Fred Wilson writes today about his favorite business model for the web, which in short is: give away your service or product for free, build a large base, then upsell that base to premium services. At McDonald’s, this is know as the “fries with your shake?” model.

This is a model I know intimately and lived with daily during my tenure at Real, and am thus all too familiar with its flaws. Which are: that it is incredibly vulnerable to attack by competitors.

At Real, we gave away a free player, built a huge base very quickly, and then tried to get many folks from that base to buy our premium player. It worked well enough at the beginning; the upsell was polite and relatively innocuous while we were a private growing company, and before Microsoft got determined to crush us. But once we went public — in the mania of the late 1990s — there was pressure to grow more quickly, and we pushed the premium player harder. Then Microsoft arrived on the scene, commoditized our other line of business (selling servers), gave away a free player that included most of the features of our premium player, and bundled it into the operating system. We were left with a bunch of bad choices, ultimately pushed the premium player a lot harder in order to survive the onslaught, and many consumers [ed. note, in flashback to my bad, pre-cluetrain enlightened mindset, I somehow used the c-word!] people never forgave or forgot that. Understandably.

This “fries with your shake” model can work, if you are in a small niche business that doesn’t attract much attention or competition. But if you are building something that becomes attractive or threatening (or both) to GYM, you basically will face the choice of folding or flipping once the onslaught begins.

Consider what might have happened with Flickr as an example, as it’s a service Fred lists and one I know better than the others. Imagine if they had taken venture money, gotten positioned to build an independent company with strong revenue growth, and with an eventual IPO. What would Google, or Yahoo, or Microsoft, or a dozen venture funded ankle-biter competitors have done? Mimicked the feature set, and given away unlimited storage for free. Indeed, some are already doing this now.

One might respond: well, Flickr built a community, and members of that community wouldn’t just switch over to a similar, but cheaper, option. They would have stayed loyal. Maybe. But a more likely scenario is this: a steady erosion of users, with a reverse network effect; small numbers of people migrating to the cheaper — but equal — option, and taking others with them over time; increased griping and snarking, wondering why flickr was charging, when others were giving away the same service for free (indeed, I’ve started to see that among some of the alpha alphas on various boards); comptetitors fueling those gripes, trying to erode the allegiance between the service and the people who used it.

It’s just too damn easy to attack these models, and people will want to do it if there is a valuable market for the service. A much more defensible model — my favorite, one I wrote about in my last post — is the efficient marketplace model. eBay and Google’s model. And Second Life’s. And the model of newer services like Etsy. These are very, very hard to attack — even if you have better technology, you can’t dent these services if your not offering a place where there are more buyers, or more sellers, and more buying-selling going on.

Imagine if flickr had built more of a marketplace function into their service. There are some great photos on flickr that I would pay to use. A dollar, or two, or three. For inclusion in the occasional slide deck, or on my site. Imagine if they had built a business not just around their community of free users, but between individual photographers (sellers) and bloggers, or people writing reports, or publishing a newsletter (buyers) with fair pricing and a farmers’ market “meet the producer” ethic and vibe. That would have been an interesting, and a big, big business. And much more defensible in the end when the predators came ’round.

As I’ve re-entered the technology and internet world over the past six months after 18 months of ignoring it, I’ve been stunned by one thing in particular: the overall poverty of thinking about business models, and the lemming-like thinking about business strategy.

I blame it all on Google.

Here’s what I think has happened. Google’s evolution from great search engine to monster force has become a canonical myth among the internet cognoscenti and entrepreneurs. From John Battelle’s blog or book or SEW or other sources, everyone now knows how Google started with a great search engine, built word of mouth, stubbornly (and, correctly) refused to adopt banner ads to drive short term revenues, and eventually copied and improved upon the model Bill Gross invented at idealab in the late 1990s and first implemented with Overture (then GoTo.com).

It is my impression that many entrepreneurs and VCs and others have essentially internalized that story, and now have this as the default business plan and strategy: launch a cool service, get good worth of mouth (especially among 18-25s), drive growth virally, then figure out a monetization strategy. Hmm, sounds eerily familiar.

The good thing about this is that out of the long shadows of despair in 2000-2001, some really cool services were thought up and launched, many providing real focus on the user experience.

The bad news is that so many entrepreneurs just aren’t thinking about how to make money from what they’re doing, and won’t be able to sustain the cool services they have dreampt up. I was at an event in February where some entrepreneurs were demo’ing new video services. Some of these services were interesting, others weren’t, but across the board it was clear that none had really thought through their business models in any depth. Basically, when pressed on that by the VCs in the room, they chanted the mantra ju jour: grow traffic quickly and virally, if the users love it we’ll figure out how to monetize.

That sounds nice, but unfortunately the fields are littered with defunct businesses that did just that, but found it harder to turn traffic into money than they imagined.

Perhaps most surprising to me is just how many investors and VCs go along with this line of thinking, and even encourage it.

My favorite counter-example to all this right now is the service Second Life, which is an incredible, forward-looking service even without its business model. (Disclosure: Philip Rosedale, the CEO/Founder, is an old colleage from early days at Real, and I think he may be one of the smarter people I’ve ever met). But it’s the thoughtfulness and future sustainability of their business model which impresses me more, because it is so rare.

Go to the SecondLife home page, and you’ll see that it has a little over 160,000 members. Yes, that far fewer than, say, YouTube or MySpace, the poster children for the “build traffic then monetize” chanters. But you’ll also notice that those 160,000 residents spend well over $100,000 every day. I’m looking right now, at Noon Pacific Time, and already the members of this virtual world have spent $70,000.

At these rates, the residents of Second Life are spending nearly $1 a day per resident. Just as with eBay, Linden Lab (the company behind SecondLife) doesn’t collect this money; the residents do. That why the model is so ingenious. Linden’s revenues will grow in proportion to the monies made by residents over time, and the most active entrepreneurs will be less likely to leave the service if they’re making money from it.

If I were an investor and had to choose between, say, YouTube with it’s 8 million uniques visitors and growing, and SecondLife with its 160,000 residents, I’d pick SecondLife in a second (sorry, it had to be done) because it has a well thought through business model that is driving impressive user spending on a per capita basis. But given the current conventional wisdom of the day, it seems most other entrepreneurs or investors would pick YouTube.

As I said at the start, I blame Google. It’s success has made its business the canonical model for most people today. Call me old school, and I know it is deeply out of fashion to say this, but I still think eBay provides the best through through business strategy to date for the internet, period. And SecondLife provides one of the better examples of a new service emulating that model.