software period, software engineers had comparatively low salaries, their departments were starved for resources and they had virtually no vote in the future of the company or its products.
Once software started to generate money and enjoyed some of the largest profit margins in the company, software gained substantial power and, in terms of resources and locations, got the cream of what was available internally to IBM divisions. The unit almost spun out as a separate company at its peak of power. Today, services and software share power and hardware, which used to define IBM, is the weaker entity. It is interesting to note that IBM uses Red Hat or Novell SuSe Linux and has not created its own Linux variant or bought a Linux company because it doesn't see the value in doing so. That's even though it has more active operating systems under IBM support, many still owned by IBM, than any other vendor in the world.
The Problem with Free
Going back to search or Microsoft's Internet Explorer (and Microsoft has a number of products that are perceived to be free), the problem is that they don't get the best resources and typically don't stay well coupled with market needs or customer expectations.
However, it isn't just a lack of resources -- it's an attitude that seems to go with "free" that bothers me the most. There seems to be this sense that if something is free then the wants and needs of the user can largely be ignored. I see this the most in things like Google Apps, where there simply does not appear to be enough focus on making the user experience competitive to Microsoft Office. Google seems to be saying "Hey, it's free, live with it".
In short, the decoupling of revenue and profit from the product creates an endemic exposure for the company, the employees related to the offering, and the customer -- all of which are not focused on the true customer and in an environment where the offering is devalued to the extreme.
Wrapping Up: Beware of Free
If you build, buy or work on a product that is perceived to be "free," you need to be extra vigilant. If you build it and it is critical to your future, you need to make sure that people get the appropriate credit and funding they need to be successful. If you buy it, the risk of failure coupled with the lack of financial leverage on the vendor needs to be considered, and if you work on it, this inability to tie back to funding will make both salary increases and job security difficult to assure.
Every successful product has, built within it, the opportunity for failure. If the product is perceived as free, that opportunity for failure may be significantly increased.