Freeconomics: Some Facts

There was some buzz at one point (2006-2007) in the blogosphere related to so-called freeconomics. Chris Anderson, unless I’m mistaken, coined the term. Seth Godin may have also popularized the idea. (It seems like something he’d pick up quite readily.) At any rate, a lot of parroting followed on the topic, and still does.

The gist of the idea is that, online, you can actually get a free lunch. And that in some offline markets, prices are decreasing to a point where they become negligible. Making a buck thereafter becomes a matter of up-selling value-added products and services — or, as is the case online, in ads or affiliate marketing.

The idea of delivering free stuff online, and making money by pushing other things to a receptive audience, had been around on the internet for as long as I can remember. In my case, that’s in 1995, when I first hooked up onto the internet. There were then talks, in internet marketing and SEO spheres, about doing so. Google glamorously turned free search into billions of revenue.

One point, which may be less clear to the average consumer, is that delivering free offers has been standard in the offline world as well for quite a while. American consumers have long traded their privacy in exchange for more targeted ads and product offers. When you get a card from your local shopping maul, you’re asking them to mine your consumption patterns and offer you products that you’ll more likely purchase. And that is not to mention the multitudes of efforts to hand over a free item to you — because you’ll likely buy something later on, if only to reciprocate the favor.

While traveling in the past years, I’ve also seen trends in a similar area, which I’ll call the zero-margin approach. In essence, you deliver a product or a service at its marginal cost, and seek to monetize your offer by up-selling value-added services. For instance, some operators in Cancun sell guided tours of Chichen Itza to tourists, add a photographer to the party, and try to sell them over-priced photos at the end of the day. In this context, it doesn’t matter much if they’re making zero on the actual bus trip — and some make zero indeed.

The above-mentioned zero-margin approach, I feel, is what lies in the future for offline businesses. This is not yet another way to say that companies will all move to China because of the lower wages. If anything, it means there’s good grounds for a US company to compete on price with its Chinese counterpart by offering value-added services to its customers; essentially making zero on the product or service; but nonetheless keeping it in its portfolio because it translates into a receptive audience who it can market new stuff to.

More recently (2007-2008), I’ve also seen approaches where Internet Marketers are actually paying for an audience. Not in the sense that they’re burning through an advertisement budget in order to register traffic. Rather, in the sense that they’re handing over a commission on ebooks that is so high that they’re actually losing money for every sale. As they do, they’re building a list to who they’ll be able to market more stuff in the future.

Anyway, I bumped into a research paper from Kristina Shampanier, Nina Mazar and Dan Ariely (2007) recently while scanning through the last author’s Predictably Irrational website. I felt like sharing the link, as it gives a few pointers on the actual value of free. If you’re not into reading this kind of stuff, here’s a quick outline of the two points I feel are worth a mention.

First and foremost, they’ve added to the mountain of data that pricing something at zero is special. Put bluntly, a zero priced item is over-valued compared to its dirt-cheap counterpart. Open source developers usually learn this the hard way: Distribution plummets as soon as they start charging a little something for their software.

In restrospect, we all know this intuitively. Given the choice between a free, low-end product and a dirt cheap, similar one, we’ll pick the free one. And given the choice between the former and one with higher added value, the rational decision is to try the free one first (after all, it is free); and then buy the one that costs something if the free option wasn’t satisfactory.

This brings me to the second finding. The researchers highlight that, when forced to give rational thoughts to the decision and to what they’re about to get, consumers can be convinced that free is not worth going for. If anything it is a point to keep in mind when marketing a product or a service in an arena where similar offers are typically free: have the prospect rationalize that the free version won’t answer his requirements; and then proceed with the sale.

Taking a deeper look into the experiment’s methodology, however, makes it look an awful lot like the researchers merely introduced some level of cognitive dissonance in the equation. In fact, it is nothing but… So the result was clearly predictable. Nonetheless, it serves as a reminder that, in spite of the possibly irrational preference for “free”, and the availability of competition that markets similar offers to yours at no cost, your prospects can be convinced to buy your offers instead if it is sold to them properly.