FREECONOMICS: In the new economy, 'free becomes inevitable'

If "free" is what you want - and who doesn't? - "free" is what you're going to get.

So says Chris Anderson, editor-in chief of Wired magazine and, according to Time magazine, one of the world's Top 100 influencers.

Speaking to The Globe and Mail from his office in San Francisco, the author of The Long Tail, who pseudonymously curates Wikipedia entries in his spare time, explains how "free" has emerged as the new economic model.

It's a little bit cheeky, I know. It's a rip-off, of course, of Steven Levitt. It's a bit of a joke. ... There are three kinds of free in the world. There's the model that's 100 years old and that's, you know, razors and blades, cross subsidies. You get the razor for free and you pay for the blades. Today we see that in everything. You get your cellphone for free but you pay for the minutes ... that's the old model of free. Then there's the model that emerged in the sort of middle of the 20th century. This is the media model ... where the consumer doesn't pay but a third party - in this case, the advertiser - pays for access to the consumer. ... What's happened online is that the media model has been extended to all sorts of things that aren't traditional media, with Google being the best example ... anything you can subsidize with advertising becomes a third-party pay, so that it's free to the consumer. But there's a third form of free, which is the fascinating one that's really just now coming of age ... where really nobody pays ... One of the unique things about Internet economics is that, unlike traditional economics, where the raw materials and the labour and the power is not zero, online all the inputs - the bandwidth, the storage, the processing - are all super cheap and getting cheaper every year. We've never seen an economy like this.

So just to be clear, what you're really saying is the foundation of this new model lies in bandwidth, storage, processing power, all on their way to being, to use your term, too cheap to meter or too cheap to matter economically.

Precisely. And then you revert to classic economics. You learn this in the first week of economics, but you never really pay attention to it ... In a competitive market the price falls to the marginal cost. ... You never think of the marginal cost falling to zero because, in most markets, it doesn't fall to zero, but online the marginal cost - that is, the cost to serve a web page or a software [application] - to a consumer is falling to zero. Today it may be one cent. Tomorrow it will be a tenth of a cent. The next day it may be a hundredth of a cent. ...

This isn't really a matter of choice or a matter of innovation. It's sort of like the laws of physics.

Free becomes inevitable ... The question is not, could it be free. The question is, how soon must it become free, because if we don't make it free somebody else will.

Money has to change hands somewhere along the line, does it not? The content has to be monetized?

It does not, it does not. ... There is a world out there that doesn't involve money at all. Wikipedia is an encyclopedia where no money changes hands. The blogosphere is largely a publishing media enterprise where no money changes hands. ... If you're a business and you're in the encyclopedia business, you're competing with Wikipedia and it's not because Wikipedia has some business model you can emulate. Wikipedia has no business model. They've just demonetized the industry. There it is.

Are you saying that any industry that can be digitalized can necessarily be demonetized?

When I say demonetized there are two aspects. One is demonetized from a consumer perspective. In other words, you don't pay. The other is demonetized in that no one makes any money anywhere. It will depend from industry to industry. In the case of encyclopedias, we're probably going to demonetize that industry. ... There are other industries where you're not demonetizing it. What you're doing is saying web mail is free to consumers now. The really, really active web mail users who want special features ... really almost become price insensitive - they're wedded to full functionality web mail. In that case, you can charge that 1 per cent, or 0.1 per cent, quite a lot of money.

This is the freemium model. It's the inversion of the typical free sample. In the free samples, we think of perfume or little bits of muffin from Starbucks. ... You give away 1 per cent to sell 99 per cent. ... The nice thing about digital services is because the underlying product doesn't cost anything, you can give away 99 per cent to sell 1 per cent. Today you see more and more businesses built around freemium. That's the Flickrs, the web mails. Because the underlying product is so cheap to offer, you can subsidize the 99 per cent with the 1 per cent.

You've used the word "subsidize," so therefore the 1 per cent has to exist in order for the 99 per cent to be subsidized.

In that particular instance. Or if it's advertising supported, then the advertisers have to exist to support the consumers. That model does still exist in terms of the advertising industry. Google, etc. ... Google is a very profitable company that makes billions by not charging consumers.

What's the future of advertising? Is it possible for advertising to be free to the advertiser? Absolutely. I just think we won't call it advertising. ... I'm a geek, as you might have guessed. I have a lot of geeky interests. I subscribe to blogs of engineers about various topics of interest. Those engineers work for companies. Those blogs are about their companies' products. ... Is it advertising? It's certainly not described as advertising. It isn't paid for. It doesn't come from the marketing department, and yet it may have the effect of advertising in the sense that it communicates information about a product to an interested consumer.

I think what you've just described kind of frightens me a bit. The notion that something becomes so intellectually embedded that you don't necessarily know what it is you're getting in terms of advertising integrity or its obverse, editorial integrity.

You've now hit an issue that only comes up when I'm talking to media people. I'm a media person, so I have a lot of sympathy. This whole thing about Chinese walls and church and state and ad versus edit and editorial independence, this is something that the generation that has grown up on Google just doesn't care about.

You've written a new book on the concept of free. Is it finished? Does it have a subtitle?

Ah! So how is it going to be free? Let's start with the digital forms. So the audio book, that's an MP3. That's going to be free. There's the e-book. That's a digital file that's going to be free. There's the web book on the website, page per view, that's going to be ad supported and free. And then there's the physical form of the book. ... One that's going to be sponsored with ads and you get that for free. ... Then there will be the traditional form without ads for which we will charge you $24.95.

Probably ads on the inside front cover and the inside back cover and a couple in the centre.

Cars will be free. There's a chapter in my book about a car company in Israel called Better Place, an electric car company. The car is free and you pay for the electricity.

It's partly a new economic model and it's partly the psychology of free. It's partly recognizing that zero point zero has a special place in our psychology. It gets our attention.

There are some interesting ideas in here, from the guy that wrote "The Long Tail".

The point about marginal cost pricing is a bit simplistic (it ignores the "time preference of money", and risk premiums) -- but, otherwise I think it's pretty good "futurism".

I don't know whether or not we'll ever have a "free" car -- but, a lot of existing business models are going to be destroyed. Also, I don't consider anything with embedded advertising to be "free" -- it takes up my time, and (potentially) alters my brain.

This is pure BS. If you choose to give away an electronic book, it's still not free. Your time had an opportunity cost associated with it. Wikipedia is not free. They must pay for and maintain their servers, staff, etc. even though they may not bill the consumer directly, someone must pay. And they will only pay if there is some form of return down the road, no matter how indirect that road is. The consumer must pay, if for no other reason than for the hardware and power to even use the Internet.

I agree with marginal cost pricing, but one is hard-pressed to give me an example of a zero marginal cost for anything. If you are putting something on the web, its marginal cost is never zero. You cannot even have a presence on the web at zero marginal cost.

This might be fun to think about and debate but it is simply wrong.

I don't know whether or not we'll ever have a "free" car

Sure you will, and it will run just as smoothly as your Linux desktop! Of course, you'll have to distill your own gasoline, to make sure that it matches the unique chemical formula optimal for your particular construction of cylinder and spark plug, but hey, that's cool - it shows how leet you are! Sure, it takes time to keep your free car properly configured and patched with the latest safety and security devices, but hey, you weren't planning on spending time doing anything productive with your car, like, you know, drive it somewhere, were you?

Fallacy.

The guy makes some wishful statements, but his error comes from his primary assumption. It's right here:

There are three kinds of free in the world. [...] But there's a third form of free, which is the fascinating one that's really just now coming of age ... where really nobody pays

That statement is false. Somebody always provides the materials, labor, or time to produce any good or service. Just because it sometimes happens to be the same guy that created the good or service doesn't mean the process of creating it didn't cost him anything. "On the house" does not mean "nobody pays".

Marginal pricing is a long-term phenomenon that happens after the original entrepreneur has made “above-average” profits for a period of time, before that profit is competed away. That service will not be profitable anymore, but you can bet that the entrepreneur will then invent some add-on product that will make some more “above-average” profit, and the cycle continues. Nobody will stay in business for too long if they make no money above marginal cost, simply because of the opportunity cost of their time employed in a more profitable endeavor.

What I think would be interesting would be the ability to pay to not be the recipient of advertising.

For example, I like NCIS on CBS. Its about the only show I watch regularly now that The Unit is pretty much gone. 1/3 of the hour I spend watching it is commercials for products I don’t or won’t buy. I’d pay a small fee to be able to see the show(s) I like without advertising - and its probably more than what CBS gets in ad revenue when they divide it across the number of viewers.

Likewise, I’d subscribe to some web sites that are currently free if I could see them without ads.

You’re right — there is no “zero marginal cost”. I mentioned the “time preference of money” (AKA “interest”, or “dividends”) and risk — I should have added opportunity costs.

Still, the notion of 1% of users of a premium service cross-subsidizing the ordinary service for the other 99% of us does seem to be happening already. So long as the 1% (or whatever) is paying for the opportunity costs, interest, risk, etc. — then it would actually be a sound business model.

You’ve prompted me to think of another problem — the huge threshold effect between a “free” service and the paid premium service. In practice, there will probably have to be tiers of “premium” service — like there is with cable or satellite TV — which would result in a larger percentage of people paying something (just like the “good ole’ days”) and the 1% paying a lot more.

Maybe we'll have free “Wiki-health care”.

You start with posting a video on You-Doc, and thousands of volunteer GPs collaborate on a diagnosis and prescription.

If surgery is prescribed; you hook yourself up to your handy household medical robot (paid for by drug company advertising) & volunteer “surgeons” manipulate the controls over the Internet. Just like volunteer encyclopedia authors create Wikipedia entries.

Voilà — free health care!

/just kidding — I hope

Give me Linux and I will get my work down in a LOT less time with a lot less effort.

Or, much greater time and effort, but it'll be a lot more satisfying to you because then at least you'll be functioning under the belief that every quirk or shortcoming is some logical result of your own configuration choices. :)

In any case, if it works for you, all the more power to ya. Just realize that you're part of a very small minority that actually know what they're doing. (Or at least part of a minority that thinks they know what they're doing. :) ) Think about the time, effort, and frustration a person faces when using Linux, and put a dollar value on it. Think also about the perk of getting to solve puzzles by using an intellectually engaging OS, as well as the ego boost of getting to feel superior to all those inferior Windows lusers - and put a dollar value on those positives. These dollar values will be radically different for different people.

My dad, for example, would find his time and effort extremely valuable and the perk of intellectual engagement when trying to accomplish routine daily tasks to be really no perk at all, and would perceive Linux as having extremely negative value. On the other hand, my former college roommate doesn't value his time, and gets a major high out of thinking of himself as superior to less technically-minded people, so Linux has huge positive value for him.

As for me, both Linux and Windows waste considerable amounts of my time, but Windows tends to waste it in less frustrating ways - if I can't get Windows to do something, it's because Windows can't do it, not because I failed to be clever enough to put an ampersand in some line of some script run by some daemon somewhere. And I know I'm superior to everyone and don't need to use a leet OS to prove it. :)

IMHO, your analysis is right on.

Marginal pricing most often comes into play when a business is declining, or on the verge of bankruptcy. It also factors big in the mining, and oil & gas industries. When deciding whether to begin production, the developers have to consider the long-run average cost — with a good profit margin factored in. Once all the capital costs become sunk costs — future decisions about whether or not to continue production pivot around the marginal costs of production, compared to marginal revenue.

Clearly, Anderson is playing to the Starbucks and cocktail party crowd. He has a knack for making dry as dust economics sound quite cool — but, in so doing, he does oversimplify. You could quote Anderson at a coctail party & be considered trendy -- if you go deeper, eyes begin to glaze over.

The number 1 rule of the Universe: There is no free lunch.

What the author really means is no apparent cost to the consumer.

If I have a great idea for a story. I might tell it for free around the campfire. But if I go to the trouble of typing it up and proofreading it and putting it on the web, I want to get paid. Paid from somebody, I don’t really care who.

Anybody remember Nuclear power so cheap electricity it will be free? Didn’t happen that way. It never does.

Cheap, yes. Free to the consumer, maybe. Nobody gets paid? Never.

“What I think would be interesting would be the ability to pay to not be the recipient of advertising.”

I feel the same way.

I like to rent serialized TV series on DVD — 24, Lost, The Wire, Sopranos, etc. It's great to be able to see them without interruption — or without the extremely annoying and distracting little promos at the bottom, or credits that are superimposed on the first 15 minutes of the show.

I also record programs, so that I can fast-forward through commercials. This isn't exactly “free” — because of the cost of the recorder, and my time setting it up, etc. Also, it doesn't get rid of the promos, etc. that are embedded in the program.

I've read somewhere that the value of all TV advertising works out to about $300/household/year. That would be a very reasonable price to pay to be ad-free. Unfortunately, a lot of people wouldn't pay — so we're stuck with the advertising. Now that there is no practical limit to the number of channels, perhaps networks could offer premium (viewer-pay) channels with the same programming, at the same time, as the regular “free” advertising-funded channels.

Standard economic analysis embeds what is called a “normal rate of return” in the cost. This is usually understood to be the long run cost of capital (e.g., historically around 3.2% in the US). Any return above that, where price is above average total cost, is called an “economic rent”. It's called that because the return is “over and above what is necessary to keep those resources in their current use”. It is those economic rents that disappear in competitive industries. However, even if those economic rents go to zero because of competition, the resources may stay in their current use if there are no other alternatives that yield economic rents.

To say the Internet is free, however, is absurd. When Al Gore said he “invented” the Internet, what he really means is that he created the tax that appears on your phone bill ever month. Clearly, it is not free.

Give me Linux and I will get my work down in a LOT less time with a lot less effort.

Or, much greater time and effort, but it'll be a lot more satisfying to you because then at least you'll be functioning under the belief that every quirk or shortcoming is some logical result of your own configuration choices. :)

I'm sorry, this is wrong...first off, distros like Ubuntu are incredibly simple to install. For most people doing web browsing, emailing, document writing; this is enough. For those of us doing certain other things, once you have acquired that 'domain' knowledge (AKA, investing in learning it), the speed at which you can do things goes up. Say that there's a log file where we need to find application errors. It's large; perhaps 70MB. What do Windows users do? Open the file and then hit Ctrl-F to search it. What does a Linux user do? Grep. One is much faster than the other.

Simple fact of the matter is this: Go learn HCI and they will tell you every time that command languages are the most powerful interfaces, but the learning curve is often too steep.
Just to top it off, the statement if I can't get Windows to do something, it's because Windows can't do it, is patently false. There are many things which Windows can do that are obscure. If this were not true, then it would not be so easy to hide malware information in the "Registry"! There are a plethora of sites dedicated to hacks of the Registry, the vast majority of which are certainly non-obvious.

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