Towards the “Free” Economy – 3 Questions for Internet Economy Thought Leader Chris Anderson

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As the editor in chief of Wired magazine, and the author of the seminal new-economy business book The Long Tail and the forthcoming book Free, Chris Anderson is an authority on emerging technologies and business models and the cultures that surround them. He will be the keynote speaker at the Infopresse/In:fluencia Digital Internet Marketing Conference May 15 in Toronto.

Anderson recently spoke with In:fluencia Digital editor Stan Sutter about the long tail and how its logical extension, the “free” economy, is transforming businesses both online and off. The full conversation can be heard as a podcast (audio file and time line after the jump). Some highlights:

Q: Free, which you are working on now for publication in spring 2009, is the logical extension of The Long Tail. Or is it?

I think it is. The world will decide if it is the logical extension or something else entirely. The ability to address niche markets, the ability to access latent demand for products of “minority” taste was initially enabled when you got over the limits on shelf space – be that physical shelf space in stores or virtual shelf space in things like television channels and radio stations. The Internet offers infinite shelf space, and the corollary to that is that it’s free shelf space. The only reason you can offer products that are probably of small appeal, but very certainly unpredictable appeal, is that it doesn’t cost you anything to do so. So free shelf space, free distribution, was what enabled the long tail to emerge over the last 10 years.

The notion that “free” is different, that zero is a number unlike any other, that zero basically takes the “is it worth it” calculation off the table, is bigger than just the long tail. And it was just the recognition that there was really a whole economy built around free growing up online – products and services that are free to consumers and yet can be the basis of really profitable business models – that struck me as being fundamentally new, fundamentally unaddressed by traditional economics and worth a whole other book.

Q: You opened the Wired essay on the ideas around “free” in March with the example of Gillette’s business model, which was created about a hundred years ago. So, in a way, free has been around. What is the difference between what was being done at that stage, and now?

There are three kinds of free: two that are old, one that is new.

The first is what we call cross-subsidies. You know, you don’t pay now, but you pay later. You don’t pay for this, but you’ll pay for that. You pay one way or another. But it sort of shifts the payment from one pocket to the other.

Razors and blades: You don’t pay for the razor, you pay for the blades later. Cellphones and minutes: You don’t pay for the cellphone but you pay for the minutes later. That’s just really the notion of shifting the time of payment and the way you pay. But it doesn’t necessarily change the overall amount that leaves your pocket. That’s the first kind of free and that’s, as you say, a hundred years old.

Another old model is the media model: third party pays. Advertisers subsidize a product so that the consumer gets it for free or close to it. And in that case it’s a three-party market. There’s the producer, the consumer and the subsidizer. And what we’re seeing online is an extension of the media model, which is the advertising-driven model, to all sorts of new products and services that don’t traditionally fall within media–search being the most obvious example.

Basically everything Google does is paid for by the media model, which is advertising-driven. That’s why Google doesn’t show up in your credit card bill. And yet Google is an extremely profitable company. Again not a new model, but we’re seeing extended to new businesses on the Internet.

The new model is the one where the cost goes to zero, not because it’s magic or slight-of-hand and you are paying later, or because an advertiser is paying. The price goes to zero because the underlying cost falls to zero. This is sort of the Web 2.0 model.

As you move goods and services online where the underlying costs of the bandwidth, the storage, the processing fall by 50% every year, then you don’t really need to charge most people for the product at all. In basic economics there’s a rule that says in a competitive market price falls to the marginal cost. Online, the marginal cost of everything digital falls toward zero every year, which means the price must inevitably fall to zero.

We can talk about all the different ways you would make money from something when you’re not charging the consumer at all. But that ability to be able to assume that the costs are going to fall to nothing at all is really unique to the last 10 years of Internet economics.

Q: I can see how the notion of free works easily in entertainment and media products. I have a harder time–and I think most people do–with more tangible goods and services. Tell me about how it works in other areas, for example with Ryanair in Europe. What are some other examples?

Ryanair is a kind of razor and blades model, which is to say most airlines are in the airline seat business. They charge you for the seat. Ryanair, as a kind of newcomer in the market back in the early nineties, decided to take a more holistic view of the business. They’re not going to be in the seat business. They are going to be broadly in the travel business, which means they could be agnostic about where they made their money. And right now you can fly from say London to Lisbon for something along the lines of 10 Euros or five pounds. And the CEO of Ryanair has promised that someday soon that will be zero.

Where do they make their money? They make their money in rental cars and hotel reservations and advertising both on the websites and on the planes. They make their money from the cargo in the hold, which is why they charge you more for your luggage. They make their money from the sandwiches and drinks on board. They get subsidies from the locations that they fly to because they fly off the beaten path. And these tertiary destinations will charge a very low landing fee or even subsidize Ryanair to bring the tourists to them. And the way you get to zero, the Ryanair CEO has suggested, is gambling. You turn the airplane into a flying casino.

In Vegas you get your drinks for free if you gamble. On Ryanair you get your seat for free if you gamble. The Internet lowers the cost of being an airline and that takes customer service and check-in and a lot of the human costs out of the equation, so it allows them to lower the costs. But that doesn’t bring them to free. What brings them to free is cross-subsidizing from the ancillary markets around the airline seat itself…

We talked about lots of other examples [of this] in the Wired article and will in the book. There’s the case of Prince giving away his CD in The Mail on Sunday in the UK to sell the concert. On phone services you can get directory assistance for free. It turns out that’s not even advertising-driven; you’re just training the speech recognition algorithms.

You can get a DVR or a plasma TV for free if you sign up for cable TV services. If you bring cross-subsidies into it, as we do because there are many creative ways to do it, the sky’s the limit. You can talk about cars for free. You can get a free electric car in Israel. You get the car for free and you pay for the electricity. You name it. There’s almost nothing you can bring up that I haven’t already found somebody giving away for free.

In the In:fluencia Digital Podcast (audio file and time line after the jump), Chris Anderson goes deeper into how the Long Tail and Free business models work, his plans to publish a free version of Free, how Apple gets away with defying all the conventional wisdom of business in the 21st century and how the Internet is changing religion and social movements.

Interview with Chris Anderson – Audio File and Timeline

  • 0:00 – Introduction
  • 0:44 – What, from the “Long Tail” article published in 2004, has turned out not quite as expected
  • 2:47 – Is “free” the logical extension of long tail economics or a separate idea
  • 4:30 – The three kinds of “free”… two old, one radically new
  • 8:14 – How “free” works with tangible goods and services beyond entertainment and media products-Ryanair example
  • 10:46 – Other examples of tangible, non-Internet based products that are free
  • 12:29 – Anderson’s plans to give away copies of the book Free
  • 13:15 – Publishing timing in the new economy, the community input publishing process, and why Anderson believes his blog does not compete with book sales
  • 16:12 – Building a community of customer evangelists
  • 17:07 – What else is lighting Chris Anderson up online and in business these days
  • 18:47 – Chris Anderson’s love/hate relationship with his iPhone
  • 19:17 – How Apple flies in the face of most currently accepted business wisdom, including long tail and free
  • 20:09 – How the Internet and personal digital devices impact religion
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