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Free! Why $0.00 Is the Future of Business

Tags: business, economics, pattern on 2008-02-29 and saved by48 people -All Annotations (33) -About

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A few billion blades later, this business model is now the foundation of entire industries: Give away the cell phone, sell the monthly plan; make the videogame console cheap and sell expensive games; install fancy coffeemakers in offices at no charge so you can sell managers expensive coffee sachets.
But until recently, practically everything "free" was really just the result of what economists would call a cross-subsidy: You'd get one thing free if you bought another, or you'd get a product free only if you paid for a service.
You know this freaky land of free as the Web. A decade and a half into the great online experiment, the last debates over free versus pay online are ending. In 2007 The New York Times went free; this year, so will much of The Wall Street Journal. (The remaining fee-based parts, new owner Rupert Murdoch announced, will be "really special ... and, sorry to tell you, probably more expensive." This calls to mind one version of Stewart Brand's original aphorism from 1984: "Information wants to be free. Information also wants to be expensive ... That tension will not go away.")
The rise of "freeconomics" is being driven by the underlying technologies that power the Web. Just as Moore's law dictates that a unit of processing power halves in price every 18 months, the price of bandwidth and storage is dropping even faster. Which is to say, the trend lines that determine the cost of doing business online all point the same way: to zero.
The Web is all about scale, finding ways to attract the most users for centralized resources, spreading those costs over larger and larger audiences as the technology gets more and more capable. It's not about the cost of the equipment in the racks at the data center; it's about what that equipment can do. And every year, like some sort of magic clockwork, it does more and more for less and less, bringing the marginal costs of technology in the units that we individuals consume closer to zero.
Digital technology benefits from these dynamics and from something else even more powerful: the 20th-century shift from Newtonian to quantum machines. We're still just beginning to exploit atomic-scale effects in revolutionary new materials — semiconductors (processing power), ferromagnetic compounds (storage), and fiber optics (bandwidth). In the arc of history, all three substances are still new, and we have a lot to learn about them. We are just a few decades into the discovery of a new world.
For good reason: It's now clear that practically everything Web technology touches starts down the path to gratis, at least as far as we consumers are concerned. Storage now joins bandwidth (YouTube: free) and processing power (Google: free) in the race to the bottom. Basic economics tells us that in a competitive market, price falls to the marginal cost. There's never been a more competitive market than the Internet, and every day the marginal cost of digital information comes closer to nothing.
The second trend is simply that anything that touches digital networks quickly feels the effect of falling costs. There's nothing new about technology's deflationary force, but what is new is the speed at which industries of all sorts are becoming digital businesses and thus able to exploit those economics. When Google turned advertising into a software application, a classic services business formerly based on human economics (things get more expensive each year) switched to software economics (things get cheaper). So, too, for everything from banking to gambling. The moment a company's primary expenses become things based in silicon, free becomes not just an option but the inevitable destination.
Their role was to conserve transistors, and they not only decided what was worthy but also encouraged programmers to make the most economical use of their computer time. As a result, early developers devoted as much code as possible to running their core algorithms efficiently and gave little thought to user interface. This was the era of the command line, and the only conceivable reason someone might have wanted to use a computer at home was to organize recipe files. In fact, the world's first personal computer, a stylish kitchen appliance offered by Honeywell in 1969, came with integrated counter space.
The purpose of this profligate eye candy? Ease of use for regular folks, including children. Kay's work on the graphical user interface became the inspiration for the Xerox Alto, and then the Apple Macintosh, which changed the world by opening computing to the rest of us. (We, in turn, found no shortage of things to do with it; tellingly, organizing recipes was not high on the list.)
From the consumer's perspective, though, there is a huge difference between cheap and free. Give a product away and it can go viral. Charge a single cent for it and you're in an entirely different business, one of clawing and scratching for every customer. The psychology of "free" is powerful indeed, as any marketer will tell you.

This difference between cheap and free is what venture capitalist Josh Kopelman calls the "penny gap." People think demand is elastic and that volume falls in a straight line as price rises, but the truth is that zero is one market and any other price is another. In many cases, that's the difference between a great market and none at all.
But free is not quite as simple — or as stupid — as it sounds. Just because products are free doesn't mean that someone, somewhere, isn't making huge gobs of money. Google is the prime example of this. The monetary benefits of craigslist are enormous as well, but they're distributed among its tens of thousands of users rather than funneled straight to Craig Newmark Inc. To follow the money, you have to shift from a basic view of a market as a matching of two parties — buyers and sellers — to a broader sense of an ecosystem with many parties, only some of which exchange cash.
In the traditional media model, a publisher provides a product free (or nearly free) to consumers, and advertisers pay to ride along. Radio is "free to air," and so is much of television. Likewise, newspaper and magazine publishers don't charge readers anything close to the actual cost of creating, printing, and distributing their products. They're not selling papers and magazines to readers, they're selling readers to advertisers. It's a three-way market.
But for digital products, this ratio of free to paid is reversed. A typical online site follows the 1 Percent Rule — 1 percent of users support all the rest. In the freemium model, that means for every user who pays for the premium version of the site, 99 others get the basic free version. The reason this works is that the cost of serving the 99 percent is close enough to zero to call it nothing.
In any package of products and services, from banking to mobile calling plans, the price of each individual component is often determined by psychology, not cost. Your cell phone company may not make money on your monthly minutes — it keeps that fee low because it knows that's the first thing you look at when picking a carrier — but your monthly voicemail fee is pure profit.
Labor exchange

What's free: Web sites and services. Free to whom: all users, since the act of using these sites and services actually creates something of value.

You can get free porn if you solve a few captchas, those scrambled text boxes used to block bots. What you're actually doing is giving answers to a bot used by spammers to gain access to other sites — which is worth more to them than the bandwidth you'll consume browsing images. Likewise for rating stories on Digg, voting on Yahoo Answers, or using Google's 411 service (see "How Can Directory Assistance Be Free?"). In each case, the act of using the service creates something of value, either improving the service itself or creating information that can be useful somewhere else.
It does. The word is externalities, a concept that holds that money is not the only scarcity in the world. Chief among the others are your time and respect, two factors that we've always known about but have only recently been able to measure properly. The "attention economy" and "reputation economy" are too fuzzy to merit an academic department, but there's something real at the heart of both. Thanks to Google, we now have a handy way to convert from reputation (PageRank) to attention (traffic) to money (ads). Anything you can consistently convert to cash is a form of currency itself, and Google plays the role of central banker for these new economies.

There is, presumably, a limited supply of reputation and attention in the world at any point in time. These are the new scarcities — and the world of free exists mostly to acquire these valuable assets for the sake of a business model to be identified later. Free shifts the economy from a focus on only that which can be quantified in dollars and cents to a more realistic accounting of all the things we truly value today.
Well, consider this analogy: In 1954, at the dawn of nuclear power, Lewis Strauss, head of the Atomic Energy Commission, promised that we were entering an age when electricity would be "too cheap to meter." Needless to say, that didn't happen, mostly because the risks of nuclear energy hugely increased its costs. But what if he'd been right? What if electricity had in fact become virtually free?The answer is that everything electricity touched — which is to say just about everything — would have been transformed. Rather than balance electricity against other energy sources, we'd use electricity for as many things as we could — we'd waste it, in fact, because it would be too cheap to worry about.
Today it's digital technologies, not electricity, that have become too cheap to meter. It took decades to shake off the assumption that computing was supposed to be rationed for the few, and we're only now starting to liberate bandwidth and storage from the same poverty of imagination. But a generation raised on the free Web is coming of age, and they will find entirely new ways to embrace waste, transforming the world in the process. Because free is what you want — and free, increasingly, is what you're going to get.