Chris Anderson’s book “Free: The Future of a Radical Price” doesn’t get off to a good start for economists. After talking about how common “zero” prices are, Anderson says, “Surely economics must have something to say about this, I thought. But I couldn’t find anything. No theories of gratis, or pricing models that went to zero.” Then he inserts an amazing parenthetical. “(In fairness, some do exist, as later research would reveal. But they were mostly obscure academic discussions on ‘two-sided markets’ and, as we’ll see in the economics chapter, nearly forgotten theories from the nineteenth century.)” He concludes, “Somehow an economy had emerged around Free before the economic model could describe it.”
This paragraph reflects such incredible ignorance and lack of research on Anderson’s part that I haven’t mustered up the enthusiasm to wade through the rest of the book although I will this weekend.
Let me begin with two-sided markets. There’s been a massive outpouring of work on two-sided markets starting with Rochet and Tirole’s seminal paper that started circulating around 2000. Yes, that has led to some highly mathematical pieces that some readers might find daunting. But it has also led to practical applications and has been the subject of one major article in Harvard Business Review, Strategies for Two-Sided Markets by Eisenmann, Parker, and Van Alstyne in 2006 and my Harvard Business School Book, Catalyst Code with Richard Schmalensee in 2007 to give just a couple of examples. Anderson should probably have consulted the Wikipedia entry on two-sided markets which describes both the business and technical aspects of two-sided markets. The books and articles—mainly in plain English—on this topic could easily overwhelm a very large desktop. The economics of two-sided markets basically show why it often makes sense to give certain products and services away or even to pay people to take them. Two-sided businesses (media, video games, credit cards, etc.) price low to one side to get them to join a platform and charge high to another side that wants access to this group. Free and negative are special cases of this titled price schedule. The two-sided concept covers an awful lot of what Anderson discusses in Free but far more systematically and with many of the caveats that he ignores.
A good portion of Free talks about reasons for pricing at zero that were well known to economists before the development of the theory of two-sided markets. Many of Anderson’s examples concern complementary products or bundling where it makes economic and business sense to price a component of a system for free. None of the 19th century theories of this—or in many cases the early and mid 20th century theories—have been forgotten. This topic is so well known in economics that it hardly bears mentioning as anything special. And we haven’t kept this to ourselves. Much of this learning has diffused into the business school curriculum and into marketing. It just isn’t new.
That brings me to the broader claim of Free that there are new 21st Century business models based on free. Most of the kinds of business models that Anderson talks about have been around for centuries if not longer. Google’s search business model isn’t fundamentally different than yellow pages. The yellow page companies charged the advertisers and give the search mechanism away for free. The only business model that Anderson points to that is really new is open source. The fact that volunteers around the world create really useful stuff for free is an amazing organizational and technological development. Of course we’ve known about that phenomenon for more than a decade.
The two-sided literature and other economic theories emphasize that free is a special case and that it doesn’t necessarily or always lead to a profitable business. Free largely ignores this point and suffers from particularly bad timing. Many online media properties that drank the “free” kool-aid have discovered that they can’t make enough money from advertisers to cover the cost of content and running the property. Many are considering charging for subscriptions.
More to come.
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Filed Under: Digital Media, Publishing, Ad-Supported, New Business Models, consumers, Economics, Newspapers, two-sided market