Free Commerce. An Oxymoron? Or Simply a Paradox?

The advent of the World Wide Web in the 1990s ushered in a rapid expansion of the digital goods economy – the market for those goods and services traded in electronic form as digital bits.  Yet the vast majority of digital goods that change hands today do so without any exchange of money.  Free?  How can that be?  Is it possible that something can be free and still be commercially viable?  Is free commerce an oxymoron, or simply a paradox, in the digital world?  [Ironically, the concept of free sells books witness the success of Chris Anderson’s latest book FREE: The Future of Radical Price.  And in the last several months a mini-industry of rebuttals and counter-rebuttals have been created around this book.]

If you ask the vast majority of digital goods producers or distributors they would say its an oxymoron.  Most are desperately trying new ways to generate revenue because they haven’t figured out how to charge for something that can be so easily copied and shared at no cost to the person doing the sharing.    The local newspaper world is the poster child for this view.  Their business has rapidly eroded because of the growth of free online classifieds, most prominently craigslist, and a decline in advertising revenue on the print side.  And their attempts to sell online subscriptions has failed in the face of other sources of free news. 

The prominent examples of digital goods businesses which have been successful, such as Apple’s  iTunes and the iPhone stores, only prove the rule.  Another example is the Wall Street Journal (WSJ) which has managed to maintain a pay wall on its online site.  But the WSJ Online benefits from having a specialized product which is bought as a business expense by many, if not most, of their subscribers.  In the vast ocean of digital goods the Apple and WSJ examples, while intriguing, represent rare species that can’t easily be replicated.  Free is still the dominant distribution model.

If we’re going to get to the bottom of the dilemma facing the world of digital commerce then we need to understand what makes it unique, aside from the much touted low barriers to sharing.  And we’ll start where others end – with the “buyers” of digital goods.  Buyers get less benefit from the “free” digital economy than is commonly perceived.  The mental transaction costs (or the perceived costs of a decision) are an overlooked cost of the “free” shopping experience.  Too often consumers back out of the layers they’ve burrowed into on the Web (search results – homepage – product page – registration page – back out again – repeat) because they are asked for something (registration information, credit card, money) which they’re not prepared to share without knowing what they will get or who they’re getting it from.  Hence the preference for digital goods which are truly free, without strings attached.

Digital goods are also distinguished from physical goods by their ability to be priced according to value received.  The price of physical goods varies from store to store but at the end of the day the price of each individual item represents cost + profit where the cost is generally some order of magnitude greater than the profit leaving limited pricing flexibility.  In the case of digital goods the cost of the digital good itself – independent of its cost of creation – approaches zero on the Internet.  Or, to look at it another way, when the cost of each incremental unit is zero, profit can be some order of magnitude greater than cost yet, in most cases, the product is given away free!

And, last but not least, there is no return policy for digital goods.  Sure, a provider of digital goods could offer a money back guarantee but what gets returned?  A file?  Which file?  The original?  Or a copy?  And what about the case where a digital good – such as news or information – is consumed online (not downloaded to the consumer’s computer)?  How do you return something that has already been consumed?  Talk about high mental transactions costs!  Better to give it away free and ask for payment after the consumer has determined its value to them.  This eliminates the barrier of the buyers’ mental transaction costs without changing the net revenue opportunity.

So, let’s summarize.  We have a product that costs almost nothing to copy and share, is difficult to assess the value of prior of consumption (high mental transaction costs), can’t be returned for a refund, and has an incremental (x + 1) cost of close to zero.  No wonder the default price is free!  Unless a digital goods producer/distributor can create a world where they control the hardware, the experience, and the digital goods delivery, ala Apple, then they’re caught between the proverbial rock and a hard place.  Better to offer their products free and find some way to extract value post consumption, either through advertising (easy, but often not enough) or through voluntary payments (harder, but more upside).  Free commerce is indeed a paradox, not an oxymoron, in the world of digital goods and services.  Learning to reconcile this paradox is the key to success in this brave new world.

[Full disclosure: I’m a partner in a company building a way for free and commerce to coexist in a mutually beneficial way.]

“FREE”: A Buyers Perspective

I just finished reading Chris Anderson’s new book FREE: The Future of a Radical Price.   Anderson certainly strikes a chord.  Anyone and everyone transacting business on the Internet has an interest in this subject.  And, although Anderson does a good job of helping us understand how we got to where we are today, he raises as many questions as he answers.

The basic premise of Anderson’s book – that “Free” is inevitable so get used to it – is probably not a revelation to those trying to make a living by delivering content over the Web.  And it is even less so to the typical consumer trying to wade through the mountains of free content available on the Web.  “Free” is of little consolation to me if I don’t get any value from the transaction.  Worse yet – and this is the irony of “Free” – it often costs me more than I get from it in the form of lost time, frustration, and loss of privacy. 

Despite Google’s search prowess – or maybe because of it – I often find myself wading through multiple information sources without satisfaction.  This is particularly true when I need advice such as where to eat, what to buy, where it invest, how to improve my garden, etc.  Too much of the “Free” information I’m directed to is paid content (by those with a vested interest), questionable amateur opinions, or simply not the information I need.  Even where the information I need is out there I simply don’t have time to dig for it. 

At one point Anderson quotes the social scientist Herbert Simon who noted – as far back as 1971 – that the new defining scarcity of our age is time and attention.  “Free” too often consumes both without delivering value.

Let me illustrate with a personal example.   I needed to replace my personal computer recently and figured I would get the information I needed by researching my options on the Web.  After spending many hours jumping from site to site, trying to sort the good from the bad and the biased from the unbiased I was certainly better educated than when I started (it had been several years since I last bought a computer).  But I still didn’t know which computer was best for me (given my budget).  My next foray was to start comparing the different options on the Web and that’s where the time spent searching really started to accumulate . 

By the way has anyone else noted that buying a personal computer has become somewhat like buying a mattress or an appliance?  There are so many different combinations and permutations and so little data comparing them – at least from a non-gamers perspective – that it’s almost impossible to make a reasoned judgement.

In the end I hopped in my car, drove to the nearest Best Buy, got the advice I needed and, on my second trip, bought my computer there.  I have no doubt I could have found a better deal on the Web but I was willing to spend a few more dollars to be able to compare multiple models side-by-side with some help from an salesperson who’s only interest was making sure I bought the right computer for my needs.  I would have saved myself considerable time and aggravation if I had started there!  In this case, I was happy to pay for information (in the form of a slightly higher price) when the same information was – presumably – available for free.

Don’t get me wrong I like to get things free as much as the next person.  And, despite being part of the 50+ crowd, I understand the explosion of free content on the Web.  My problem with “FREE” is that it too often costs me in ways that aren’t measured in dollars and cents.  Free content has its place, and Anderson does a good job of explaining the different business models it fits, but there should also be a risk-free (now that’s a free I can relate to) way for me to pay for content that delivers value and saves me time.

Let me end this post by using a quote (it’s FREE!) that Anderson used in his book (it’s from the behavioral economist Dan Ariely’s book Predictably Irrational):

Most transactions have an upside and a downside, but when something is FREE! we forget the downside.  FREE! gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is.  Why?  I think it’s because human beings are intrinsically afraid of loss.  The real allure of FREE! is tied to fear.  There’s no visible possibility of loss when we choose a FREE! item (it’s free).  But suppose we choose the item that’s not free.  Uh-oh, now there’s a risk of having made a poor decision – the possibility of loss.  And, so given a choice, we go for what’s free.

Ariely’s observations came from experiments involving things (as opposed to information).  Yet the Web – at least the free part of it – is about information.  What if we apply the same concept of risk aversion to the content delivered over the Web?  Is it simply about not spending money?  I don’t believe so.  There are too many other risks on the Internet including the risk of wasting time, the risk of loss of privacy, and the risk of being ripped off.  So, as long as the free means elimination of all of these risks, I’m all for it.  If not, bring on PAID.