Free Radical

As a follow-up to Mr. Chris Anderson’s talk at Haas Alumni Luncheon and his description of continuously decreasing marginal cost I talked about opportunity costs and when it replaced the cost to produce/store/serve one additional unit.

Let us set aside the cost discussion and focus on price. Mr. Anderson’s new book’s sub-title is “The Future of a Radical Price”. Free service with Ad supported business model is not new and Mr. Anderson says that as well. What he says about free model is the emergence of a “freemium” model. What is “freemium”? Mr. Anderson explains this in a letter he wrote to The Economist,

The big shift since the crisis has been the rise of “freemium” (free+premium) models, where products and services are offered in free basic and paid premium versions. Think Flickr and Flicker Pro (more storage), virtually all online games and even your own site (some free and some paid content).

So many users pay nothing and get limited service and some pay to get a different class of service. I am not certain why this is radical or new. Let us consider following scenarios

  1. Taxation on Paying Customers: The free users are irrelevant to provide service to the paid customers. In this case the business is simply throwing away money by serving the free customers. There is nothing new here. Paying customers subsidize the free customers – so paying a higher price to support the marketer’s higher cost structure. What is in it for these customers to support the freeloaders? If the business one day decides to jettison all free users, it is simply eliminating a cost function that has no associated revenue and giving value back to paying customers.
  2. Up-sell: The business depends on converting a part of the free users to paid users over a period but otherwise it does not need the presence of free users to serve paid users. In this case it is no different from a business spending on marketing to bring in paid customers. Any one free user  by herself is not important but as a collection she is. This is similar to a mail campaign that has 1% conversion rate. Each mail you send out by itself is not important, but it is as part of the whole bunch you send out. So suddenly eliminating free customers is the equivalent of completely cutting off marketing spend. As long as the business can hold on to current paid customers and  has other ways to acquire new customers it can cut-off free users. In this case too the model is no different from what exists  in non digital businesses. Incidentally, whether or not there is a  cost to serve one single free user is irrelevant because the relevant cost to consider is the total cost to serve all free customers.
  3. Value Distribution: The business needs the presence of free users to serve its paid users, in other words presence of the free customers adds value that is shared between the marketer, paying customers and the free customers. This is the classic two sided market, like eBay, in which one side creates value and hence is not charged and the other side consumed value and is charged for that. One again this is not radical. The presence of free customers is essential for the service and the paying customers who are not subsidizing free customers but compensating them for the value add.

Price is about capturing value created for customers, if the business chooses not to charge for that value-add then they do not have a working business model. Free is not a price, definitely not radical,  it is either failure to capture value, customer acquisition activity or  simply matching price with value added.

5 thoughts on “Free Radical

  1. The freemium model cannot be compared directly with a mail shot. Although sharing superficially similar economics, the models differ in one important aspect. The documentation sent in a mail shot has no direct bearing on the product being offered, whereas with the freemium model it does.

    The freemium model contains a built-in Catch-22: the better the free part, the more chance the marketing tactic has of succeeding. But, the better the free part, the less chance there will be of conversions to the premium version.

    • My example was about taking it to the extreme to compare freemium to a customer acquisition activity like mail campaign. You are correct that a free service may meet the needs of many customers who will never find a need to upgrade. By giving way for free the marketer sets the worst reference price ($0) and destroys value. My core arguments are that free is not a business model, costs do not matter whether or not you give away your service and there is nothing new or radical about free.

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