Freeconomics Part I – or who is paying for your Free lunch?

There have been a number of recent discussions – spanning free music, blog aggregation models, social media futures, open source strategies, various Citizen mediated activities etc - that have made it clear ( to me at any rate ) that when some people talk about “Free” services – i.e. free to user services – they tend to get caught up in a sleight-of-mind, conflating “Free” – i.e. costing nothing to use them – with “Free” as in costing nothing to produce, and/or “Free” as in not owned or controlled.

A minute’s sober reflection makes you realize that this is impossible – if the service is free to user, but not free to produce, then it must be being paid for in some other way.

So why the belief that this can all be free, forever?

Part of the reason is that costs across the supply chain have gone down (see below), plus there is also always some cost absorption due to VC funding and, (if the business takes off) Advertising subsidized models.

But that is not the whole story, there is almost an attitude of entitlement in some quarters, that all things can and will be free, sustainably, into the far future – and anyone who dares suggest otherwise is a rogue, a heretic, and doesn’t “Grok” the New New Economy. As it was put on Slashdot recently:

“You must be new, welcome to the Internet. Here on the Internet you are required to view any publicly held company as evil and any effort on their part to charge for a service as pure, unadulterated greed preferably attributed to their CEO or other high-ranking executive. Corporations should provide as many possible services for free, regardless of the time, capital, and human resources required to develop and run those services or products. Any efforts of corporations to charge money in voluntary exchange for their services or products is to be likened to highway robbery, extortion, or in the case of particularly large corporations, rape. I hope these guidelines have helped.”

I have called the set of beliefs around this mythplex “FreeConomics”

But first it may be useful to look at the facts about where cost actually is created in the value chain.

The Facts of “FreeConomics”

There is no doubt that costs across the supply chain have been reduced, sometimes by orders of magnitude. Below is a simplified model of the digital supply chain, showing the major stages and cost reduction in it..



Content Creation - lower costs of content producing equipment has reduced costs of capture and creation (as has the ability to copy and evade rights charges), and the emergence of User Generated (aka free) Content has reduced content costs for professionals where differentiation is low (Photography comes to mind). In addition, enthusiasts are often tempted to offset their costs in creation of content (See our earlier post on this here), which is the underlying economic driver of initial Open Source economics

Aggregation – Moving from Push to Pull via Search has reduced costs, as has the automation / socialization of editing functions. Marketing costs are also reduced in a networked world, to the extent where the transaction costs of some items makes it cheaper to give them away rather than charge for them

Distribution – Moore’s Law, working open standards and a glut of bandwidth and kit from the dotcom failures has meant the cost per megabyte, teraflop and kilobaud has plummeted.

Customer Environment – Moore’s Law, Metcalfe’s Law and increasing adherence to open architectures, plus device interchangeability and application flexibility, has led to the total cost of ownership falling.

There is also no doubt that the dramatic fall in costs has totally changed the industry structure, by changing the transaction costs of doing business, and this is a true shift to lower costs. In addition, I contend there has been a temporary “Dotcom Bust benefit” – so much stuff was sold off at firesale prices in the dotcom crash, which has driven a “one off” cost crash - and these effects leads some people into mistaking a (temporary, one off) rapid decline in cost for a trend towards “always free”.

But, even if costs fall by 90% across teh board, it does not mean free, and certainly not indefinitely, especially as volumes rise. If you look along that supply chain, at each point there is still hardware to buy, software to write, wetware to feed etc.

FreeConomics is not pervasive, if you look at that supply chain, the services closest to the customer – Distribution and Customer Premise Environment (CPE) - are most definitely not free to use, and the customer already pays for them fairly happily. They will pay for connectivity (DSL, Mobile, Cable) and into this is typically bundled their “Free” hosting etc etc. Similarly, the customer is paying for their CPE, they are buying laptops, routers, iPhones etc, and in fact often paying premiums for the look, feel, brand etc rather than pure functionality.

No, what is more curious is that there is a pervasive view that even though we are happy (to varying degrees) to pay the downstream costs, the more upstream services – the content and aggregation services – should be Free Forever. Herein lies the heart of FreeConomic theory.

FreeConomics is based upon two key Myths, viz:

- All Free-to-Use services are Free to Produce
- All Free-to-Use services in their turn use data and information that is “Free”, as in open and portable etc etc

The Myths of FreeConomics – Part I

The “All Free to Use services are Free to Produce” belief drives these two main submyths:

A Free to User service costs nothing to build
A Free to User service costs nothing to deliver

Now another moment’s thought will tell you that I’m being dim – how could anyone think these absurd things? And yet, and yet – in post after post on the Blogosphere, often by Very Important (A-List) Persons, whether it’s the raptures that greet Google’s every new “Free” service, or every new paean to the copious bounties that will be provided by the “Free” Open Source model, or the wonders of Portable social network data , or Citizen Media’s latest shafting of the Olde Order, or “Net Neutral” services that can and must be “Free” – at every turn I see people proposing building great empires of commercial or citizen capitalism atop these sandy economic constructs.

The risk of course is that people are going to be very disappointed, because the hidden but iron hand of Real World economics sits behind all these dreams, and its not the smell of coffee that dreamers will wake up to, but something far nastier .

Another reason I want to make the myths of FreeConomics clear to all is that, in my view, some of the promoters of the FreeConomic ideas are well aware this is all snake-oil, but so long as they can entice “digital sharecropping” (as Nick Carr puts it) they can make out like bandits on the Information Superhighway. If reading this makes the average geek more aware of this – even if initially they are apoplectic with rage at my heresy in questioning FreeConomics – then I will have done my job here.

So, examining the Sub-Myths in turn:


All Free to Use services are Free to Produce

The first Submyth states that all Free to Use services are free to make – this divides into “stuff already built” – ie sunk costs – and “stuff to be built” – ie creation costs

i) Sunk Costs

This FreeConomic sub-principle states that stuff that has already been paid for (i.e. where costs have been sunk) should now be Free regardless of who still owns it (Otherwise known as the Great Music Brouhaha). Yes, you can get nearly any existing recorded music, book, or video for free if you know where to go. But is this (a) ethically right, and (b) economically, is it sustainable?

Ignoring Ethics for now (after all, everyone else will) you hit 2 simple problems with existing material:
- Someone else owns it and wants to keep it
- It is Free to Use, so Google wants to own it

At any rate, it starts to fall into the realm of the “All Free to Use Content must be Free from ownership” myth which I will deal with in Part II in more detail.

(ii) New Content/Service Creation Costs

The FreeConomic sub-principle here is that new creative content should be Free to use, copy and most certainly should not be not paid for. Unfortunately, if no-one is paying the creator, the creators will do one (or more) of three things (driven mainly by the need to eat) viz (a) stop creating and get another job, (b) create crap on limited budgets or (c) move into the main option for Free Creation, the Offset Model (see below).

A small number of Creatives will no doubt opt for Parisian garrets, absinthe and starvation, but that, as we know from history, is not sustainable – they tend to die young.

If the New Media industry’s travails so far is any indication, option (b) – creating crap – is the initial default option. As Nick Davies notes in Flat Earth News, the newspaper industry has significantly moved from an investigative reporting model to a PR release broadcasting model, and from paid-for content to Ad funded content.

The other option for "Free" creation, and the only sustainable one, is the frequently misunderstood (wilfully in some cases) approach called Offset Economics.


Offset Economics 101

A non-free service can be offered free to the user for a number of reasons, from wanting to contribute for recognition reasons (e.g. Open Source developers as noted above) to wanting to grow market share (name your Web 2.0 startup here) through to more subtle requirements (build a database to better target customer adverts or sell it on to others).

This is the world of Offset economics.

In this model, peoples’ or organisations’ time and effort are given away for free because they are earning income elsewhere, from someone else (for example their daytime employer). What they are doing is giving up their “Free” time to produce these wonderful things you then get for free.

That worker’s time is not “Free” of course – it is an opportunity cost of say coding Open Source software vs some other use of the time, and so for the game theory to work here, the non financial paybacks (eg peer recognition, a better job later) have to exceed the benefits of the alternative options for it to be sustainable.

Thus, where this model breaks down is when it becomes clear that the time input is not creating the desired non financial return, or worse is being usurped by others for their own financial gain – ie Digital ShareCropping.

Common examples of Offset Economics are:

(i) Cost Offset via 3rd party benefit

- Cross-subsidy - Service provider gives away free service X because it makes money elsewhere, often the free service actually drives a benefit elsewhere
- Commercial funding - funded by advertising (or more insidiously, by selling customer databases)
- Non Economic Offset – aka “Dumping” - the service is given away for free because the benefits sought are non-economic, eg to prevent competitor entry (or deliberately non sustainable – such as trying to break a competitor, eg Microsoft vs Netscape)

(ii) Time Offset - Giving Away services for returns later

In this case the services are given away for free in the explicit hope of a future benefit – usually market share. Common examples are:

- Self Funded – Service is given away free but is funding itself e.g. via Friends, Family & Fools
- Other People’s Money (e.g. VC) funded - companies give away service for free funded by capital in the enterprise

(iii) Arbitrage

One could argue that Dumping is a form of arbitrage, but by this I mean taking advantage of short term discontinuities created by the arrival of new technologies. Examples are:

- Free copying – the ability to copy and distribute digital media at near zero cost, usually because the rightsholders have no similarly low cost way to force payment (aka Piracy today)
- A market pricing mechanism that creates a surplus that can suddenly be exploited by new technologies (this is how FreeServe started in the UK) creating an illusion of Free. The service is rapidly built and flipped, typically to dumb money or a large player who can actually drive the arbitrage synergies (or even better, both), eg FreeServe sold to a NewTelco

All Free to Use services are Free to Deliver

When you use Twitter, or Skype, or Google, or Facebook, or Friendfeed, or whatever Freebie 2.0 you are into, there is a temptation to think of it as “Free” to deliver because it is free to consume. This just isn’t true, especially Video services with big user bases and big bandwidth transport bills.

It is true that many of these services today are offsetting in the hope of a Greater Gain tomorrow, using VC money and a dream of Ad revenue. But it’s worth keeping in mind how else they may choose to make money in future.

The issue with many Social Network based services is that they lend themselves very well to the less benign areas of Offset Economics, owing to the level of data about yourself you expose, and the content value you are adding to (other people’s) properties.

It’s worth looking now in a bit of detail at these less benign forms, as these are the fundamental rationales behind the value add of social media systems:

(i) Data Mining

Facebook’s Beacon is the most public example of this play to date, but anyone who is collecting user data is up to this to some extent. A company attempts to extract large amounts of data about its users and their interactions, and then sell it on to people who wish to influence them – usually for advertising, but be aware there is a darker side to Social Media, the amount that can be deduced about you from data mining is truly staggering.

(ii) Digital Sharecropping

This is the “User Generated Content” social network play. The value is added by the users, the money is made by the platform owners when they sell – from Flickr to YouTube to Bebo there is a litany of services where the owners have cashed out handsomely on the back of free user effort and input. Nick Carr put it well:

To put it a different way, the sharecroppers operate happily in an attention economy while their overseers operate happily in a cash economy. In this view, the attention economy does not operate separately from the cash economy; it's simply a means of creating cheap inputs for the cash economy.

Now, a cynic may argue that this is just the California Cult model writ into software, where a band of dedicated cultists drink the kool-aid, tithe over their money, their daughters and their free time to the cause, and continue to look on in admiration and love as the New Media Maharishis drive off into the sunset in the new Rolls Royces

Fortunately that’s not strictly accurate either, as the user is typically gaining a host of free benefits they otherwise wouldn’t have had. And there is even hope (of a kind). Because of the Pareto nature of these things, about 20% of the people (at most) are doing 80% of the (free) work, so its only the true faithful that are getting ripped off in any major way, the majority are in fact “below average” contributors and thus benefit more than they lose. (And the faithful may well be getting their jollies in non financial ways, though it would seem that even these worms may be turning now judging by increasing moves to pay contributors)

In summary then, any and every Free to User Service is not Free, and those costs are being recouped in one or more of the Offset Economic models. Some are more benign to the user (choosing to do something with spare time, giving away free services to gain market share) and some are far less so (Data Mining, Digital Sharecropping).

Anyway, next time you sign away your data in the T&C, just make sure you f(au)st understand which bargain you are striking.

We'll go into this area - how free is that walled garden - in more detail in Part II

(PS you can thank (blame ?) Stephen Waddington for persuading me to post this by the egregious tactic of telling me it made some sense )