Pricing bits and bytes in a world of free

Larry Borsato — Fri, 14 Mar 2008 09:43:04 -0700

In the March 2008 issue of Wired, Chris Anderson suggested that free, or "freeconomics," is the future of business. Anderson contended that the costs of technology (i.e., processing power, bandwidth, storage) have dropped so fast that economies of scale apply, meaning that the marginal cost of supporting the next user, or 10,000 users, is almost zero. He goes on to say that moving across a psychological gap -- from "almost zero" to "zero" -- is how great markets are created.

But free doesn't translate to a loss of money-making opportunities. For instance, terrestrial, over-the-air television stations and networks have provided "free" programming for decades, but they are actually selling viewers' attention to advertisers. It's not much different than what Google and others do today with online ads appearing alongside free Web content.

Yet even though free seems to be everywhere, paid services continue to pop up in unexpected areas, generating real money -- and plenty of it.

For instance, the market for mobile ringtones is more than a half billion dollars annually in the U.S. Record companies constantly complain about the legions of kids who download pirated music rather than paying $0.99 per song. Yet those same kids freely choose to pay as much as $3.50 for a 30-second snippet of that same song.

The same is true of wallpaper for your mobile phone. People will pay $1 or more for a square, 50 pixel graphic. The images are similar to what you might see on a t-shirt -- for instance, for the 18-25 year old male demographic, there are wallpaper files featuring scantily clad women.

Besides the content itself, price is also driven by a sort of artificial scarcity. Labeling these ringtones and wallpapers as "limited editions" makes them sell even faster. The popular Facebook Gifts application sells "gifts" – small images of things like teddy bears or birthday cakes – for $1 apiece. The Facebook home page displays the gift of the day to members, and the newsfeed shows your friends who is giving gifts to whom. The "limited edition" gifts (only 1,000,000 available – get them while you can!) go quickly.

Let's step back for a second, and consider what's being sold. Regardless of the perceived quality or value of ringtones and graphics, these images are simply collections of bits, virtually free to create, and obviously free to replicate infinitely. Everyone understands this, but something inside of our heads tells us that we must have one of those limited items. And we're willing to pay handsomely to get them.

The theory behind freeconomics is derived primarily from the fact that technology becomes more abundant and much cheaper over time. But free services really aren't free. There is always a tradeoff. For AdSense, Google sells Internet users' attention to advertisers. For Flickr, members provide the free photographs, and parent company Yahoo monetizes them through advertising and premium services. In many cases, the freeconomics concept seems to act as an enabler for a secondary market which drives real revenue.

There's another important concept to consider: Perceived value. Humans are a bit strange in that we will ascribe different values to similar things. Even though we can access technologies and services for free, we still seem willing to pay for similar products, such as ringtones and gift images. And what we are willing to pay for will change over time. Ringtones may have already peaked, but that doesn't mean the opportunity for the music industry is gone. Despite the widespread availability of free music, a thirty-second ringtone is still worth two or three bucks to somebody. If there are enough somebodies who have a similar mindset, then there's still plenty of money to be made in an ocean of free.