New Statesman and the Old Story of New Wine, Old Bottles

Andrew Orlowski ran a piece in the New Statesman last week about the limits to Freeconomics, which we are in agreement with (start here for a canon of our work). Andrew was kind enough to quote me in the article:

Alan Patrick, co-founder of the Broadsight media and technology consultancy, points out that despite falling marginal costs, the idea of anything being “free to produce” is a myth; the costs are hidden elsewhere in the system.

While at McKinsey, Patrick ran simulations of the “free to produce” business model and found that “it results in wholesale value destruction with no accruing market benefit, unless you can build an extremely commanding lead and get the whole positive dynamic of increasing returns working for you. But that’s hard and rare.”

If you go to the links above you will see my thoughts on how anything being free to produce is a myth. What I thought may be illustrative was to talk a bit more about the modelling mentioned in the 2nd paragraph. You may be interested to know that:

- it was done in 1996 (We've done others since, the point was we've known this stuff for a long time)
- It largely predicted the Freeconomic model of the dotcom era (ie give stuff away "free to user, but its expensive to investor)
- The "Free" of 2008/9 is largely a rehash of this mythos (ie you've known this stuff for a long time).

I was one of 4 people who did it, it was mostly written as spreadsheet macro by another chap, but we did run it in a number of business games with teams competing with each other, as well as a virtual simulation. The results were quite interesting:

- In the first few rounds, some teams went free while others tried to charge - of course, the "free" teams built share rapidly
- Once the others caught on, they too went to free and advantage was eroded, but...
- ....those who had established a commanding presence carried on gaining users due to virtuous circle (positive return) benefits

Once it had been played a few times everyone was wise to it so everyone started off free, and there was little benefit to be gained.

In the initial simulations we put a cap on the bounds ( 2 years if I recall correctly) and that created artificial winners, in that those who went free first won, as they then charged their huge numbers of customers a fee in the last round and made out like bandits. Of course, if you let the simulation carry on they then lost customers in droves the next bound.

But the majority of the Free strategies just lost money. The few that managed to get an early traction got bigger - but there was room for very few big plays, positive returns/network effect means the biggest just carried on growing and the smaller ones lost customers over time

But the issue was how to actually make, not destroy, value if you want a sustainable business. Free always gains customers but the cost eventually kills the business at some size.

Now bear in mind this was done long before Google even existed, but it was clear from these models that to make money you had to find a way of making it in another way from your users - eg advertising paying for search, as Google does, or being able to drive some other benefit from it. (I don't think this model was ever used for Freemium services, that I modelled later and found "interesting" interplays between price, cost and % uptake - ie very narrow "ledges" of stability)

Plus ca change - here we are in 2009, the same myth has popped up, and unfortunately the same tears will fall when it all froths away. A "Free" strategy has to have an offset approach to being funded that will sustain it, as it cannot run on risk equity (VC money) for ever. Costs are lower, but that just raises the bar - and they still catch you in the end as volumes increase.