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Free: The dismal deal

Chris Hoofnagle, adjunct professor of information | April 26, 2010

The Journal recently reported that popular social networking site Ning is ending their free account services. Rumors are circulating that major newspapers, including the New York Times, are going to erect a pay-wall. These developments have not deterred the “free” evangelists.

For instance, in Chris Anderson’s provocative new book, Free: The Future of a Radical Price, he argues that in the digital world, “free” pricing is a realistic and normatively good approach to pricing information products. Unlike the physical world of “free” products, which is plagued with fraud and tricks, the properties of the digital world make free actually possible when bits are sold. The physical world is limited, but the digital world is abundant. Businesses can leverage this abundance, and give it away while making money by charging for whatever is still scarce. For instance, software can be given away free while support can be charged for. Stripped down products can be provided free, while expert users will pay for fully-featured products that subsidizes the free.

Anderson begins his book by describing two types of reactions to his thesis. The young say, “no duh.” They’ve grown up with Gmail and other free services. Older people react differently, finding free to be a harbinger of fraud. These olds are individuals who have grown up with free in the physical world; they’ve been burned by “free” offers.


It's a Trap!

It's a trap! By The Frankfurt School


I think “free” is a trap. I’ve expressed doubt about Anderson’s thesis, and even made the bold claim that Malcolm Gladwell’s critique had the better argument about free.

Anderson is convincing in arguing that some business models really do work with free as a price. However, the argument that the digital world is fundamentally different fails for reasons that Anderson does not address. Free in the digital world exhibits the same predations it does in the physical world.

Free and the Law

My initial skepticism comes from the legal issues surrounding free offers, something that Anderson does not address. The FTC’s guidelines on the use of the word free allows marketers to use the term to describe products that are not free, so long as the terms are adequately disclosed. Thus, those who approach these issues from a consumer protection paradigm are right to be guarded. Free in the physical world (as Anderson recognizes) is often just a scam. In the digital world, things are different, Anderson claims.

But the problem is that they really are not. Anderson invokes many anecdotes of seemingly free and good digital deals, but I can do the same, with seemingly free but bad deals. Exhibit 1: the FTC was recently ordered by Congress to reevaluate the marketing of so called “free” credit reports. Millions of consumers have been hoodwinked into expensive subscription scams in order to obtain a “free” digital copy of their credit report.

The Psychology of Free

The psychology of free is also worth visiting. David Friedman’s recent article, Free Offers: A New Look, explores these forces in detail. Friedman argues:

Over time, merchants, service providers, marketers, and advertisers have discovered a psychological glitch that works to their advantage. Use of the word “free” and the illusion of “gifting” in a commercial context can impact consumer behavior in ways not readily apparent.

One example of this…is the way in which the brain calculates the value of bundles. When a consumer is presented with an unbundled “gain”–that is, a split package of goods–the consumer will value the goods more than if they were bundled. Another way free offers impact and distort behavior is through creation of an atmosphere where the powerful noncommercial obligation of reciprocity is required.

“Free” makes people take different decisions. Ones that lead, in my opinion, to suboptimal outcomes:

Corner Cutting

First, offerors of free products, since the product is free, are free to cut corners. Consumers do not expect high quality when things are free. Often, these are hidden corners that only become apparent when things go wrong.

Anderson invokes Ryanair as an example of a company that has adopted a free business model. But this example makes my point: this is the company whose executive told the Journal in 2004 that, “It’s all about re-educating the passenger to accept a lower level of services…” In other respects, Ryanair and other “discount” carriers cut corners–most notably, by landing at airports are in the middle of nowhere. You save money on the ticket, but experience costs elsewhere that are difficult to measure and are often overlooked by consumers until one gets the $90 taxi bill.

“…people will pay if you make them, once they’re hooked.” – Chris Anderson

Second, free products are almost always a gimmick to promote lock-in. In the physical world, Anderson discusses the Gillette razor. As Maryland residents, my brothers and I all received a nice Gillette razor on our 18th birthdays. Once we went to the store to get replacement razors, it became clear how we paid for that free razor. Those razors are so expensive, and the value proposition is so poor that individuals regularly steal them!

Anderson uses this and many other examples as normative arguments in favor of free business models. These models are good for self-interested business, but bad for competition. Writing in Wired, Anderson expounds:

Give away the cell phone, sell the monthly plan; make the videogame console cheap and sell expensive games; install fancy coffeemakers in offices at no charge so you can sell managers expensive coffee sachets.

Why is it good to fool the consumer into a relationship where the value of the free offer is extracted through hidden fees and add-ons? Take wireless phones. Ringtones can play natively on unlocked phones. But when you get a “free” phone, that functionality is often locked, thus causing you to have to pay for tones (the carrier gets a 50% revenue share). That phone is free, but marketed such that total cost of ownership is increased and obscured. We’d be better off if these products were presented in a total cost of ownership framework rather than “free.”

These are the same practices that the financial services industry engages in. You get a card with “no annual fees” but the FIs have mastered ways to pack in costs “at the back of the product.” You optimistically believe that you’ll never be subject to those fees. But this very moment, there are teams of people just as smart as you whose enormous bonuses are keyed to their ability to make you believe that.

Anderson seems to argue that lock-in is good, and that consumers have to exercise common sense. The problem is, as Friedman has elucidated, common sense goes out the window when “free” is invoked.

The Free Mediocracy

Third, the combination of corner cutting and lock-in promotes mediocrity. Companies cannot compete with free, and this is one of the many reasons why bad products remain on the market despite the presence of better ones. People who value quality will have a harder time finding it, and in some cases, it will simply disappear.

Still Wearing Uggs? Free is for You!

This leads to my audacious prediction: eventually, tastemakers will see these trends in free offers, and much like big-box stores and other signals of massification, “free” will become uncool. There will be a backlash against free. Because free is cheap and consumers will want to distinguish themselves from the big-shorts-wearing mouthbreathers, paid services will gain reputational value.

Conclusion

Anderson’s is an optimistic book that does not fully address the reality of what free offers have been. Experts in consumer protection have long been skeptical of free offers as both potential scams, but also impediments to competition. Anderson addresses these counterarguments breezily.

Privacy issues are dealt with glibly too, and some important ones are missed entirely. For instance, I’d pose these questions to Gmail users: what is the cost to civil liberties from Gmail? How can one reasonably expect their email to be private from law enforcement in a world where users allow companies to scan content for advertising?

More problematic are Anderson’s examples. He lauds the New York Times for removing its paywall, but this is the same paper that is facing layoffs by the end of the year, while the Journal is increasing its subscribership with a paywall in place.

From a public policy perspective, Anderson’s book highlights why the FTC should revisit its free guidelines. Businesses are knowingly trading upon the psychological biases that free produces. The book also points to the need for total-cost-of-ownership advertising. In my consumer heaven world, most advertising could be comparative, like this. “Free offers,” in a world of such advertising, would soon be shown to be what they really are.

Originally posted on Denialism Blog

Free is available at no cost to you in audiobook format at Audible, and at Amazon for about $20.