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  • Free Economics

    By: David Evans on July 24th, 2009

    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.


    4 Responses to “Free Economics”

    1. 1 Derek Pilling

      David,

      Thanks for committing this reaction to words David. I too have struggled to get through the book.

      My own two cents are that Anderson was cavalier to use the umbrella of free pricing to describe such a vast array of business models. Two-sided business models and complement/bundled business models are not the same thing. Yes, they share a component of free, but use it to quite different effect. As a result, Anderson’s use of the free umbrella serves only to confuse, not clarify, the underlying economic effects involved with free.

      Not all free is created equal.

    2. 2 David Evans

      Thanks, yes, it is a hodgepodge of examples of free which arise for many different reasons and follow from many different business models. Focusing on “free” is cute–and I guess it sells books–but free is just a special case of pricing below marginal cost which could include a positive but unprofitable price or a negative price. Fortunately, I guess, his timing is so bad given the problems free business models have been facing that hopefully not too many business novices will be mislead by this.

      I still haven’t made it through the book since I keep hitting show stoppers!

    3. 3 Tom Eisenmann

      Thanks for mentioning the article that Geoff Parker, Marshall Van Alstyne and I published in Harvard Business Review on two-sided markets. I, too, was shocked by Anderson’s remark that research on his topic was limited to “obscure academic discussions.” FWIW, I’m two-thirds of the way through the book. It’s uneven, with lots of logical inconsistencies. Better, on balance, than “Long Tail,” which was a disappointment in book form after following the rich discussion that Anderson moderated on his blog. In “Free,” Anderson presents an encyclopedic compilation of lots of different business models that have a subsidy component — many of which were unfamiliar to me. This rich set of examples pushed me to rethink my own frameworks, so it’s been a worthwhile read.

    4. 4 David Evans

      Well, Tom, you’ve at least encouraged me to finish the book. I think the compilation of different subsidy business models is a basic mistake as is the focus on “free”. The Long Tail was about something and one can debate whether what he said made sense or not. Free is about a particular price that could arise for a multitude of reasons. As a management tool I don’t think we want people to be focused on “free” or $1.95–we want them to focus on the business model (e.g. two-sided, complements, bundling, etc.) that applies in their particular circumstances and then think about what that pricing strategy implies.

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