This post on Wired by the long tailed Chris Andersen is a good and detailed discussion about
"free" business models. Some key notes from it:
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?)
That third party offset model is critical in our view, as we have discussed before there is just not enough advertising revenue to go round, and its likely that VRM and similar technologies will reduce Ad usefulness anyway.
The second piece of the discussion that is key is this one, on the impact of technology advance on business economics:
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.
Not just consumers - it gets harder to argue that businesses should spend a fortune on something that consumers get for nowt. The Freemium will start at SoHo and divisions in Corporates and spread - free is an easy business case in corporate life as well!
The next interesting point is the transferenece of "Free" to where things are not free - ie where there are new limits:
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.
And another - in an interesting point, Chris alludes to the other area that is increasingly not free when he notes...:
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.
And not only did it not happen, but ironically its going to be one of the great drivers of "Not Free" economics on the internet - its already been calculated (somewhat tongue in cheek) that a second life avatar consumes more energy than a Brazilian peasant, and that trend is not going to go away.
So, net-net Chris is probably right in the short term (ie the time taken to get your startup up, out and bought), but externalities, unseen obstacles and value transference means that in the long run the free lunch eventually gets paid for.....
