Cloudy With a Chance of Free Business Model

There is a children book called Cloudy With A  Chance of Meatballs which is  a great story about a town where food was in abundance, because it rained food three times a day. It rained breakfast, lunch and dinner. In this scenario, there is such thing called free lunch. In fact the town hired sanitation crew just to cleanup the excess food from the streets and keep them clear. I bet no one in the town went hungry and there was no need to save food for the rainy day (pun intended). There is a page in the book that shows a restaurant with people eating inside. One notable aspect about that restaurant is there was no roof. Waiters simply caught “the rain” and served their customers. The marginal cost of food is zero for the restaurant.

That brings us to free as a business model that Mr. Chris Anderson talks about. Mr. Anderson says how free is the future for digital goods and services because their marginal cost approaches $0.  The meatballs book  applies Mr. Anderson’s argument about marginal cost to physical goods. Abundance of one component simply makes it irrelevant in pricing because a marketer cannot make a value proposition based on that component. The business model shifts to other components that deliver value.

  1. Since the marginal cost of food is zero, should the restaurant serve its customers for free?: No. The marginal cost is irrelevant. The restaurant should charge the customers for the convenience  (someone else catching the raining and serving) and experience. The fact that marginal cost is $0 for food only changes the product/service that is being sold.
  2. If the restaurant simply serves the rain that people can do it for themselves, why would anyone go to any restaurant?: Same answer as above.
  3. How would one restaurant differentiate itself from others?: Better service, live entertainment,  complements like wine that is not part of the rain.
  4. What role do chefs have to play in such a town? If the food from the rain is bland or flavorless then chefs role could be to improve its flavor. They could also specialize in plating the dishes in an attractive manner.

Pricing is about capturing a share of that delivered value. Since  “free” does not capture value it cannot be a business model.

4 thoughts on “Cloudy With a Chance of Free Business Model

  1. Peter
    Thanks for your compliment. It helps when you an avid little reader who picks out the books for you.

    To me the business model is, value creation and value capture. How is my service adding value to my customers? Do I get to share in that value. If someone has to give away part of the service or a version of the service or free despite the value-add, they do not have a business model. However if they are using free version as a way to bring in customers and later convert them into paying customers then they are simply using free as a marketing tactic. Hence free is neither a business model nor part of it.

    When a marketer decides to offer a free version, as long as there is incremental profit (i.e., there is more revenue than it costs to serve) they should do it. In this case the marginal cost (cost to serve one additional customer ) is not the relevant cost because these costs are all bundled together as fixed cost to serve a whole bunch of free customers. Here a marketer is not making a decision, should I server n-th customer, how about n+1-th… They should look at, it would cost me $X to have the service up and running and support N free customers of which n% will convert to higher service generating $Y in revenue. As long as $Y> $X (or more rigorously the investment is NPV positive over a time horizon) then by all means offer the free service.

    That is why I said that the marginal cost is not the relevant cost when doing the incremental analysis. Even if we set aside my cost accounting argument, what it costs to produce is irrelevant to what you charge for it except in highly competitive market with excess capacity and no differentiation. The problem with most digital goods is that there is excess capacity and no differentiation.

    Newspaper is great example – one for the reason you said and the other is some (WSJ and FT) are making money by not making it free. WSJ infact raised it prices. This is because what they provide is not available elsewhere and adds considerable value to their readers. Other newspapers are struggling because they cannot make a credible value proposition. Even if your service adds value (NYTimes) by giving it away for free you set a bad reference price that destroys value and prevents you from later charging for the service that used to be free.

    For providing better context of this comment you will have to see my other articles:
    https://iterativepath.wordpress.com/2009/06/18/free-radical/

    https://iterativepath.wordpress.com/2009/06/13/relevant-cost-do-not-ignore-opportunity-costs/

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  2. I really like the way you use the children’s book as an example. It sounds like a very illustrative story to talk about the nature of free. I have just ordered it.

    Yet i think that you have misunderstood the idea of using free as described by Chris Anderson(among others).
    The concept is not that free is a business model, but rather a part of a business model. As Mike Masnich puts it on techdirt “No one ever said free is the business model– but it absolutely should be a part of the business model”
    http://ww.techdirt.com/articles/20070919/230654.shtml

    I also have a hard time following your argument about how the marginal cost has is irrelevant. A marginal cost of free allows competitors to offer the product at a lower price or even at no price at all. A great example of this s the newspaper business. Which is in trouble because they are now competing with free news.

    The marginal price of zero might not effect the single restaurant in your example. Yet don’t you think that there would be a lessened demand for restaurants or even supermarkets in that town ?

    I look forward to reading the story, but it sounds like a great spoof on how digital production is affecting business.

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