My assessment of some key freeconomics arguments

(Originally written as a comment on Fred Wilson's blog. http://www.avc.com/a_vc/2009/08/some-serious-freeconomics.html#comment-14635342)

Rather than commenting on 'another' perspective, here are my key points on free, which I have been repeating over and over here and there. I think there are too many fuzzy (and sounding fancy and deep) statements when it comes to discussing freeconomics. So, I stated using 'right' and 'wrong' to make it as clear as possible.

1. Ever decreasing marginal costs naturally lead to free. (Wrong)
First, the marginal cost is never zero. Unless you invented a perpetual motion machine, there will be costs of electricity, network, computers, storages, etc. Small price times many units, which is necessary if you want to make profits, are still a lot. Most importantly, living expenses of people involved, whether you classify it marginal or not, is substantially over zero.

Second, even if we assume the marginal cost was really zero, it does not justify zero price. There is always the economic cost, which is called opportunity cost, cost of capital, etc. Put simply, you don't want to do a business just because you are not making loss. Unless you make certain level of income, you have no reason to do it over a long term.

2. You should give away contents, and make money giving services, consulting, lectures, performances. (OK, if it's your philosophy. Wrong, if it is your logic.)

I think those who argue for this are generally against the idea of 'idea being sold at any price'. Because it's their value and philosophy, we cannot discuss it analytically. You cannot say I am wrong, because I like rock music more than jazz. So, if you don't like paid contents, you don't have to justify it analytically.

But if you are saying 'that's the only way to make money with contents', that's an analytical statement. And a wrong one. When you have two things to sell, you can make one loss leader and the other profit leader. Assuming piracy is reasonably controlled, it makes as much (or often more) sense to give lectures/consulting for free and make money with contents.

3. Free can be a powerful element to have in a business model. (Right)
First, as someone commented quotating Dan Ariely (though I think it is too obvious to quote an economist), free seems to have a powerful psychological appeal. So it will bring more than usual increase in demand.

Second, free actually saves costs other than the price itself, namely transaction costs. By pricing a product as free, you don't need payment process, which costs time and money. So it is possible that free is economically better than a really low price.

4. Freemium is the best business model for many content and web services. (Not much to comment)

I generally agree with this statement, but there is little to argue for or against. Free samples are almost necessary and have existed always. And it is very efficient to give away free samples on the web. I think the statement should be more concrete, like having some quantitative threshold or distinguishing between what's just tradtional free samping and what's new freemium. For example, is HBR freemium or just traditional paid model with some free samples?

5. You should make contents free for occasional reader and charge niche contents consumed by heavy users. (Not sure, yet.)

This is difficult for me, as it appears to conflict with loyalty economics. In my view, loyalty economics is more solid and lasting management theory than RMS-ROS, BCG matrix type of scale-based strategies. Loyalty says loyalty of your customers, not scale per se, makes your business grow and healthy. And many problems of modern companies occur from the fact that they are nicer to new customers and focus too much on sales. You are treated best when you are a new subscriber, and they milk you over time.

I like loyalty economics, not only because it is analytically solid but also because it's morally high-road. Basically, you give back to whom you owe your living.

On the other hand, it is probably necessary to give away some samples to non-users. And when you have very innovative products, the ones who do the most favor to you are the ones who dared to use your products initially. I think in this situaltion, they are the loyal ones who deserve your special treatment. However, the problem is that, when you distribute your most popula contents for free, most of the users are not the brave early adopter who risked their valuable time and efforts.

My hypothesis is that this is a problem of degree or subtle business model design(free which content to whom and how much). Just like how much focus on sales and how much on caring loyal customers are a subtle degree issue.

I hope Fred Reichheld, Bain partner who started Loyalty Economics, to think about this from loyalty perspective. He seemed to find it interesting, but it would be really nice to listen to his perspective.

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