There are two things I accept as special about free: much less transactional costs/efforts (as I can skip the payment process entirely) and the psychological appeal (of not having to pay any!). Other than that, there is nothing special about free. But it seems that free is gaining the status as a very special price. Here are quotes from Chris Anderson's Wired article "Free! Why $0.00 Is the Future of Business" and my thoughts.
“The new model is based not on cross-subsidies — the shifting of costs from one product to another — but on the fact that the cost of products themselves is falling fast.”
This is misleading. I wonder any of Google exec believes that they give away Gmail mainly because it does not cost anything to them. They do it because it helps their business. You have to make money somewhere. You cannot offer something for free forever no matter how low your cost is, unless you can make profits somewhere. You should somehow shift to or bundle with another profitable business, Whether it is very visible (buy A and get B free) or not (Google’s Gmail and Adwords).
“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.”
I agree that free does have certain psychological appeal to people, making the demand jump at the price zero. There is a research-based book by behavioral economist Dan Ariely (http://www.predictablyirrational.com/). You may want to have a look.
“The huge psychological gap between "almost zero" and "zero" is why micropayments failed.”
No, I would not extend the psychological magic of zero price to this far. I think we just do not have a micropayment model yet that is very convenient, like cash. The price may be just one dollar, but I have to go through the hassle of entering this and that information. I actually listed this as a factor for paid music to be popular again. See http://hyokon.com/2008/02/in-addition-to-free-part-2-how-to.html. I bet we'll have more convenient micropayment toold in the future, and we'll have much more small transactions.
“Free music is just publicity for a far more lucrative tour business. Nobody thinks of this as piracy.”
No, I don't think so. I think the reason why a lot of musicians are turning to free model is that they lost the alternative. The musicians think “Why not give away our songs? They won’t pay anyway. Let’s just think of it as a promotion, and do a tour to make money.” Touring is more profitable? I am surprised. When people actually did pay for music, tour was a promotion. Not the other way around.
“Some artists give away their music online as a way of marketing concerts, merchandise, licensing, and other paid fare. But others have simply accepted that, for them, music is not a moneymaking business. It's something they do for other reasons, from fun to creative expression. Which, of course, has always been true for most musicians anyway.”
I was worried some would bring this up someday. Maybe my concerns are becoming real. Before, the pro-free argument was ‘make it free, and you will make more money.’ Now, it is ‘Don’t be sad that you don’t make money. It is not about the money, right?’ I am very sad. I want a world, where you can succeed just by being a good musician. I want to see more Beatles, more Queen, more Stevie Wonder. Someone out of nowhere becoming a star and becoming rich. I think some of the pro-free arguments are heading towards discounting the division of labor, by saying you do multiple things to make a living (or if you are lucky one thing as a job and the others as a hobby). Do we want it to happen? It is one thing that we can do multiple things, which I like, but it is an entirely different thing that we ‘should’ do multiple things. I mentioned it also at In addition to free (Part 1- Free is not a cure-all).
“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.”
I agree that this will reduce the price for the users, just like self-service hamburger can be cheaper. This is every web entrepreneur’s dream - Users doing the work for free. But is this implying that this will ultimately create a perpetual money-making machine where you as a company does not have to incur any cost? Otherwise, I wonder why this is mentioned related with the free issue.
Enabled by the miracle of abundance, digital economics has turned traditional economics upside down. Read your college textbook and it's likely to define economics as "the social science of choice under scarcity." The entire field is built on studying trade-offs and how they're made. Milton Friedman himself reminded us time and time again that "there's no such thing as a free lunch." But Friedman was wrong in two ways. First, a free lunch doesn't necessarily mean the food is being given away or that you'll pay for it later — it could just mean someone else is picking up the tab. Second, in the digital realm, as we've seen, the main feedstocks of the information economy — storage, processing power, and bandwidth — are getting cheaper by the day. Two of the main scarcity functions of traditional economics — the marginal costs of manufacturing and distribution — are rushing headlong to zip. It's as if the restaurant suddenly didn't have to pay any food or labor costs for that lunch.
I was shocked. I could not believe that the most fundamental of economics is being declined here. I don't know how to respond. Let me just say that I do believe that there is no free lunch. Even the most low-cost Internet business of the world cannot go on very long providing 'only' free products. They do have trade-offs. (By the way, Friedman did say that there is free lunch, which is free markets and private property. http://www.cato.org/speeches/sp-mf050693.html And on this free lunch, I agree with him.)
Two last points. First, free is not the lowest price. There can even be negative price. Heard about ‘get paid to use’? Try search it on the web, and you’ll find quite a few. When a customer is more valuable to you than your product is to your customer, you’ll even pay the customers. As traditional mass marketing becomes less and less effective, businesses will try to spend money directly to customers. And we'll see more of these.
Second, digital products are not always different from physical products in terms of marginal costs. Let’s say you are a car manufacturer. You just produced 1000 cars and have them as inventory. What is the marginal cost of giving away the car? (I am ignoring the opportunity cost here, which by the way is present even in the case of free-to-produce digital products.) Zero. Internet is not really different at all. When do you occur your costs? When you bought servers and hired people to develop your service. After that? Yes, it is near zero. But you still have the ultimate marginal cost, that is keeping vs. shutting down your business. There is no such thing as no-cost business. If you give away all your products thinking "The marginal cost is zero. Therefore I am OK", you will go bankrupt sooner or later. Even if all you have is just some magically free servers and no staff, you still have costs. That is, 'you' have to eat. There is nothing magical here.
To be fair, I do accept that free has some special qualities. One, it has psychological appeal that seems to boost demand. Two, when you buy a free product, usually you don't have to go through the payment process. Which makes it cheaper than free otherwise.
Still, we are not having another new economy. We don't have to write the economics again. We do live with trade-offs, no matter how cheap microprocessors become. Or, maybe we do have a new economy, only until when we enter a negative-price economy.