Freeconomics: Should Everything Be Free on the Internet?

This week we saw the release of Chris Anderson's book Free and reviews from the New Yorker (Malcolm Gladwell) and the Financial Times. I'd like to talk a bit about the firestorm that freeconomics (fed by Chris's book) has unleashed but first we need to clarify something.

The FT piece says:

The most plausible contender for an "entirely new economic model" made possible by the internet is what Fred Wilson, the New York venture capitalist, has dubbed "freemium".

There was no dubbing by me. In March 2006, I wrote a post called My Favorite Business Model in which I outlined the freemium concept and I asked the readers to help me give it an easy handle. The word Freemium was not coined by me. It came from Jarid Lukin, who at the time was working for Alacra, a company I am on the board of. Fortunately, we've got Wikipedia which has got the story straight.

Now let's talk about freeconomics. I don't believe everything will be free on the Internet. There will be plenty of paid business models. For example, if you want to watch Major League Baseball games live over the Internet, you'll pay for that. If you want to use services like the FT and the WSJ (NWS) frequently (more than 10x per month), you'll pay for that. If you want to watch HBO (TWC) over the Internet, you'll pay for that. If you want a Twitter desktop or mobile client, you might pay for that too.

But we also must recognize that the cost of delivering many services over the Internet has decreased significantly from what it cost to deliver them in the analog world. The marginal cost of delivering a piece of content is approaching zero. But the total cost of delivering content on the Internet is far from zero. My partner Albert wrote a great post about this last week. He said:

The price of watching a stream on Youtube is zero. With marginal cost zero and marginal benefit zero, from a perspective of maximizing total social (net) benefit, free is the right price because it does not preclude any video that could possibly have benefit from being viewed. That does not mean that free is sustainable because it obviously doesn’t help cover the total cost.

And, as Albert recognizes at the end of his post, this debate is not entirely about economics. It is about the value of various participants in the content ecosystem.

Gladwell got pretty negative on Anderson and his book in the New Yorker piece. He said:

It would be nice to know, as well, just how a business goes about reorganizing itself around getting people to work for “non-monetary rewards.” Does he mean that the New York Times should be staffed by volunteers, like Meals on Wheels? Anderson’s reference to people who “prefer to buy their music online” carries the faint suggestion that refraining from theft should be considered a mere preference. And then there is his insistence that the relentless downward pressure on prices represents an iron law of the digital economy. Why is it a law? Free is just another price, and prices are set by individual actors, in accordance with the aggregated particulars of marketplace power.

These are the anti-freeconomics arguments we hear from the likes of Andrew Keen and his ilk. Lambasting file sharers and entrepreneurs who rightly recognize that free is the right way to build market share on the Internet might be fun and make certain people feel good. But it's ignorance of a fundamental fact. And that fact is that free, ad supported media works best on the Internet. We have seen it again and again. I'm not going to even give examples.

Once you have built that audience, you can deliver upsells via freemium models, you can monetize it via advertising and you can branch out into other services which are easier to monetize. This post by Silicon Alley Insider on Facebook's revenues this year is instructive:

Earlier this week, we spoke to several sources who each have some insight into Facebook's financials (none of them know precisely). Taking the sources' input together, we'd estimate the company's expected 2009 revenue this way:

• $125 million from brand ads
• $150 million from Facebook's ad deal with Microsoft
• $75 million from virtual goods
• $200 million from self-service ads.

These numbers are similar enough to others that I have heard that I feel comfortable republishing them here. Facebook has 200mm+ monthly active users worldwide. Let's say they are doing $50mm per month in revenue. That's a revenue per monthly active user of $0.25. Low for sure, but enough to operate at breakeven. And I expect the self service ads and the virtual goods revenues to grow strongly in the next year, more than making up for the likely loss of some of the $150mm from the ad deal with Microsoft.

And the next move for Facebook is to generate transaction revenues with its payment service and off site ad and transaction revenues from its Facebook Connect service. I'm pretty confident that Facebook can take its revenue per monthly active user to at least $0.50 and maybe higher in the coming years.

Facebook is a perfect example of freeconomics at work. A woman who works for a major media company was in my office recently. She quoted her CEO as saying "why doesn't Facebook just charge a monthly subscription fee, they'd be making money hand over fist?". Well I believe that if Facebook did that, they'd be vulnerable to other networks offering a free service. And certainly not every one of those 200mm+ users are going to cough up a monthly subscription. But by offering a friction free service, they have built a powerful and growing network that they are now starting to monetize in various ways and that they will monetize even further in additional ways. And they are super hard to compete with because they are free.

I like to keep my posts short, so I'll end here with the observation that the Internet allows an entrepreneur to enter a market with a free offering because the costs of doing so are not astronomical. And most entrpreneurs who take this approach will maintain an attractive free offering of their basic service forever. But that doesn't mean that everything they offer will be free. That's the whole point of freemium. Free gets you to a place where you can ask to get paid. But if you don't start with free on the Internet, most companies will never get paid.

Comments

[morph366:]

The concept of marginal cost and fixed cost seem to be totally unsuited to the business model for a company that produces content for free consumption on the web.
If you take the underlying business costs - infrastructure, financing costs and administration etc. as the fixed costs then surely the creation of the content is at least in large part a variable costs
If the producers collect zero revenue per transaction - the marginal contribution is negative i.e. contribution = unit revenue per variable - unit variable cost.
Every transaction makes a negative contribution to the fixed costs.
Either the business model needs re-thinking or the economic theory does.

Jul 05 05:52 AM

[Arthur Hau:]

Many newspapers and magazines are FREE today!

Well, at least they are free to the readers, not to the advertisers though.

Free or not free is NOT the key here. What matters is whether you have a profitable business model.

A singer can rely on selling CDs. On the other hand, the same singer can make his/her music free for downloads and relies on selling live concert tickets instead!

Economics works perfectly. It is dumb human beings who cannot adjust themselves quickly to new business models to make profits!

Jul 05 10:29 AM

[drpaul1139:]

Free

Well I did coined the term Product Equity Value© www.productequityvalue... and I am very happy to take this credit. I actually like ‘My Favorite Business Model’ better than the book ‘Freeconomics’ because it is more descriptive.

I am not particular happy with the way that FT is treating the concept outlined in Freeconomics and I would imagine that My Favorite Business Model’ would be treated the same then or now.

What we have here is a mere scratching of the surface of the exactly meaning of capitalisms which is free, not the free of buy one and get one free but the free in that x=(a*b)/c where x is stocks price and A is revenue, B is earnings as a percentage of revenue and C is a rate of return when A-B-C are controlled then this formula always produces multiple values of capitalization over revenue for public corporations.

We cannot forget something that we never knew, and we never knew what capital means exactly because if we knew what capital meant then this ‘free’ would be an existing reality and we would not have an economy driven by debt consumption as a model.

Lets agree once and for all that Capital should be the primary tool of a capitalist economic model. Capital means to capitalize or the bringing in of cash value from the future for present use. The vehicle for bringing in capital from the future for present use is the public corporation by its ability to issue unlimited upside and unlimited downside ‘risk-reward’ shares where the earnings of the public corporation determines the up and down sides.

The earnings for the corporation starts from the labor units demand for products and services, spending called consumption, which is the revenue of the public corporations and then the earnings as a percentage of revenue driving share prices causing the equity to rise in value.

Equity is the differences between the revenue of the public corporation and the total value of the corporation called capitalization…

There is nothing new here in this description we all know this…

Now notice that the concepts of credit, debt, and interest are nowhere in our descriptions of capital which is the foundation of capitalism?

It is this false inclusion of free credit access based on permissible unemployment, debt, and interest into the misunderstanding of capitalism that causes the US economy to be one currently driven by ‘negative’ unpredictable debt consumption by labor units rather than one of ‘positive’ predictive free equity driven consumption which solves the debt consumption problem and makes 100% employment permanent.

Lets be clear and stop wasting time… www.productequityvalue...

In a nutshell what we know now, from careful investigation of the multiple value creation variables for public companies, is that when 46% to 69% of the equity of new public corporations are given free to a precise number of customers simultaneous to the product or service purchases by the customers then the prices of the free shares are ALWAYS greater by 3, 5, 11, 20, and over 40 times the price of the product or services by x=(a*b)/c.

Would you buy a $30 product to have $600 worth of free tradable shares in an IPO? www.productequityvalue...

Jul 05 12:32 PM

[donzelion:]

Gladwell cites an interesting experiment: given a choice between Lindt truffles at 15 cents and Hershey's Kisses at 1 cent laboratory subjects tend to take the truffles. Reduce both prices by 1 cent (aka, "free Kisses" and cheap but not-free truffles), and preferences reverse. Fair enough. But what happens when one of test subjects "steals" all the "free" Hershey's Kisses and then resells them to the others?

"Free" may work in a handful of controlled environments (which is the crux of Gladwell and Gapper's arguments: intriguing possibilities, but not likely to amount to a revolution), but behind free, there is always the risk of being "taken." Once upon a time, settlers in America could take "free" land (provided the natives were run off - poor things, they were obsolete). Similarly, today, "digital content" is often "free" (provided traditional media are run off from "mind-space" - poor things, they were obsolete).

A "Freemium" strikes me as just another means of jockeying for that mind-space. Lawyer offer "free initial consultations," brokerages offer "free newsletters," and a paper boy shouts the headlines from a street corner. Giving something away to get more isn't revolutionary - but it can be powerful if one gets the gift/gain balance right.

Jul 05 04:37 PM