Fred Wilson corrects the reference in my review of Chris Anderson’s Free to him dubbing the business model that Chris advocates prefers as “freemium”. He attributes it to Jarid Lukin.

Fred, whose early stage investing group Union Square Ventures, is an investor in Twitter, goes on to make some interesting points about free and paid-for services on the internet:

“I don’t believe everything will be free on the Internet. There will be plenty of paid business models. For example, if you want to watch Major League Baseball games live over the Internet, you’ll pay for that. If you want to use services like the FT and the WSJ frequently (more than 10x per month), you’ll pay for that. If you want to watch HBO over the Internet, you’ll pay for that. If you want a Twitter desktop or mobile client, you might pay for that too . . .

. . . the Internet allows an entrepreneur to enter a market with a free offering because the costs of doing so are not astronomical. And most entrepreneurs who take this approach will maintain an attractive free offering of their basic service forever. But that doesn’t mean that everything they offer will be free. That’s the whole point of freemium. Free gets you to a place where you can ask to get paid. But if you don’t start with free on the Internet, most companies will never get paid.”

This raises a point that I think is sometimes ignored in the free/freemium debate, which is that a company’s interests differ according to its position. In particular, charging nothing may well make sense to a start-up or a venture capitalist but not to an established business.

For social media services such as Twitter and Facebook, which are platforms for people to create their own content, free is a logical price. Because the cost of distribution is so low, and the cost of content is zero (people are donating it), any attempt to charge is likely to be undercut by a rival.

For a venture capitalist investing in internet businesses that are trying to grow as rapidly as possible, free is also a good bet. If nine out of 10 of those businesses fail because they burn through their capital but one grows enough to make money from advertising or freemium services, that is a good result.

Contrariwise, if does not make much less much sense for an established business with high fixed costs to start giving away content at below marginal cost because that way lies bankruptcy.

Of course, this is one reason why the internet is so disruptive. It provides a huge boost to the process of creative destruction by giving small businesses a platform to undermine big ones.

Here is Chris Anderson’s final contribution to our debate about his book Free: The Future of a Radical Price. See my earlier post An interactive review of Free by Chris Anderson for details. Please put comments on the entire debate at the foot of this post - I have switched off comments on the other posts.

John,

Let’s get to the meat of your argument: that ad-driven free has shown
its limits and Freemium is still small.

I don’t disagree.

But I also don’t suggest that we’ve worked out all the business models that will allow us to profit from Free. We’ve figured out some of them (ad-driven Free is still nothing to sniff at and Freemium, as you note, is a fast-growing multi-billion dollar business) and we’ll no doubt figure out others in the years to come. Maybe my book will even help.

The point, however, is that Free is not a choice in a digital economy - it is an inevitability. Not that everything is going to be free, but that Free is going to be a price you either use or compete with. The music industry chose not to go free, so the pirates did it for them. Professional content creators dreamed of paywalls, while the amateurs robbed them of their monopoly on consumer attention, without any business model at all (or need for one).

Just because neither I nor anyone else has figured out how to replace all the pay-based profit pools with free-based ones doesn’t mean the deflationary forces of digital economics won’t push price to the floor anyway.

I can see why you find this unsettling. And I wish I had all the business models worked out, so that every company could just apply the formula and rest easy. But zero is a disruptive price and may well see industry demonetize before they remonetize.

In short, Free is an economic force online that’s a strong as gravity. That’s not news - it’s been obvious from the time of Stewart Brand, Nicholas Negroponte, George Gilder and Kevin Kelly. What is news is that we finally have a better answer than “just throw the last generation’s business model - advertising - at it and hope it all works out”.

These are still early days for Freemium, and you’re right that many companies who try it won’t get it right (t’was ever thus). But I’d encourage you to look more closely at iPhone Apps, online games and the fast-growing software-as-a-service industry, and ask yourself: are you so sure that this isn’t the first 21st-century business model in the making?

I’ve enjoyed the debate!

Chris

Here is my latest reply to Chris Anderson in our debate about his book Free: The Future of a Radical Price. See my earlier post An interactive review of Free by Chris Anderson for details.

Dear Chris,

You are right: this debate has been far too civil, so let me get less friendly. I don’t believe you. Or, to be more exact, I hope you turn out to be right but I fear you are not.

I suspect you of advocating Freemium because Free turned out not to work. Not long ago, there were many calls for content owners - music and publishing companies in particular - to make all content free on the internet without any Freemium element such as premium subscriptions.

The idea then was that Google had uncovered a gusher of online advertising and that the lower yield of online ads would be balanced by the low cost of digital distribution. In other words, advertising would meet the entire costs of content delivery.

But, as we now know, that has not worked so well. I am sorry to use the example of newspapers since Malcolm Gladwell’s review prompted you to note (rightly, I think) that journalists find it hard to write about anything else in the context of web economics. It is, however, a good case.

Most general interest newspapers give away their content free online but have little hope of making up the yield gap between print and online advertising. So several newspaper groups in the US have gone into Chapter 11 bankruptcy.

Now, you arrive with an amended theory, which goes roughly: OK, advertising-supported content did not work out but here is something else for you to try.

Freemium may well be the best available option for a lot of companies, but how much hope does it really provide? Take your own figures on the Freemium economy in the US.

You quote a figure of about $1bn for spending on Web 2.0 premium services, which is not very much considering how much chatter there is about Twitter, Facebook etc.

You add to this $30bn for services relating to open source software - premium software, consultancy etc, and throw in a further $4bn for the casual games market.

My criticism is that a lot of open source services are provided by companies on the back of what you would call the “gift economy” - ie software developers working for free. So the enterprises that are offering Freemium-style services do not bear the full costs of production.

The economics are tougher for companies that that give away software and services they have built from scratch and then attempt to turn a profit with related premium services.

The true Freemium economy is extremely small and many companies are trying out business models without clear proof that they will work. If they fail, it will be hard or impossible for them to retreat to charging for their products and services.

So I fear that Freemium could turn into just as big a trap as Free.

What do you say?

John

Here is Chris Anderson’s latest contribution to our debate about his book Free: The Future of a Radical Price. See my earlier post An interactive review of Free by Chris Anderson for details.

Dear John,

You ask three good good questions (and sorry this is turning out to be such a civil dialogue; couldn’t you, for your traffic figures alone, have accused me of being anti-capitalist or just a bad writer?)

First, an aside. The book starts with a taxonomy of Free, which explains the difference between ad-supported free, freemium, cross-subsidies and the “gift economy”. All use the word “free”, but some are more free than others. Calling the book “Freemium” and just focusing on one, would have missed the opportunity to cast the broadest lens on this fascinating word. But when it comes time for the tactical advice in the book, as you’ve noted, Freemium is by far the most interesting.

On your questions:

1. Can Freemium can really spread far beyond the software and internet industries?

By and large, Freemium is a creature of the bits world, where the marginal costs of production and distribution are near zero. If something can be turned into bits, it can adopt a Freemium business model, but if it can’t, it’s hard to see how that same ratio of most-free, some-paid can be sustainable in any real way. (I won’t include trivial examples like how watching the Bellagio fountains in Las Vegas is free but gambling there is not!) That said, the number of things that can be turned into software is growing fast, including services (from travel agents to tax accountants) and it is not impossible to imagine that many of the health services you mention will someday be software. I can see a day when my doctor uses a Freemium model; free for routine consultation (artificial intelligence) and very expensive to see the lady in the white coat for more complicated stuff.

2. Is the point of Freemium marketing or advertising?

The point of Freemium is to use the free version as marketing for the paid version, but a form of marketing that is useful and trust-building, rather than just hyperbolic and annoying. The free form is useful, and if you like it the paid form is more useful yet.

3. Can Freemium make up for lost advertising revenue?

I do think for some in the media industry, Freemium can replace lost advertising. It’s exactly what the Wall Street Journal is doing: the most popular content is free, because it gets the kind of traffic that can generate big ad dollars, while the more niche content on specific industry domains is paid. Maybe a model for the FT?

Regards,

Chris

Here is my response to Chris Anderson’s post below about my review of his book Free: The Future of a Radical Price. See my earlier post An interactive review of Free by Chris Anderson for details of the review and this exchange of ideas.

Dear Chris,

Well, yes. Maybe I was a bit slow in not realising that Free was really about “freemium”. On the other hand, Free was the title of the book; if it had been called Freemium, I would not have complained.

But let us leave that on one side. What is unquestionably true is that you devote a lot of space in the book to examining the freemium model and that some innovative things are occurring under that label. I would even include the FT’s model for online access.

I like the way that you phrase the distinction between freemium and the old practice of free offers in your response:

Rather than giving out few percent of your product away for free as marketing, hoping to sell the rest, you give away most of your product for free as marketing, hoping to sell to a minority.

That is an intriguing notion, if more a matter of quantity than an entirely new phenomenon. As you say, the software and internet world is now rife with freemium-type attempts to make money.

One thing I like about your focus on freemium is that it moves the debate beyond an argument over whether everything should be paid for online or everything should be given away. The latter implies that the entire media industry can become advertising-supported, which I doubt.

Still, as I say in my review, there is a lot of experimentation going on with freemium pricing models and, in many cases, it has not been proven conclusively to work - one exception being the open source software industry. So I would be interested in your thoughts on these questions:

First, can freemium can really spread far beyond the software and internet industries? It clearly faces a lot of barriers in manufacturing or services that involve human interaction, such as health and hospitality, which are unable to send out free samples.

Second, is the point of freemium marketing or advertising? In other words, do companies need to get a big audience by distributing free content in order to attract advertisers or to market their premium services to larger audiences?

Third, how large do you think revenues from freemium-type models can be in the media industry, and can they replace the loss of traditional forms of advertising?

All guidance gratefully received.

John

Here is Chris’s first salvo to my review of his book Free: The Future of a Radical Price. See my earlier post An interactive review of Free by Chris Anderson for details of the review and this exchange of ideas.

Dear John,

You write in your review of my book Free: The Future of a Radical Price:

“The most plausible contender for an ‘entirely new economic model’ made possible by the internet is what Fred Wilson, the New York venture capitalist, has dubbed ‘freemium’. This refers to companies that allow anyone to use their products free but offer a premium version for which a few users are persuaded to pay.

Many internet companies employ freemium, from Skype, which charges customers to make computer-to-phone calls, to companies that charge for more versatile versions of software. Many of them, however, are still experimenting to see what, if anything, works.”

I agree, and this is actually the core of the book. When I refer to a “new economic model”, I’m not referring to slapping advertising against stuff, which dates back centuries. Instead, I’m talking about the underlying economics that allow Freemium to work. Freemium is the inversion of the traditional free sample. Rather than giving out few percent of your product away for free as marketing, hoping to sell the rest, you give away most of your product for free as marketing, hoping to sell to a minority. This is only possible in the online realm, where the marginal costs of production and distribution are close enough to zero to “round down.”

Freemium is now the main business model of the booming “software as a service” industry online, the online games industry and the fast-growing iPhone applications market. I think that creating business models around Freemium - what to charge for and what not to, a question determined as much by psychology as economics - will be the most interesting, and lucrative, efforts of this online era. And the book, both in its chapters and its tactical advice at the back, is intended to help guide that.

In short, I agree with you that Freemium is the big new story in the Free economy. I’m just surprised that you didn’t see the book as essentially telling that story. The history of Free is in the book for context, but “the future of a radical price” is what it’s actually about.

Chris

We are about to try something a bit different on this blog. I have reviewed the book Free: The Future of a Radical Price by Chris Anderson for Thursday’s FT and you can read the start of the review below. But, instead of leaving it at that, we are using the review as the stepping-off point for a debate.

Chris has agreed to respond to my review, and his first salvo will be published tomorrow morning here, at the same time as readers of the paper in Europe get a chance to read my review. I don’t know of any other cases (although there may be some) where an author has responded to a review simultaneously.

I plan to continue the debate with my thoughts on Chris’s response tomorrow and hopefully we will carry on with the exchange until the weekend, or we get tired of it, whichever comes sooner.

To start things off, here are the first few paragraphs of my review:

Chris Anderson has built a career out of making bold pronouncements that the economics of Silicon Valley – the way in which software and digital technology are built and distributed – are likely to spread to, and ultimately conquer, the rest of the economy.

His first claim, in The Long Tail: Why the Future of Business is Selling More of Less, was that consumption patterns were being fundamentally altered by the plentiful and cheap shelf space provided by digital technology. Instead of most dollars being spent on hits, consumption would instead skew towards thousands of niche products.

Now Mr Anderson, editor-in-chief of the US edition of Wired magazine, has followed that up with Free: The Future of a Radical Price, a manifesto for giving away products to consumers rather than charging for them. He writes: “There really is a free lunch. Sometimes you get more than you pay for.”

The obvious criticism of Mr Anderson’s work is that, as Mandy Rice-Davies said of Lord Astor’s denial of an affair with her: “Well, he would say that, wouldn’t he?”

Wired is a West Coast magazine, grounded in Silicon Valley’s software culture, where companies such as Apple profit from the free availability of “content” that runs on their far-from-free hardware.

Silicon Valley, and particularly Google, has a brutal variation of King Gillette’s razors-and-blades business model. According to this theory, the razor is sold cheaply in order to get consumers hooked and then be inclined to buy pricey disposable blades. And in the case of the biggest company of the internet age, it gets newspapers, music, television and film companies to take the losses while it accumulates the gains.

You can read the rest of the review here. Please follow the debate between Chris and I, and offer your own thoughts in the comments below.

My column in the FT this week is on what Steve Jobs can teach US companies:

Steve Jobs is returning to his post as chief executive of Apple, following a liver transplant, to some good news. On Sunday, Apple’s iPhone 3GS, the latest version of its device, passed 1m sales in three days.

Mr Jobs permitted himself a boast that “customers are voting and the iPhone is winning”. This was aimed at Palm’s Pre, which is the best effort to match the iPhone, but trails it in one vital regard.

Owners of iPhones can choose among 35,000 applications, most built by other companies, that run on the phones. Competitors including Palm and Google have not yet matched this creative alliance.

The fact that Apple persuaded others to rally round has helped to shield it from the margin squeeze in the personal computer and consumer electronics industries. It has become the hub of a creative network.

Lots of businesses are suffering in the recession but that masks a longer-term trend that only relatively few – Apple among them – have managed to buck. This is a squeeze imposed by intensifying competition across many industries.

Chief executives sometimes bemoan the passing of the old days, when the pace of change was slower and they were under less pressure. It sounds like self-delusion but they are correct: it is harder to make a good return than it used to be.

Evidence for this comes from some intriguing research into US corporate performance by John Hagel and John Seely Brown of Deloitte’s Centre for the Edge. They found that the return on assets at US companies has fallen steadily since 1965, from about 4 per cent to 1 per cent.

Consumers have done well out of this squeeze since they can get more for their money, while employees with scarce skills have been able to get more of the pie. The shareholders (and less-skilled workers) have been served thinner slices.

The notion that companies are suffering is counterintuitive since corporate profits reached an all-time high as a percentage of US gross domestic product in 2006, at the expense of wages. But this rosy picture for companies and investors masks an underlying deterioration in corporate performance.

You can read the rest here and comment below.