Freeconomics Questions

The big giveaway

International flights that don’t cost a thing? Books or music you don’t have to pay for? Even companies handing out cars? Traditional business is based on the certainty that everything has a price. But now US writer Chris Anderson believes we are at the dawn of a new consumerist era, governed by what he dubs ‘freeconomics’. He talks to Stuart Jeffries

• Stuart Jeffries
• The Guardian, Tuesday 6 May 2008

A few years ago, Ryanair’s founder Michael O’Leary told an interviewer that he had a dream. He had already democratised air travel: “For years flying has been the preserve of rich fuckers. Now everyone can afford to fly.” His new ambition, he told the Financial Times in 2004, was to give customers free tickets, perhaps even to pay them to fly. He predicted: “In a decade or so, airlines will pay travellers to distribute people around Europe.”

But how could he make his dream of free air travel a profitable reality? It’s a question that takes us to the heart of a new philosophy called freeconomics that turns traditional capitalist business models on their heads. O’Leary argued that the airline industry would have to learn from commercial TV, which allows viewers to watch for free while advertisers pay for access to them. It would also have learn from the internet, where websites make money for delivering click-through traffic to other sites.

As you may have noticed, O’Leary isn’t yet paying you to fly, not even to from Birmingham to Bratislava (which currently costs £10 one way), but he has a few years to deliver on his prediction. If he manages it, Ryanair will become an exponent of a revolutionary idea being developed by Chris Anderson, editor-in-chief of Wired magazine.

Anderson’s freeconomics thesis is that more and more goods and services are being provided for free and that those businesses that fail to follow suit are likely to go to the wall. “As much as we complain about how expensive things are getting, we’re surrounded by forces that are making them cheaper,” Anderson wrote in a recent article that will form the basis of a book called Free, to be published next year. “Forty years ago, charity was dominated by clothing drives for the poor. Now you can get a T-shirt for less than the price of a cup of coffee, thanks to China and global sourcing. So too for toys, gadgets and commodities of every sort. Even cocaine has pretty much never been cheaper (globalisation works in mysterious ways).”

But freeconomics is hardly a deluded eulogy to global capitalism. Rather, Anderson’s idea is that the internet, by reducing marginal costs, encourages businesses to make their money by offering free goods or services to an extent we have not witnessed before. And that this change in supply alters the nature of demand: free services such as Craigslist, Skype, Freeview, Wikipedia and Google have created a generation that doesn’t just resent paying, but expects stuff to be free. This is the generation that, for example, paid nothing (or next to nothing) for Radiohead’s new album and got Prince’s last CD free with the Mail on Sunday. This is the generation that doesn’t walk into HMV like losers and shell out £15 for a new album, but downloads it for free from one of the many (often legally dubious) filesharing websites.

This is the generation that saw the Arctic Monkeys rise to fame in Britain a few years ago through having their music freely distributed on the internet. What happened was that the Sheffield-based band burned demos on to CDs to give away at gigs, but because demand for the discs outstripped supply, fans copied the CDs on to their home computers and shared the music with other fans. The Arctic Monkeys’ fans even set up a MySpace page without the band’s knowledge. Only later did the band sign a record deal, the historic prerequisite for pop fame. It was sharing internet users that made Gordon Brown’s favourite band what they are.

Most importantly, this is the generation that is driving companies to turn their business models around by 180 degrees. Only last month, it was reported that Apple was considering giving customers unlimited free access to its iTunes music library if they were willing to pay more for the iPods or iPhones that play the stuff they download. Even though some business analysts suggested this new model would create an accounting nightmare because some customers would pay for iTunes and others would not, the fact that Apple was contemplating changing the terms of access to iTunes shows how freeconomics is giving companies the jitters.

“The internet has revolutionised economics,” says Anderson down his cellphone as he drives to work in California. “On the web, the marginal costs of manufacturing and distribution are zero, or close to it. This means that you can now experiment with giving away one thing to sell something else much more than you could in the pre-internet era. Or you can experiment with third-party support, where you give away a product to sell attention to another. The traditional model is of giving 1% of goods away as samples in order to sell 99% of the product; on the web, you can give 99% away as free samples to sell 1%.” You’re kidding, I say to Anderson. And still make profit? “Sure. Why not?”

It is a dizzying inversion of economic thinking. Anderson goes so far as to claim that Milton Friedman, the Nobel prize-winning economist, is wrong: there is such a thing as a free lunch. And not just a free lunch, but free phone calls, free downloads, free advertisements, free newspapers. Significantly, much of the free stuff Anderson cites is in cyberspace. “In every industry where the product can be made into a digital file, somebody is, or is going to be, offering you that product for free because the marginal cost of doing so online is heading towards zero. Divorce papers? Free. Books? Music? Free.”

But not all examples of freeconomics Anderson cites are in cyberspace. For instance, if Anderson were British, he might also cite Loot’s classified advertising and Metro’s free newspapers as part of the economy of free. Anderson predicts that more and more free goods will become available in the next few years as businesses, catalysed by what is happening on the internet, devise hitherto unthinkable business models. “I’ve got a friend who has an electric-car business in Israel,” Anderson says. “He is going to give away cars for free. Imagine: free cars, right? But it’s not so wild. In the US, we’re very used to getting high-end cellphones for free because the retailers make their money by other means – contracts, advertising. And the same thing can happen with an electric car.” But how will his friend make money? “He’s got you locked into a contract for the energy to run the thing. As gas gets relatively more expensive, people will be more eager to drive electric cars. They won’t mind being in a contract to pay for the fuel – ie electricity – because it will be cheaper than gas.”

He offers another example: in Japan there is a university photocopying service that has two queues. “In one, people are queueing to pay 10 cents or whatever per copy. In the other line, it’s free. In the second line, people are prepared to put up with having advertisements on the backside of the copy.” Bargain-hungry Japanese devotees of freeconomics stand in the second queue.

“Friedman was wrong in two ways,” Anderson wrote challengingly in his Wired article. “First, a free lunch doesn’t necessarily mean the food is being given away or that you’ll pay for it later – it could just mean someone else is picking up the tab. Second, in the digital realm the main feedstocks of the information economy – storage, processing power and bandwidth – are getting cheaper by the day. Two of the main scarcity functions of traditional economics are rushing headlong to zip. It’s as if the restaurant suddenly doesn’t have to pay any food or labour costs for that lunch.”

But surely, I ask Anderson, Friedman was right. If I am not picking up the tab, then someone, somewhere is. And my fear is that it’s likely to be some poor dope who can’t afford to defray the costs. Either that, or I’m getting personally screwed when someone dangles a freebie in front of me. After all, a “free lunch” sign on holiday means someone is going to bore me over coffee with a timeshare pitch. And, even online, when we receive free services, we pay in valuable time – as often as not by wading through advertising to get to the stuff we want.

“I don’t disagree,” says Anderson. “You’re talking about externalities, which means that money is not the only scarce thing in the world, but that your time and respect are important too. Sure there may be costs in terms of time, you may have to put up with advertising to get something for free, but I’m talking about free money and not time. That’s where critics of freeconomics misunderstand me. In monetary economics, there is such a thing as a free lunch.”

Anderson is used to being misunderstood. His last book was called The Long Tail: Why the Future of Business is Selling Less of More (2006). There, he worked out why business such as Amazon or Netflix could make big profits not from blockbusters (DVDs from Roland Emmerich’s fatuous cinematic oeuvre, Jordan’s novel) but from selling hard-to-find items (Tarkovsky DVD boxed sets, out-of-print Ivy Compton-Burnett novels). “A lot of people thought The Long Tail is great because it meant blockbusters are dead. But that isn’t what I was saying. I was saying the monopoly of the blockbuster is dead.”

But even that was good news. High-street bookshops might not have space to stock those Compton-Burnett novels I so ardently crave, but some warehouse off the M1 near Daventry might supply my outre demand if I ordered online. What is more, the internet could link geographically distant secondhand booksellers into one webpage. As a result, I need not visit Hay-on-Wye to trawl secondhand book shops. I could instead buy a book online, thereby saving me travel costs, while incurring negligible postal charges. In so doing I would be making someone outside the book-retailing mega-chains a few bob. Which has to be a good thing, doesn’t it?

Just like Anderson’s notion of the long tail, his freeconomics thesis has been made possible by the rise of the internet. That said, Anderson isn’t so witless as to claim that free products are new. He has a nice story about the frustrated American inventor King Gillette who, in 1895 had a eureka moment while shaving. He was using an old-fashioned straight razor that was difficult to sharpen. What if, Gillette thought as he struggled with his stubble, he manufactured a razor with a thin metal strip that its users could throw away when it became blunt (of course, in 1895 the ethics of disposability were not at the forefront of an inventor’s concerns). His plan hit a problem: nobody bought his disposable-blade safety razor. So, Gillette had another brainwave: he gave away his razors with packets of gum, coffee, tea, spices and marshmallows. The idea was that the razors were useless in themselves, but by giving them away he was creating a demand for disposable blades.

“A few billion blades later,” says Anderson, “this business model is now the foundation of entire industries: give away the cellphone, sell the monthly plan, make the videogame console cheap and sell expensive games.” This isn’t freeconomics as such; it is called cross-subsidising. “The old model is essentially a trick that involves moving money from one pocket to another. The idea was that you’d get one thing for free if you bought another or a service if you bought the product.” That old model is still with us, and growing: the prospect of free cars or free iTunes access are ideas premised on the cross-subsidy model.

Even Ryanair’s cut-price air travel is a trick of moving money from one pocket to another. But how can a flight across the Channel be cheaper than the cab ride to your hotel? Ryanair cuts costs by boarding and disembarking passengers from the tarmac to cut gate fees, negotiates lower access fees with airports hungry for more traffic (this is why, for example, if you’re flying on Ryanair to Vienna, you will land across the Austro-Slovakian border in Bratislava), charges for in-flight beverages, collects a share of car rentals and hotel reservations booked through its website, and charges for in-flight advertising. It is a short step from this trick to the free Ryanair flight, Anderson argues. Any idea how? “Perhaps offset their costs by in-air gambling, turning planes into flying casinos,” he suggests. It’s just crazy enough to work.

Anderson argues that freeconomics (his coinage riffs on the 2005 Freakonomics bestseller, in which economist Steven Levitt and journalist Stephen J Dubner applied economic theory to areas – sumo wrestling, drug dealing – not usually covered by traditional economists) is different from the old cross-subsidy model. Anderson has written: “Over the past decade, however, a different kind of free has emerged. The new model is not based on cross-subsidies – the shifting of costs from one product to another – but on the fact that the cost of products is falling fast. It’s as if the price of steel had dropped to close to zero that King Gillette could give away both razor and blade, and made his money on something else entirely. (Shaving cream?)”

He contends that the rise of freeconomics is driven by falling web costs. Last year, for example, Yahoo announced that its free webmail would provide unlimited storage – the price for online storage is falling to zero. “The stunning thing,” says Anderson, “is that nobody was surprised: many had assumed unlimited free storage was already the case.”

But, surely, there are costs: surely those expensive banks of hard drives and racks of servers, cost someone, somewhere, something even if customers are getting services for free? Anderson does not disagree, but makes the distinction – familiar to anyone who has A-level economics – between fixed and marginal costs. Hard drives are fixed costs, but they can serve tens of thousands of users. The fixed costs stay the same, but the marginal costs fall all the time. This is freeconomics’ magical secret. “The web,” argues Anderson, “is all about scale, finding ways to attract the most users for centralised resources, spreading those costs over larger and larger audiences as the technology gets more and more capable. It’s not about the cost of the equipment in the racks at the data centre; it’s about what that equipment can do. And every year, like some sort of magic clockwork, it does more and more for less and less, bringing the marginal costs of technology in the units that we individuals consume closer to zero.”

But the web isn’t just about that technological magic trick. In his new book We-think, Charles Leadbetter, a former Financial Times journalist and now a leading authority on creativity in organisations, argues that what is most unsettling and (paradoxically) thrilling about how the web has evolved is that so much of it is about free sharing between users.

This evolution turns traditional economics upside down. Since the publication of Adam Smith’s Wealth of Nations in 1776, economists have insisted that private property provides the basis for capital. And it is capital that Leadbetter calls “the elixir at the heart of capitalism, which propels its constant growth and renewal”. Karl Marx described capital as “the hen that lays the golden eggs”. But the web has shown us another way of laying golden eggs, as Leadbetter writes in We-think: “The web’s significance is that it makes sharing central to the dynamism of economies that have hitherto been built on private ownership. That is why the new organisational models being generated by the web are so unsettling for traditional corporations created in an industrial model of private ownership.”

These corporations are particularly threatened by what Leadbetter calls “gift exchange”, in which ideas and services are made freely available on the web – an exchange that catalyses freeconomics. “The web reconnects us,” writes Leadbetter, “with a different story about the rise of the west: one that gives a central role to the way ideas are aired and shared rather than focusing on how land and buildings are locked down in private property.”

How far can freeconomics go in subverting existing capitalistic models? “Anything that can be digitised or made in silicon can be free,” says Anderson. True, but Hollywood has so far proved immune to freeconomics even though films can, at least in principle, be converted into digital files. When will I be able to download the latest cinematic releases to my home computer? “I think Hollywood studios have another five years before this becomes an issue. The files are larger than music files and people don’t yet have connection between their computers and big-screen TVs. But it will happen.”

Will Hollywood survive in an age of freeconomics? “It might take its cue from music. More and more music is free online, but the live experience of seeing a band play is becoming more popular and that, increasingly, is where musicians make money. Perhaps Hollywood will have to do the same thing – make the experience of going to the movies something you pay for because you want it more than watching the same thing at home for free.”

Will Britain, the world’s second most expensive nation, become a cheaper place because of the rise of freeconomics? “Maybe. Remember when there were cross-Channel ferries that were £1? In principle, there’s no reason why there shouldn’t be more of that in your country.”

But for some, freeconomics is, morally, a terrible thing. One of Anderson’s leading critics, the American computer technologist Alex Iskold, says: “Just a few decades ago, people had low expectations and worked hard to make a living. They did not know free and never expected it. Now, the opposite trend is happening, with free becoming expected online. Will the new generation, the one that expects something for nothing, work as hard to maintain the high standards of living that we created?” Iskold doubts it.

Whether freeconomics undermines such a Protestant work ethic remains to be seen, but Anderson’s idea of freeconomics offers a beautiful, if infantile, dream of a return to the Garden of Eden, where if you are hungry, you merely have to reach to the fruit-laden trees. Similarly, it seems to confound Sigmund Freud’s reality principle. Freud wrote that the pre-conscious baby believes in the power of its desires to become real; the infant only has to imagine a breast or a feeding bottle, and it appears. Only later do babies learn the disenchanting truth – which Freud called the reality principle – that to desire is not to get.

Arguably, a generation raised on the web’s free-for-all never emerges from this infantile world, never leaves Eden, and never gets taught the hard lessons of economics: namely that we need to do work to get what we want, and that there is no such thing as a free lunch.

Christian Michel, a French libertarian who runs a philosophical discussion group at London’s Institut Français and has written about the ethics of freedom, argues that such hard lessons are good, since they teach us humility. “The fact that we need to work in order to narrow the distance between our desires and realising them means that nothing in this world comes for free. The myth of a free lunch, whether it takes the form of ‘free health care’ or ‘free education’, is the ultimate dream of the consumer society, to take and consume everything without having to give anything back. The obligation to pay is the restraint that economics puts on human greed. Yes, we can have everything we want, but we must accept that there is a price to pay.”

But why? “To produce something is to destroy human energy and nature’s resources,” argues Michel. “This is a serious act, and one which has consequences in the whole universe. By paying for what we have destroyed, we restore cosmic balance.”
Does freeconomics destroy the cosmic balance? “I doubt it,” says Anderson.” The point about waste is a telling one, but even that’s an old idea. Years ago there was the fear that if electricity cost nothing people would waste it. The complaint is that the environmental impact of free goods and services would be cataclysmic. Fair enough. But that just means profligate consumption is based on improper accounting, not that free stuff is in itself bad.”

Is freeconomics morally corrupting? “Why should it be? Does anyone think less of Google because it’s free? I don’t think so.”

One last question. Will Anderson be giving his book away for free? “Of course. I don’t aim to make money from the sale of the book. My thing is to get my ideas out there.” Really? “Yeah, really. It’s like when I was in a band; it was never to make money – it was to get girls. People have to recall that most books don’t make money. In so far as I will make money from the book, it’ll probably be in terms of speaking engagements.” In fact, when his book, Free, is published next year, it will appear in different editions, including a free ebook, and two different printed editions. In this, he will be following the novelist Scott Sigler, whose new book, Infected, was offered online as a free pdf late last month, but only for five days. When that period expired, Random House’s Crown imprint withdrew the free pdf and charged, as normal, for printed copies sold in bookshops – a move that exasperated critics. Anderson is more sanguine: “The important thing is that Crown believes that free digital books can sell more hard copies. Exactly how to do it is a work in progress, but the philosophical hurdle has now been crossed. Now we can expect more and better experiments and less hand-wringing about free. Which is quite an advance, any way you look at it.”

Will Anderson do something similar to Random House when his book is published? “We’re going to be more sophisticated, but again it’s still a work in progress. I’m not at all sure about time-limited free online editions. We’re still experimenting with this, but one idea is to use the third-party model and have Microsoft, say, pick up the cost by having advertising in an edition of the book that will be distributed free. And then there will be a hardback version too, which will be sold in regular bookstores.” Will I have to pay for that? “‘Fraid so,” giggles Anderson down the phone.

Run that by me again. A book with the word “Free” emblazoned on its cover and contents that hail a new philosophy of freeconomics is going to cost me? Somehow, that seems wrong.

Question 1

Explain what is meant by the term ‘freeconomics’.

 

In freeconomics goods are provided to consumers for free. For example Facebook provides its services for free however makes money with advertisements. This ideology is heavily based on the internet.

Question 2

How can firms afford to make goods and services available for free?

 

By providing free services on the internet, firms are able to obtain money from advertisements. Examples include Facebook and Youtube. Firms are able to afford goods and services for free by gaining profits from not the consumer of the product, but a different source.

Question 3

“Anderson’s idea is that the internet, by reducing marginal costs, encourages businesses to make their money by offering free goods or services to an extent we have not witnessed before”. Discuss the extent to which doing business over the internet reduces marginal costs.

 

Question 4

Using your knowledge of economics, draw 2 diagrams from microeconomics that help explain the concepts in this article.

Posted in: HL1 Economics