Somewhere along the way they thought that by doing so they would gain access to some sort of public service magic money tree (licence fee for the graun perhaps), forgetting that their funding actually had to come from somewhere.
Alan Rusbridger took a massive gamble. When he first built the Guardian website, he was determined to make it bigger and better than everyone else's, and pretty much succeeded. The gamble was thinking that they didn't need to charge for content because they would attract advertising and sponsorship. You could have job ads on the site, classified ads, consumer ads, plus you could get big companies to sponsor specific sections. At the time it must have seemed like a risk worth taking. What he didn't foresee was that the advertisers simply wouldn't follow, and that 90% of advertising would end up going to Google and Facebook.
To make it worse, the Guardian cannibalised its own print readership, so print sales fell and so advertising in the print edition fell. And of course the website took away readers from other print newspapers, hastening the demise of print in general.
The thing I really don't understand - and this is where I agree with you - is why they continue to pursue this model when it clearly doesn't work and is never going to work. Their website now is enormous, it has tons of content, it has editions in Australia and the US - the whole thing must cost a bloody fortune to produce. Why relentlessly pour money into giving away a product for free? What other sector does that?