http://www.wired.com/techbiz/it/magazine/16-03/ff_free
Free! Why $0.00 Is the Future of Business
By Chris Anderson
At the age of 40, King Gillette was a frustrated inventor, a bitter
anticapitalist, and a salesman of cork-lined bottle caps. It was 1895,
and despite ideas, energy, and wealthy parents, he had little to show
for his work. He blamed the evils of market competition. Indeed, the
previous year he had published a book, The Human Drift, which argued
that all industry should be taken over by a single corporation owned
by the public and that millions of Americans should live in a giant
city called Metropolis powered by Niagara Falls. His boss at the
bottle cap company, meanwhile, had just one piece of advice: Invent
something people use and throw away.
One day, while he was shaving with a straight razor that was so worn
it could no longer be sharpened, the idea came to him. What if the
blade could be made of a thin metal strip? Rather than spending time
maintaining the blades, men could simply discard them when they became
dull. A few years of metallurgy experimentation later, the
disposable-blade safety razor was born. But it didn't take off
immediately. In its first year, 1903, Gillette sold a total of 51
razors and 168 blades. Over the next two decades, he tried every
marketing gimmick he could think of. He put his own face on the
package, making him both legendary and, some people believed,
fictional. He sold millions of razors to the Army at a steep discount,
hoping the habits soldiers developed at war would carry over to
peacetime. He sold razors in bulk to banks so they could give them
away with new deposits ("shave and save" campaigns). Razors were
bundled with everything from Wrigley's gum to packets of coffee, tea,
spices, and marshmallows. The freebies helped to sell those products,
but the tactic helped Gillette even more. By giving away the razors,
which were useless by themselves, he was creating demand for
disposable blades. 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.
Thanks to Gillette, the idea that you can make money by giving
something away is no longer radical. 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.
Over the past decade, however, a different sort of free has emerged.
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. It's as if the price of steel had
dropped so close to zero that King Gillette could give away both razor
and blade, and make his money on something else entirely. (Shaving
cream?)
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.")
Once a marketing gimmick, free has emerged as a full-fledged economy.
Offering free music proved successful for Radiohead, Trent Reznor of
Nine Inch Nails, and a swarm of other bands on MySpace that grasped
the audience-building merits of zero. The fastest-growing parts of the
gaming industry are ad-supported casual games online and free-to-try
massively multiplayer online games. Virtually everything Google does
is free to consumers, from Gmail to Picasa to GOOG-411.
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.
But tell that to the poor CIO who just shelled out six figures to buy
another rack of servers. Technology sure doesn't feel free when you're
buying it by the gross. Yet if you look at it from the other side of
the fat pipe, the economics change. That expensive bank of hard drives
(fixed costs) can serve tens of thousands of users (marginal costs).
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.
As much as we complain about how expensive things are getting, we're
surrounded by forces that are making them cheaper. Forty years ago,
the principal nutritional problem in America was hunger; now it's
obesity, for which we have the Green Revolution to thank. Forty years
ago, charity was dominated by clothing drives for the poor. Now you
can get a T-shirt for less than the price of a cup of coffee, thanks
to China and global sourcing. So too for toys, gadgets, and
commodities of every sort. Even cocaine has pretty much never been
cheaper (globalization works in mysterious ways).
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.
What does this mean for the notion of free? Well, just take one
example. Last year, Yahoo announced that Yahoo Mail, its free webmail
service, would provide unlimited storage. Just in case that wasn't
totally clear, that's "unlimited" as in "infinite." So the market
price of online storage, at least for email, has now fallen to zero
(see "Webmail Windfall"). And the stunning thing is that nobody was
surprised; many had assumed infinite free storage was already the
case.
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.
One of the old jokes from the late-'90s bubble was that there are only
two numbers on the Internet: infinity and zero. The first, at least as
it applied to stock market valuations, proved false. But the second is
alive and well. The Web has become the land of the free.
The result is that we now have not one but two trends driving the
spread of free business models across the economy. The first is the
extension of King Gillette's cross-subsidy to more and more
industries. Technology is giving companies greater flexibility in how
broadly they can define their markets, allowing them more freedom to
give away products or services to one set of customers while selling
to another set. Ryanair, for instance, has disrupted its industry by
defining itself more as a full-service travel agency than a seller of
airline seats (see "How Can Air Travel Be Free?").
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.
WASTE AND WASTE AGAIN
Forty years ago, Caltech professor Carver Mead identified the
corollary to Moore's law of ever-increasing computing power. Every 18
months, Mead observed, the price of a transistor would halve. And so
it did, going from tens of dollars in the 1960s to approximately
0.000001 cent today for each of the transistors in Intel's latest
quad-core. This, Mead realized, meant that we should start to "waste"
transistors.
Waste is a dirty word, and that was especially true in the IT world of
the 1970s. An entire generation of computer professionals had been
taught that their job was to dole out expensive computer resources
sparingly. In the glass-walled facilities of the mainframe era, these
systems operators exercised their power by choosing whose programs
should be allowed to run on the costly computing machines. 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.
And here was Mead, telling programmers to embrace waste. They
scratched their heads — how do you waste computer power? It took Alan
Kay, an engineer working at Xerox's Palo Alto Research Center, to show
them. Rather than conserve transistors for core processing functions,
he developed a computer concept — the Dynabook — that would
frivolously deploy silicon to do silly things: draw icons, windows,
pointers, and even animations on the screen. 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.)
Of course, computers were not free then, and they are not free today.
But what Mead and Kay understood was that the transistors in them —
the atomic units of computation — would become so numerous that on an
individual basis, they'd be close enough to costless that they might
as well be free. That meant software writers, liberated from worrying
about scarce computational resources like memory and CPU cycles, could
become more and more ambitious, focusing on higher-order functions
such as user interfaces and new markets such as entertainment. And
that meant software of broader appeal, which brought in more users,
who in turn found even more uses for computers. Thanks to that
wasteful throwing of transistors against the wall, the world was
changed.
What's interesting is that transistors (or storage, or bandwidth)
don't have to be completely free to invoke this effect. At a certain
point, they're cheap enough to be safely disregarded. The Greek
philosopher Zeno wrestled with this concept in a slightly different
context. In Zeno's dichotomy paradox, you run toward a wall. As you
run, you halve the distance to the wall, then halve it again, and so
on. But if you continue to subdivide space forever, how can you ever
actually reach the wall? (The answer is that you can't: Once you're
within a few nanometers, atomic repulsion forces become too strong for
you to get any closer.)
In economics, the parallel is this: If the unitary cost of technology
("per megabyte" or "per megabit per second" or "per thousand
floating-point operations per second") is halving every 18 months,
when does it come close enough to zero to say that you've arrived and
can safely round down to nothing? The answer: almost always sooner
than you think.
What Mead understood is that a psychological switch should flip as
things head toward zero. Even though they may never become entirely
free, as the price drops there is great advantage to be had in
treating them as if they were free. Not too cheap to meter, as Atomic
Energy Commission chief Lewis Strauss said in a different context, but
too cheap to matter. Indeed, the history of technological innovation
has been marked by people spotting such price and performance trends
and getting ahead of them.
>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.
The huge psychological gap between "almost zero" and "zero" is why
micropayments failed. It's why Google doesn't show up on your credit
card. It's why modern Web companies don't charge their users anything.
And it's why Yahoo gives away disk drive space. The question of
infinite storage was not if but when. The winners made their stuff
free first.
Traditionalists wring their hands about the "vaporization of value"
and "demonetization" of entire industries. The success of craigslist's
free listings, for instance, has hurt the newspaper classified ad
business. But that lost newspaper revenue is certainly not ending up
in the craigslist coffers. In 2006, the site earned an estimated $40
million from the few things it charges for. That's about 12 percent of
the $326 million by which classified ad revenue declined that year.
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.
The most common of the economies built around free is the three-party
system. Here a third party pays to participate in a market created by
a free exchange between the first two parties. Sound complicated?
You're probably experiencing it right now. It's the basis of virtually
all media.
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.
In a sense, what the Web represents is the extension of the media
business model to industries of all sorts. This is not simply the
notion that advertising will pay for everything. There are dozens of
ways that media companies make money around free content, from selling
information about consumers to brand licensing, "value-added"
subscriptions, and direct ecommerce (see How-To Wiki for a complete
list). Now an entire ecosystem of Web companies is growing up around
the same set of models.
A TAXONOMY OF FREE
Between new ways companies have found to subsidize products and the
falling cost of doing business in a digital age, the opportunities to
adopt a free business model of some sort have never been greater. But
which one? And how many are there? Probably hundreds, but the
priceless economy can be broken down into six broad categories:
· "Freemium"
What's free: Web software and services, some content. Free to whom:
users of the basic version.
This term, coined by venture capitalist Fred Wilson, is the basis of
the subscription model of media and is one of the most common Web
business models. It can take a range of forms: varying tiers of
content, from free to expensive, or a premium "pro" version of some
site or software with more features than the free version (think
Flickr and the $25-a-year Flickr Pro).
Again, this sounds familiar. Isn't it just the free sample model found
everywhere from perfume counters to street corners? Yes, but with a
pretty significant twist. The traditional free sample is the
promotional candy bar handout or the diapers mailed to a new mother.
Since these samples have real costs, the manufacturer gives away only
a tiny quantity — hoping to hook consumers and stimulate demand for
many more.
Photo Illustration: Jeff Mermelstein
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.
· Advertising
What's free: content, services, software, and more. Free to whom: everyone.
Broadcast commercials and print display ads have given way to a
blizzard of new Web-based ad formats: Yahoo's pay-per-pageview
banners, Google's pay-per-click text ads, Amazon's pay-per-transaction
"affiliate ads," and site sponsorships were just the start. Then came
the next wave: paid inclusion in search results, paid listing in
information services, and lead generation, where a third party pays
for the names of people interested in a certain subject. Now companies
are trying everything from product placement (PayPerPost) to
pay-per-connection on social networks like Facebook. All of these
approaches are based on the principle that free offerings build
audiences with distinct interests and expressed needs that advertisers
will pay to reach.
· Cross-subsidies
What's free: any product that entices you to pay for something else.
Free to whom: everyone willing to pay eventually, one way or another.
Scenario 3: It's a free second-gen Wiii! But only if you buy the
deluxe version of Rock Band.
When Wal-Mart charges $15 for a new hit DVD, it's a loss leader. The
company is offering the DVD below cost to lure you into the store,
where it hopes to sell you a washing machine at a profit. Expensive
wine subsidizes food in a restaurant, and the original "free lunch"
was a gratis meal for anyone who ordered at least one beer in San
Francisco saloons in the late 1800s. 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.
On a busy corner in São Paulo, Brazil, street vendors pitch the latest
"tecnobrega" CDs, including one by a hot band called Banda Calypso.
Like CDs from most street vendors, these did not come from a record
label. But neither are they illicit. They came directly from the band.
Calypso distributes masters of its CDs and CD liner art to street
vendor networks in towns it plans to tour, with full agreement that
the vendors will copy the CDs, sell them, and keep all the money.
That's OK, because selling discs isn't Calypso's main source of
income. The band is really in the performance business — and business
is good. Traveling from town to town this way, preceded by a wave of
supercheap CDs, Calypso has filled its shows and paid for a private
jet.
The vendors generate literal street cred in each town Calypso visits,
and its omnipresence in the urban soundscape means that it gets huge
crowds to its rave/dj/concert events. Free music is just publicity for
a far more lucrative tour business. Nobody thinks of this as piracy.
· Zero marginal cost
What's free: things that can be distributed without an appreciable
cost to anyone. Free to whom: everyone.
This describes nothing so well as online music. Between digital
reproduction and peer-to-peer distribution, the real cost of
distributing music has truly hit bottom. This is a case where the
product has become free because of sheer economic gravity, with or
without a business model. That force is so powerful that laws, guilt
trips, DRM, and every other barrier to piracy the labels can think of
have failed. 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.
· 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.
· Gift economy
What's free: the whole enchilada, be it open source software or
user-generated content. Free to whom: everyone.
>From Freecycle (free secondhand goods for anyone who will take them
away) to Wikipedia, we are discovering that money isn't the only
motivator. Altruism has always existed, but the Web gives it a
platform where the actions of individuals can have global impact. In a
sense, zero-cost distribution has turned sharing into an industry. In
the monetary economy it all looks free — indeed, in the monetary
economy it looks like unfair competition — but that says more about
our shortsighted ways of measuring value than it does about the worth
of what's created.
THE ECONOMICS OF ABUNDANCE
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.
Surely economics has something to say about that?
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.
FREE CHANGES EVERYTHING
Between digital economics and the wholesale embrace of King's
Gillette's experiment in price shifting, we are entering an era when
free will be seen as the norm, not an anomaly. How big a deal is that?
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.
All buildings would be electrically heated, never mind the thermal
conversion rate. We'd all be driving electric cars (free electricity
would be incentive enough to develop the efficient battery technology
to store it). Massive desalination plants would turn seawater into all
the freshwater anyone could want, irrigating vast inland swaths and
turning deserts into fertile acres, many of them making biofuels as a
cheaper store of energy than batteries. Relative to free electrons,
fossil fuels would be seen as ludicrously expensive and dirty, and so
carbon emissions would plummet. The phrase "global warming" would have
never entered the language.
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.
http://www.wired.com/techbiz/it/magazine/16-03/ff_free?currentPage=all
Cheers
Amit
--
Amit Varma
http://www.indiauncut.com
