Freeconomics 2.0 - or how Pay! is the New Free!

On Monday I'll be speaking at the Chinwag session on Freeconomics, so I thought I'd get my riposte in first, as it were

About a year ago, I wrote the first paper on the blog about the "Limits to Freeconomics", to universal popular derision by the supposed Smart Set at the time. You can see those main papers here and here

That was the time of the Max Bubble, when speculative money was flooding in and many people confused this capital injection with real sustainable income. When The Crunch came this all changed, and by the time I gave a talk on my work at the O'Reilly/Web Expo session in Berlin in October 2008, it was interesting to see that Chris Anderson, who had been leading the FreeConomic charge, was already shifting from "Free" to "Freemium".

(O'Reilly/Web 2.0 talk is posted above on Slideshare)

Then came the riposte by the music industry that one of the underpinnings of "Free", ie the Long Tail, was neither Long nor a Tail. I was at the Telco 2.0 conference when that work was presented there, and that led to further shifting of the ground under the Free when Harvard University weighed in.

I had a chance to see the next paradigm shift at SXSW, when Chris Anderson was interviewed by Guy Kawasaki. (A Guardian piece on the session is here, my SXSW "Limits to Freeconomics video will be shown on the SXSW site soon, I'll link to it when it appears). One of the brilliant bits was Mr Anderson's comment that in the 20th Century "Free" was an economic thing, but in the 21st century its a Semantic thing.

This semantic shift pretty much says it all. Free no longer means Free!, it now means Pay!

And as the capital wave drains away, it is clear that many "Web 2.0" companies' business models were built on the assumption that some fool would fund them for as long as it took for Google to buy them. No VC money, no Google = no company - the shells of bust companies are starting to litter the beach behind the receding tide.

Still, Mr Anderson insisted that it was still the natural order of Digital Media to be free:

"It's the animal force of economics. The internet is the most competitive market we have ever seen and costs are nearly zero. The law of physics means that if you do not make your product free, gravity will do it for you."

And to those doubting him and nitpicking his economics, he noted that:

"I'm not telling the apple to fall - I'm just telling that the apple will fall. That is what the laws of digital economics require. My book says you either compete with free or use free but fundamentally the book is about how you make real money, the old fashioned way."

In fact, as The Economist noted, the "Real" Freeconomic gig was to grab some VC money on the back of dubious promises about Ad revenue, persuade a whole lot of muppets to generate user generated content, code and karma for free and then sell the f*cker to some behemoth like Google or AOL before the non-free transaction costs killed it

How to make money the Old Fashioned Way is to charge people for things. This is, following the Semantic shift, Pay! is the New Free

This was inevitable - FreeConomics was not true a year ago, and it becomes even more untrue today, for the same reasons as last year - to summarise:

1. Nothing in the Digital supply chain is Free. Some parts of the chain have reduced in cost, but others have not. It starts off low cost, but as volume rises all thoe other costs start coming into play

2. Nearly everything that looks Free is actually being subsidised by economic offsets - voluntary labour, risk capital, subsidies (eg Google subsidises nearly all its businesses with search advertising). And these offset economies are dwindling, not rising.

3. Ditto Advertising. There is a total of c $50bn in olnine advertising globally, about 80% is spoken for by the big guys, the rest is fought over by current small fry and wannabee $100m VC backed startups. A quick calc shows that $10bn (20% of $50bn) will support c 100 of these $100m startups globally, so most will fail.

4. Free allows rapid market groth, it is claimed. But, any company attempting to make a market with a Free Service will find its advantage rapidly eroded as all the others follow it down. With abundant offset funding it may live awhile, without it will fail. See point 2 above.

5. Services in the digital space that are free are increasingly so because the data from your digital activity is in chains, ie the data you give it is being processed to deliver value to someone else, elsewhere. However, DataPhishing is becoming increasingly controversial as this becomes more widely known

The new Free! plan is in fact Freemium - where a small number of people subsidise the majority, who get it for free. But "Freemium" models have existed since antiquity, they work in some situations, don't work in others. This is also likely to be true for Digital goods. The issue lies in the price sensitivity

Assume for example that a service serves photos (like Flickr), and that the hosting, bandwidth and distribution costs, fully loaded, are c $0.10 per month ($1.20 per year) per person. For 100 users, thats $120. Assume also that c 5% of these 100 users pay Freemium prices, so 5 people have to pick up $100 or $24 pa each (Flickr charges $25 for its Pro account)

But now imagine a video sharing site - files are c 10 - 100x bigger, so suddenly a 5% takeup is a $240 to $2,400 cost per person. Or imagine that one can only get a 2.5% takeup, thats $50 per person.

Not all things will work as Freemium. There are also Razor & Blade models (get shiny new mobile phone free, pay over the top for 24 month contract) and other forms of offset will persist (mainly driven by dataphishing to get some view of your future net present value, we hypothesize)

His latest iteration in the story is that America may be the Land Of The Free, but China is the Land of Free due to its libertine attitude towards copyright and conservative attitude towards labour costs. As the Guardian reports:

Anderson hails the Chinese music business as a perfect example of how the country's lack of intellectual property protection can work. "Pirates will pirate a CD, which creates celebrity, which you can use to create cash," he says. "Chinese pop stars make money not off music sales, but from making personal appearances, starring in advertisements, etc."

but...

touring is a loss-making venture until you can fill venues that hold a few thousand people or more. Then you can at least break even. Besides, the songwriters who write for others make few royalties from these tours, and the record producers make nothing. Merchandising income does not exist for either.

Similarly, ad funding has not been able to save the journalists who were laid off recently as their newspapers folded. For music sites such as Spiralfrog, which recently went under, the ad-funding business model hasn't worked. It's been even more difficult to pull in enough revenue, since advertisers realise that you don't actually have to look at the site while you're listening to the music.

YouTube, a site that actually has people looking at the screen while listening to the music, claim they can't pay the people who wrote the music more than what they have been paying so far. Mark Kelly from Marillion says he received 0.6p from YouTube for more than 10m views, which means that either Chris Anderson's "freeconomics" theory is faulty or Google, the owner of YouTube, is lying (incidentally, analysts at Jeffries & Co project that YouTube revenues will top $500m this year).

0.6p for a million views. Yup, you can live on that.....not!

Which brings us to the core issue for new content creation - artists may starve in garrets for art, but they still starve. Others just exit and do something else, The main reason that Freeconomics has survived to date is that copying other people's stuff is the lowest form of content creation going. Problem is, as YouTube is finding, its hard to attract paying customers or advertisers to such content. Without signifiicant Google subsidy, YouTube would collapse in months.

So where does that leave us?

Simple - Freemium will work in some cases, there is about $50bn for Ads to subsidise stuff (it will grow, but not rapidly in recessionary times as Ad spend is tied to GDP) and there are some last pools of risk capital left among the rocks.

But that is not going to fund Teh InterWebz. In Google we (may) trust, but for many of the others we'll be paying cash.